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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, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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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 July 20, 2000, 29,132,267 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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FACTORS AFFECTING FORWARD LOOKING STATEMENTS...............................................................3
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets-- June 30, 2000 and December 31, 1999............................4
Consolidated Statements of Operations-- Three Month and Six Month Periods Ended
June 30, 2000 and 1999...................................................................5
Consolidated Statements of Cash Flows -- Six Month Periods Ended
June 30, 2000 and 1999...................................................................6
Notes to Consolidated Financial Statements...................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations...................................................................12
Item 3. Qualitative and Quantitative Disclosures About Market Risk..................................19
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds...................................................21
Item 4. Submission of Matters to a Vote of Security Holders.........................................21
Item 6. Exhibits and Reports on Form 8-K............................................................22
SIGNATURES................................................................................................23
</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," "estimate," "expect," "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 the Company'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, estimated, expected 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 under the
Securities Exchange Act of 1934, as amended.
Unless otherwise indicated, references to "Houston Exploration" or the
"Company" refer to The Houston Exploration Company and its subsidiary on a
consolidated basis.
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
2000 1999
----------- ----------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Cash and cash equivalents ...................................................... $ 1,560 $ 15,502
Accounts receivable ............................................................ 52,062 34,917
Accounts receivable -- Affiliate ............................................... 4,012 12,315
Inventories .................................................................... 1,623 969
Prepayments and other .......................................................... 3,937 1,082
----------- -----------
Total current assets .................................................. 63,194 64,785
Natural gas and oil properties, full cost method
Unevaluated properties ....................................................... 159,095 164,377
Properties subject to amortization ........................................... 1,029,369 956,484
Other property and equipment ................................................... 9,834 9,744
----------- -----------
1,198,298 1,130,605
Less: Accumulated depreciation, depletion and amortization ..................... (561,501) (520,489)
----------- -----------
636,797 610,116
Other assets ................................................................... 3,316 3,582
----------- -----------
TOTAL ASSETS .......................................................... $ 703,307 $ 678,483
=========== ===========
LIABILITIES:
Accounts payable and accrued expenses .......................................... $ 45,253 $ 56,004
Subordinated note -- Affiliate ................................................. -- 80,000
----------- -----------
Total current liabilities ............................................. 45,253 136,004
Long-term debt and notes ....................................................... 277,000 281,000
Deferred federal income taxes .................................................. 56,830 43,736
Other deferred liabilities ..................................................... 161 153
----------- -----------
TOTAL LIABILITIES ..................................................... 379,244 460,893
COMMITMENTS AND CONTINGENCIES (SEE NOTE 3)
STOCKHOLDERS' EQUITY:
Common Stock, $.01 par value, 50,000,000 shares authorized and 29,112,807 shares
issued and outstanding at June 30, 2000 and 23,923,020 shares issued and
outstanding at December 31, 1999,
respectively ................................................................ 291 239
Additional paid-in capital ..................................................... 313,014 231,370
Retained earnings (deficit) .................................................... 10,758 (14,019)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY ........................................... 324,063 217,590
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ........................... $ 703,307 $ 678,483
=========== ===========
</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,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES:
Natural gas and oil revenues ................... $ 57,533 $ 35,021 $106,451 $ 61,541
Other .......................................... 397 116 827 461
-------- -------- -------- --------
Total revenues ......................... 57,930 35,137 107,278 62,002
OPERATING EXPENSES:
Lease operating ................................ 5,712 4,333 12,089 8,295
Severance tax .................................. 2,095 1,188 3,701 2,187
Depreciation, depletion and amortization ....... 20,250 17,972 41,007 35,029
General and administrative, net ................ 2,572 919 4,761 1,949
-------- -------- -------- --------
Total operating expenses ............... 30,629 24,412 61,558 47,460
Income from operations ........................... 27,301 10,725 45,720 14,542
Strategic review expenses ........................ -- -- 1,752 --
Interest expense, net ............................ 2,517 3,192 6,538 6,213
-------- -------- -------- --------
Net income before income taxes ................... 24,784 7,533 37,430 8,329
Provision for federal income taxes ............... 8,456 2,344 12,653 2,394
-------- -------- -------- --------
NET INCOME ....................................... $ 16,328 $ 5,189 $ 24,777 $ 5,935
======== ======== ======== ========
Net income per share ............................. $ 0.56 $ 0.22 $ 0.93 $ 0.25
======== ======== ======== ========
Net income per share -- assuming dilution ........ $ 0.56 $ 0.21 $ 0.93 $ 0.25
======== ======== ======== ========
Weighted average shares outstanding .............. 29,041 23,897 26,510 23,896
Weighted average shares outstanding -- assuming
dilution ..................................... 29,402 28,177 26,752 24,022
</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,
---------------------------
2000 1999
---------- ----------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES:
Net income ............................................................. $ 24,777 $ 5,935
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion and amortization ............................. 41,007 35,029
Deferred income tax expense .......................................... 13,094 2,909
Changes in operating assets and liabilities:
Increase in accounts receivable ................................... (8,842) (4,449)
Increase in inventories ........................................... (654) (47)
Increase in prepayments ........................................... (2,855) (158)
Decrease (increase) in other assets and liabilities ............... 274 (593)
(Decrease) increase in accounts payable and accrued expenses ...... (10,751) 2,849
-------- --------
Net cash provided by operating activities .............................. 56,050 41,475
INVESTING ACTIVITIES:
Investment in property and equipment ................................... (67,688) (59,353)
-------- --------
Net cash used in investing activities .................................. (67,688) (59,353)
FINANCING ACTIVITIES:
Proceeds from long term borrowings ..................................... 16,000 27,000
Repayments of long term borrowings ..................................... (20,000) (12,000)
Proceeds from issuance of common stock ................................. 1,696 160
-------- --------
Net cash (used in) provided by financing activities .................... (2,304) 15,160
-------- --------
Decrease in cash and cash equivalents .................................. (13,942) (2,718)
Cash and cash equivalents, beginning of period ......................... 15,502 4,645
-------- --------
Cash and cash equivalents, end of period ............................... $ 1,560 $ 1,927
======== ========
Cash paid for interest ................................................. $ 13,729 $ 11,483
======== ========
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 THE 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,
1999, the Company had net proved reserves of 541 Bcfe, 97% of which were natural
gas and 75% 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. Brooklyn Union became a subsidiary of KeySpan Corporation ("KeySpan") in
May 1998 through the combination of Brooklyn Union's parent company KeySpan
Energy Corporation and Long Island Lighting Company. As of June 30, 2000, THEC
Holdings Corp., an indirect wholly owned subsidiary of KeySpan, owned
approximately 70% of the outstanding shares of Houston Exploration's common
stock. KeySpan is a diversified energy provider that (i) distributes natural gas
to a customers in the New Yorker City boroughs and Long Island areas; (ii) is
contracted by Long Island Power Authority to manage electricity service to
customers 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, 2000 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, 1999 is
derived from the December 31, 1999 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, 1999.
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.
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THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Reclassifications and Use of Estimates
The preparation of the 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 results could differ
from the estimates. Certain reclassifications of prior year items 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, as adjusted, by the weighted average number
of shares of common stock outstanding plus all potentially dilutive securities.
<TABLE>
<CAPTION>
THREE MONTHS ENDED, SIX MONTHS ENDED,
JUNE 30, JUNE 30,
------------------ -----------------
2000 1999 2000 1999
------- -------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net income .................................................. $16,328 $ 5,189 $24,777 $ 5,935
Interest savings on convertible debt, net of tax ........ -- 689 -- --
------- ------- ------- -------
Net income, as adjusted ..................................... $16,328 $ 5,878 $24,777 $ 5,935
======= ======= ======= =======
Weighted average shares outstanding ......................... 29,041 23,897 26,510 23,896
Add: dilutive securities
Convertible debt (1) .............................. -- 4,092 -- --
Options ........................................... 361 188 242 126
------- ------- ------- -------
Total weighted average shares outstanding and dilutive
securities ................................................ 29,402 28,177 26,752 24,022
======= ======= ======= =======
Net income per share ........................................ $ 0.56 $ 0.22 $ 0.93 $ 0.25
======= ======= ======= =======
Net income per share -- assuming dilution ................... $ 0.56 $ 0.21 $ 0.93 $ 0.25
======= ======= ======= =======
</TABLE>
----------
(1) The computation of diluted EPS for the six months ended June 30, 1999
did not assume the conversion of the KeySpan Facility as its inclusion
would have been antidilutive. For information on the KeySpan Facility,
see Note 4 -- Related Party Transactions.
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<PAGE> 9
THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 -- LONG-TERM DEBT AND NOTES
<TABLE>
<CAPTION>
JUNE 30, 2000 DECEMBER 31, 1999
------------- -----------------
(IN THOUSANDS)
<S> <C> <C>
SENIOR DEBT:
Bank revolving credit facility, due 2003 ............. $177,000 $181,000
SUBORDINATED DEBT:
8 5/8% Senior Subordinated Notes, due 2008 ........... 100,000 100,000
-------- --------
Total long-term debt and notes ................... $277,000 $281,000
======== ========
</TABLE>
The carrying amount of borrowings outstanding under the revolving bank
credit facility approximates fair value as the interest rates are tied to
current market rates. At June 30, 2000, the quoted market value of the Company's
$100 million of 8 5/8% Senior Subordinated Notes was 94% of the $100 million
carrying value or $94 million.
Credit Facility
The Company has entered into a revolving bank credit facility (the
"Credit Facility") with a syndicate of lenders led by Chase Bank of Texas,
National Association ("Chase"). The Credit Facility, as amended, provides a
maximum commitment of $250 million, subject to borrowing base limitations. At
June 30, 2000, the Company's borrowing base was $210 million. 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, 2000, $177 million was outstanding under the Credit
Facility and $0.4 million was outstanding in letter of credit obligations.
Subsequent to June 30, 2000, the Company borrowed an additional $10 million
under the Credit Facility bringing outstanding borrowings and letters of credit
under the facility to $187.4 million as of July 20, 2000.
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 0.875% to
1.625%, 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 0.25%
and 0.375% per annum on the unused portion of the Designated Borrowing Base, and
(ii) an unavailable commitment fee equal to 33% of the commitment fee in (i)
above on the difference between the lesser 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
earnings before interest, taxes and depreciation ("EBITDA") to cash interest;
(ii) a total debt to capitalization ratio of less than 60%, exclusive of
non-cash charges; and (iii) sets a maximum limit of 70% on the amount of natural
gas production the Company may hedge during any 12 month period. In addition to
maintenance of certain financial ratios, cash dividends and/or purchase or
redemption of the Company's stock is restricted 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, 2000, the Company was in compliance with all such covenants.
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THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Senior Subordinated Notes
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 equal
in right of payment to all existing and future subordinated indebtedness.
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 affect on the
financial position or results of operations of the Company.
NOTE 4 -- RELATED PARTY TRANSACTIONS
KeySpan Facility
On November 30, 1998, the Company entered into a revolving credit
facility with KeySpan (the "KeySpan Facility"), which provided a maximum
commitment of $150 million. The Company borrowed $80 million under the KeySpan
Facility to finance a portion of the November 1998 acquisition of the Mustang
Island A-31 Field. On March 31, 2000, the outstanding borrowings of $80 million
were converted into 5,085,177 shares of the Company's common stock at a
conversion price of $15.732 per share. As a result of the conversion, KeySpan's
ownership interest in the Company increased from 64% to 70%. The conversion
price was 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 March 31, 2000. The
conversion of the KeySpan Facility was approved by the Company's stockholders at
the Company's 1999 annual meeting held April 27, 1999. Borrowings bore interest
at LIBOR plus 1.4% and the Company incurred a quarterly commitment fee of 0.125%
on the unused portion of the maximum commitment. The KeySpan Facility terminated
on March 31, 2000 and as a result, the Company incurred no interest or fees
during the three month period ended June 30, 2000. For the three month period
ended June 30, 1999, the Company incurred $1.6 million in interest and fees to
KeySpan. For the six month periods ended June 30, 2000 and 1999, the Company
incurred $1.5 million and $2.6 million, respectively, in interest and fees to
KeySpan.
KeySpan Joint Venture
In March 1999, the Company entered into a joint exploration agreement (
the "KeySpan Joint Venture") with KeySpan Exploration & Production, LLC, a
subsidiary of KeySpan, to explore for natural gas and oil over a term of three
years expiring December 31, 2001. Either party may terminate the KeySpan Joint
Venture at the end of the then current calendar quarter by giving thirty days
prior written notice. Houston Exploration is the joint venture manager and
operator. KeySpan receives 45% of Houston Exploration's working interest in all
prospects drilled under the program. Revenues are shared 55% Houston Exploration
and 45% KeySpan. For the year 2000,
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<PAGE> 11
THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
KeySpan will pay 100% of actual intangible drilling costs up to a
maximum of $7.7 million. All additional intangible drilling costs incurred
during 2000 will be 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.
For the year 2000, KeySpan has agreed to commit approximately $35
million for a 2000 drilling program under the terms of the KeySpan Joint
Venture, as amended. The $35 million commitment will include approximately $20
million for exploratory drilling, $12 million for development and the balance
for general and administrative reimbursements. During the three month periods
ended June 30, 2000 and 1999, KeySpan incurred approximately $1.3 million and
$4.2 million, respectively, in exploration and development costs and the Company
received approximately $0.6 million and $1.1 million, respectively, in general
and administrate reimbursements. For the six month periods ended June 30, 2000
and 1999, KeySpan incurred approximately $13.8 million and $8.4 million,
respectively, in exploration and development costs and the Company received
approximately $1.2 million and $2.2 million, respectively, in general and
administrative reimbursements
Sale of Section 29 Tax Credits
Effective January 1, 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,
which represents benefits received from the Section 29 tax credits, was a
reduction to income tax expense of $0.2 million and $0.3 million, respectively,
for the three month periods ended June 30, 2000 and 1999 and $0.4 million and
$0.5 million, respectively, for the six month periods end June 30, 2000 and
1999.
-11-
<PAGE> 12
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, 2000 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
The Houston Exploration Company 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 offshore properties are
located primarily in the shallow waters of the Gulf of Mexico, and its onshore
properties are located in South Texas, South Louisiana, the Arkoma Basin, East
Texas and the Appalachian Basin in West Virginia. The Company's strategy is to
continue to increase its reserves, production and cash flow through the
application of a three-pronged approach that combines (i) high potential
offshore exploration; (ii) lower risk, high impact exploitation and development
drilling onshore; and (iii) selective opportunistic acquisitions both offshore
and onshore.
At December 31, 1999, net proved reserves were 541 Bcfe with a
discounted present value of cash flows before income taxes ("PV-10%") of $530
million. The Company's focus is natural gas and approximately 97% of its net
proved reserves at December 31, 1999 were natural gas and approximately 75% were
classified as proved developed. The Company operates approximately 90% of its
production.
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.
New Accounting Pronouncements.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities." The statement , as amended, requires
companies to report the fair value of derivatives on the balance sheet and
record in income or in comprehensive income, as appropriate, any changes in the
fair value of the derivative. The Company plans to adopt SFAS No. 133 effective
January 1, 2001. The Company estimates, using New York Mercantile Exchange
(NYMEX) forward prices as of July 20, 2000, that a charge of approximately $1.8
million to comprehensive income would result when the Company adopts SFAS 133 on
January 1, 2001 based on the Company's current hedge positions outstanding for
the months January 2001 through March 2001.
-12-
<PAGE> 13
Recent Developments.
At the Company's quarterly meeting of its Board of Directors held July
19, 2000, the Company's capital expenditure budget for the year 2000 of $125
million was increased by $25 million to $150 million.
In September 1999, the Company and KeySpan, the Company's majority
stockholder, jointly announced their intention to review strategic alternatives
for Houston Exploration. A full range of strategic transactions was considered
including the possible sale of all or a portion of Houston Exploration. On
February 25, 2000, KeySpan and the Company jointly announced that they had
concluded their review of strategic alternatives for Houston Exploration.
KeySpan also announced that it planned to retain its equity position in Houston
Exploration for the foreseeable future. During the first quarter of 2000, the
Company incurred approximately $1.8 million in expenses related to the strategic
review process.
-13-
<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,
------------------ -----------------
2000 1999 2000 1999
------- -------- ------- -------
<S> <C> <C> <C> <C>
PRODUCTION:
Natural gas (MMcf) ......................... 18,472 16,675 37,816 32,810
Oil (MBbls) ................................ 99 85 174 140
Total (MMcfe) .............................. 19,066 17,185 38,860 33,650
AVERAGE SALES PRICES:
Natural gas (per Mcf) realized(1) .......... $ 2.98 $ 2.03 $ 2.70 $ 1.82
Natural gas (per Mcf) unhedged ............. 3.37 2.03 2.88 1.82
Oil (per Bbl) .............................. 24.40 14.34 25.19 12.84
OPERATING EXPENSES (PER MCFE):
Lease operating ............................ $ 0.30 $ 0.25 $ 0.31 $ 0.25
Severance tax .............................. 0.11 0.07 0.10 0.06
Depreciation, depletion and amortization ... 1.06 1.05 1.06 1.04
General and administrative, net ............ 0.13 0.05 0.12 0.06
</TABLE>
----------
(1) Reflects the effects of hedging.
RECENT FINANCIAL AND OPERATING RESULTS
COMPARISON OF THREE MONTHS ENDED JUNE 30, 1999 AND 2000
Production. Houston Exploration's production increased 11% from 17,185
million cubic feet equivalent (MMcfe) for the three months ended June 30, 1999
to 19,066 MMcfe for the three months ended June 30, 2000. The increase in
production was primarily attributable to newly developed production offshore at
Mustang A-31 and West Cameron 76 and onshore at the Charco Field. Offshore
production increased a total of 21% or an average of 16 MMcfe/day from 75
MMcfe/day during the second quarter of 1999 to an average of 91 MMcfe/day during
the second quarter of 2000. The increase in offshore production for the second
quarter of 2000 was offset in part by a sharp decline in production from High
Island 38 which experienced mechanical problems in early May 2000 cutting the
Company's production at High Island 38 from an average of 12 MMcfe/day to
approximately 1.2 MMcfe/day. Onshore, production at the Charco Field increased
9.5% or an average of 7 MMcfe/day from an average of 74 MMcfe/day during the
second quarter of 1999 to an average of 81 MMcfe/day during the second quarter
of 2000. The lower production at the Charco Field during the second quarter of
1999 reflects the impact of the Company's decision to curtail drilling during
the fourth quarter of 1998 due to low natural gas prices.
Natural Gas and Oil Revenues. Natural gas and oil revenues increased
64% from $35.0 million for the three months ended June 30, 1999 to $57.5 million
for the three months ended June 30, 2000. The increase in revenues was due to
the 47% increase in average realized natural gas prices from $2.03 per Mcf for
the three months ended June 30, 1999 to $2.98 per Mcf for the three months ended
June 30, 2000 combined with the 11% increase in production.
Natural Gas Prices. As a result of hedging activities, the Company
realized an average gas price of $2.98 per Mcf for the three months ended June
30, 2000, which was 88% of the average unhedged natural gas price of $3.37 that
otherwise would have been received, resulting in natural gas and oil revenues
for the second quarter of 2000 that were $7.1 million lower than the revenues
the Company would have achieved if hedges had not been in
-14-
<PAGE> 15
place during the period. For the corresponding three month period of 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 was equal to the average
unhedged natural gas price of $2.03 per Mcf.
Lease Operating Expenses and Severance Tax. Lease operating expenses
increased 32% from $4.3 million for the three months ended June 30, 1999 to $5.7
million for the three months ended June 30, 2000. On an Mcfe basis, lease
operating expenses increased from $0.25 during the second quarter of 1999 to
$0.30 during the second quarter of 2000. The increase in both the lease
operating expenses and lease operating expense on a per unit basis during the
second quarter of 2000 is primarily a result of the continued expansion of the
Company's operations combined with higher service costs across the industry.
Severance tax, which is a function of volume and revenues generated from onshore
production, increased 75% from $1.2 million for the three months ended June 30,
1999 to $2.1 million for the three months ended June 30, 2000. On an Mcfe basis,
severance tax increased from $0.07 per Mcfe, during the second quarter of 1999
to $0.11 per Mcfe, during the second quarter of 2000. The increase in severance
tax expense and severance tax per Mcfe is due to higher natural gas prices
received during the second quarter of 2000 as compared to prices received during
the corresponding period of 1999 combined with the increase in onshore
production.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization expense increased 13% from $18.0 million for the three months ended
June 30, 1999 to $20.3 million for the three months ended June 30, 2000.
Depreciation, depletion and amortization expense per Mcfe increased slightly by
1% from $1.05 for the three months ended June 30, 1999 to $1.06 for the
corresponding three months in 2000. The increase in depreciation, depletion and
amortization expense reflects the 11% increase in production during the second
quarter of 2000 as compared to the second quarter of 1999 combined with the
slight increase in the depletion rate. The slightly higher rate is a result of a
higher level of capital spending during the second quarter of 2000 as compared
to the second quarter of 1999.
General and Administrative Expenses. General and administrative
expenses, net of overhead reimbursements received from other working interest
owners, of $1.3 million and $0.9 million, for the three months ended June 30,
1999 and 2000, respectively, increased more than 100% from $0.9 million for the
three months ended June 30, 1999 to $2.6 million for the three months ended June
30, 2000. Included in reimbursements received from working interest owners were
reimbursements totaling $0.6 million for the second quarter of 2000 and $1.0
million for the corresponding period of 1999 received from KeySpan pursuant to
the KeySpan Joint Venture (see Note 4 -- Related Party Transactions). For the
year 2000, the Company and KeySpan agreed to reduce the amount of the general
and administrative reimbursements the Company will receive to a maximum of
$625,000 per quarter. The Company capitalized general and administrative
expenses directly related to oil and gas exploration and development activities
of $1.3 million and $2.9 million, respectively, for the three months ended June
30, 1999 and 2000. The increase in capitalized general and administrative
expenses is a result of higher aggregate general and administrative expenses
during the second quarter of 2000 as compared to the corresponding period of
1999. Aggregate general and administrative expenses were higher during the
second quarter of 2000 primarily as a result of expansion of the Company's
workforce combined with an increase in incentive compensation and benefit
related expenses. On an Mcfe basis, general and administrative expenses
increased 160% from $0.05 for the three months ended June 30, 1999 to $0.13 for
the three months ended June 30, 2000. The higher rate per Mcfe during the second
quarter of 2000 reflects the increase in aggregate general and administrative
expenses and the effect of the reduction in the reimbursements received pursuant
to the KeySpan Joint Venture.
Interest Expense. Interest expense, net of capitalized interest,
decreased 22% from $3.2 million for the three months ended June 30, 1999 to $2.5
million for the three months ended June 30, 2000. Capitalized interest increased
from $2.8 million during the second quarter of 1999 to $3.4 million during the
second quarter of 2000. Aggregate interest expense decreased slightly by $0.1
million and the decrease was attributable to lower average debt levels during
the second quarter of 2000 primarily due to the conversion of $80 million in
borrowings under the KeySpan Facility into shares of Houston Exploration common
stock on March 31, 2000 (see Note 4 -- Related Party Transactions). Lower
average debt levels were partially offset by higher interest rates during the
second quarter of 2000 as compared to the corresponding period of 1999.
-15-
<PAGE> 16
Income Tax Provision. The provision for income taxes increased from an
expense of $2.3 million for the three months ended June 30, 1999 to an expense
of $8.5 million for the three months ended June 30, 2000. The increase in income
tax expense for the second quarter of 2000 as compared to the second quarter of
1999 is due to the increase in pretax income for the three months ended June 30,
2000 as a result of higher natural gas prices and an increase in production,
offset in part by higher operating expenses.
Operating Income and Net Income. Although operating expenses increased
25%, the 11% increase in production and the 47% increase in realized natural gas
prices was significant enough to cause operating income to increase 155% from
$10.7 million during the second quarter of 1999 to $27.3 million during the
second quarter of 2000. Net income increased 213% from $5.2 million for the
three months ended June 30, 1999 to $16.3 million for corresponding three months
of June 2000 and reflects lower interest expense and higher taxes.
COMPARISON OF SIX MONTHS ENDED JUNE 30, 1999 AND 2000
Production. Houston Exploration's production increased 15% from 33,650
MMcfe for the six months ended June 30, 1999 to 38,860 MMcfe for the six months
ended June 30, 2000. The increase in production was primarily attributable to
newly developed production, both offshore and onshore, brought on-line since the
end of the second quarter of 1999. Offshore production increased 31% from an
average of 71 MMcfe/day during the first half of 1999 to an average of 93
MMcfe/day during the first half of 2000 and is primarily attributable to new
wells drilled during 1999 at Mustang Island A-31 and West Cameron 76. Onshore at
the Charco Field, production increased 12% from an average of 73 MMcfe/day
during the first half of 1999 to an average of 82 MMcfe/day during the first
half of 2000. Production at the Charco Field was lower during the first half of
1999 due to the Company's decision to curtail development drilling during the
fourth quarter of 1998 due to low natural gas prices.
Natural Gas and Oil Revenues. Natural gas and oil revenues increased
73% from $61.5 million for the six months ended June 30, 1999 to $106.5 million
for the six months ended June 30, 2000 as a result of a 48% increase in average
realized natural gas prices, from $1.82 per Mcf in the six months ended June 30,
1999 to $2.70 per Mcf in the six months ended June 30, 2000 combined with a 15%
increase in production for the same period.
Natural Gas Prices. As a result of hedging activities, the Company
realized an average gas price of $2.70 per Mcf for the six months ended June 30,
2000, which was 94% of the average unhedged natural gas price of $2.88 that
otherwise would have been received, resulting in natural gas and oil revenues
for the six months ended June 30,2000 that were $6.8 million lower than the
revenues the Company would have achieved if hedges had not been in place during
the period. For the corresponding six month period during, 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.
Lease Operating Expenses and Severance Tax. Lease operating expenses
increased 46% from $8.3 million for the six months ended June 30, 1999 to $12.1
million for the six months ended June 30, 2000. On an Mcfe basis, lease
operating expenses increased from $0.25 for the six first months of 1999 to
$0.31 for the first six months of 2000. The increase in lease operating expenses
and lease operating expenses on a per unit basis for the six months ended June
30, 2000 is attributable to the continued expansion of the Company's operations
combined with an increase in service costs across the industry. Severance tax,
which is a function of volume and revenues generated from onshore production,
increased from $2.2 million for the six months ended June 30, 1999 to $3.7
million for the six months ended June 30, 2000. On an Mcfe basis, severance tax
increased from $0.06 per Mcfe for the six month periods ended June 30, 1999 to
$0.10 per Mcfe for the corresponding period of 2000. The increase in severance
tax expense and the rate per Mcfe reflects the higher natural gas prices
received during the first six months of 2000 as compared to the first six months
of 1999 combined with the increase in onshore production.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization expense increased 17% from $35.0 million for the six months ended
June 30, 1999 to $41.0 million for the six months ended June 30, 2000.
Depreciation, depletion and amortization expense per Mcfe increased 2% from
$1.04 for the six months ended June 30, 1999 to $1.06 for the six months ended
June 30, 2000. The increase in depreciation, depletion and amortization expense
was a result of higher production volumes combined with a slightly higher
depletion rate. The higher depletion rate is primarily a result of a higher
level of capital spending during first six months of 2000 as compared to the
corresponding period of 1999.
-16-
<PAGE> 17
General and Administrative Expenses. General and administrative
expenses, net of overhead reimbursements received from other working interest
owners, of $2.5 million and $1.7 million for the six months ended June 30, 1999
and 2000, respectively, increased 152% from $1.9 million for the six months
ended June 30, 1999 to $4.8 million for the six months ended June 30, 2000.
Included in reimbursements received from working interest owners were
reimbursements totaling $1.2 million for the first six months of 2000 and $2.2
million for corresponding period of 1999 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 $2.5 million and $5.2 million,
respectively, for the six months ended June 30, 1999 and 2000. The increase in
capitalized general and administrative expenses is a result of higher aggregate
general and administrative expenses during the first six months of 2000 as
compared to the corresponding period of 1999. Aggregate general and
administrative expenses are higher during the first half of 2000 due to
expansion of the Company's workforce combined with an increase in incentive
compensation and benefit related expenses. On an Mcfe basis, general and
administrative expenses increased 100% from $0.06 for the six months ended June
30, 1999 to $0.12 for the six months ended June 30, 2000. The higher rate per
Mcfe during the first six months of 2000 reflects an increase in aggregate
general and administrative expenses and the effect of the reduction in the
KeySpan Joint Venture reimbursements offset in part by an increase in
capitalized expenses.
Strategic Review Expenses. During the first quarter of 2000, the
Company recorded $1.8 million for expenses incurred in the review of strategic
alternatives for the Company. In September 1999, the Company and KeySpan, the
Company's majority stockholder, announced their intention to review strategic
alternatives for KeySpan's investment in Houston Exploration. KeySpan was
assessing the role of Houston Exploration within its future strategic plan, and
was considering a full range of strategic transactions including the possible
sale of all or a portion of Houston Exploration. On February 25, 2000, KeySpan
and the Company jointly announced that the review of strategic alternatives for
Houston Exploration was complete. KeySpan also announced that it planned to
retain its equity position in Houston Exploration for the foreseeable future.
Interest Expense, Net. Interest expense, net of capitalized interest,
increased 5% from $6.2 million for the six months ended June 30, 1999 to $6.5
million for the six ended June 30, 2000. Capitalized interest increased 20% from
$5.6 million for six months ended June 30, 1999 to $6.7 million for the six
months ended June 30, 2000. The increase in aggregate interest expense was
attributable to higher average debt levels during the first three months of 2000
prior to the conversion of the KeySpan Facility on March 30, 2000 combined with
higher interest rates paid during the first half of 2000.
Income Tax Provision. The provision for income taxes increased from an
expense of $2.4 million for the first six months of 1999 to an expense of $12.7
million for the first six months of 2000 due to the 350% increase in pretax
income during the first half of 2000 from $8.3 million for the six months ended
June 30, 1999 to $37.4 million for the first six months of 2000 as a result of
the combination of higher natural gas prices and increased production offset in
part by the increase in operating expenses.
Operating Income and Net Income. Despite the 30% increase in operating
expenses, the 15% increase in production and the 48% increase in realized
natural gas prices was significant enough to cause operating income to increase
215% from $14.5 million for the first half of 1999 to $45.7 million for the
first half of 2000. Correspondingly, net income increased 320% from $5.9 million
for the six months ended June 30, 1999 to $24.8 million for the six months ended
June 30, 2000. Absent the strategic review expenses of $1.8 million ($1.2
million net of tax), net income for the first six months of 2000 would have been
$25.9 million.
-17-
<PAGE> 18
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically funded its operations, acquisitions,
capital expenditures and working capital requirements from cash flows from
operations, equity capital from KeySpan as well as public sources, public debt
and bank borrowings. On March 31, 2000, the Company converted $80 million in
outstanding borrowings under a revolving credit facility established in November
1998 with KeySpan (the "KeySpan Facility") into 5,085,177 shares of common stock
of the Company at a conversion price of $15.732 per share. The KeySpan Facility
was terminated at conversion and as a result of the conversion, KeySpan's
ownership interest in the Company increased from 64% to 70% as of March 31,
2000.
Cash Flows From Operations. As of June 30, 2000, the Company had
working capital of $17.9 million and $32.6 million of borrowing capacity
available under its revolving bank credit facility. Net cash provided by
operating activities for the six ended June 30, 2000 was $56.0 million compared
to $41.5 million for the six months ended June 30, 1999. The 35% increase in
working capital during the first six months of 2000 is primarily related to the
timing of cash receipts and payments. Receivables are higher due to the increase
in natural gas revenues caused by an increase in both natural gas price and
production volume, and payables are lower due to an increase of available cash
caused by higher revenues. The Company's cash position decreased during the
first six months of 2000 by a net pay down of borrowings under its revolving
bank credit facility of $4.0 million. In addition, cash increased by $1.7
million during the first six months of 2000 due to the issuance of common stock
from the exercise of stock options. Funds used in investing activities consisted
of $67.7 million for investments in property and equipment. As a result of these
activities, cash and cash equivalents decreased $13.9 million from $15.5 million
at December 31, 1999 to $1.6 million at June 30, 2000.
Capital Expenditures. During the first half of 2000, the Company
invested a total of $67.6 million in natural gas and oil properties. This
included $3.0 million for exploration, $40.7 million for development drilling,
workovers and construction of platforms and pipelines, $15.9 million for
leasehold and leasehold acquisition costs and $8.0 million for producing
property acquisition costs. In May 2000, the Company acquired incremental
working interests in three existing offshore properties: West Cameron 76,
Mustang Island 858 and Vermilion 203. Net proved reserves for the natural gas
and oil interests acquired are estimated at approximately 8 Bcfe as of April 1,
2000, the effective date of the acquisition. The $8.0 million purchase price was
paid from working capital.
At the Company's quarterly meeting of its Board of Directors held on
July 19, 2000, the Company's capital expenditure budget for the year 2000 was
increased from $125 million to $150 million. The Company does not include
property acquisition costs in its capital expenditure budget as the size and
timing of capital requirements for property acquisitions are inherently
unpredictable. The capital expenditure budget includes development costs
associated with recent discoveries and newly acquired properties and amounts are
contingent upon drilling success. No significant abandonment or dismantlement
costs are anticipated in 2000. The Company will continue to evaluate its capital
spending plans throughout the year. 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 revolving bank credit facility will be sufficient to fund these
expenditures. 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.
Under the terms of the joint exploration agreement between KeySpan and
the Company, as amended, (the "KeySpan Joint Venture"), KeySpan has agreed to
commit approximately $35 million during 2000 to drill approximately six offshore
exploratory wells and to complete the development and facility installation of
the six successful wells drilled under the KeySpan Joint Venture during 1999.
During the first six months of 2000, KeySpan spent approximately $13.8 million
and together with the Company completed the drilling of three successful
exploratory wells, two of which were in progress at December 31, 1999, and two
unsuccessful wells, of which one was an exploratory well and the other was a
development well. Currently, the Company and KeySpan are in the process of
drilling three exploratory wells under the terms of the joint venture: High
Island 39, Matagorda Island 704 and Vermilion 408.
-18-
<PAGE> 19
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. Depending on market conditions and the
Company's capital needs, the Company may utilize the shelf registration in order
to raise capital. The Company would use the net proceeds received from the sale
of any securities for the repayment of debt and/or to fund an acquisition. There
can be no assurance that the Company will be able to consummate such offering on
acceptable terms.
Capital Structure
Credit Facility. The Company has entered into a revolving bank credit
facility (the "Credit Facility") with a syndicate of lenders led by Chase Bank
of Texas, National Association ("Chase"). The Credit Facility, as amended,
provides a maximum commitment of $250 million, subject to borrowing base
limitations. At June 30, 2000, the borrowing base was $210 million which will
remain in effect until the next scheduled semi-annual redetermination on
September 1, 2000. 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, 2000, $177
million was outstanding under the Credit Facility and $0.4 million was
outstanding in letter of credit obligations. Subsequent to June 30, 2000, the
Company borrowed an additional $10 million under the Credit Facility bringing
outstanding borrowings and letters of credit under the facility to $187.4
million as of July 20, 2000.
Senior Subordinated Notes. 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 in the indenture governing the Notes), 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 rank senior or equal in right of payment to
all existing and future subordinated indebtedness.
ITEM 3. 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.
-19-
<PAGE> 20
As of July 20, 2000, 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 2000 was 6,516 MMcf (6,743 million
British thermal units, or MMMbtu).
<TABLE>
<CAPTION>
COLLARS
---------------------------------------------------
NYMEX
VOLUME CONTRACT PRICE
PERIOD (MMMbtu) AVERAGE FLOOR AVERAGE CEILING
------ -------- ------------- ---------------
<S> <C> <C> <C>
July 2000................................... 4,650 2.400 2.959
August 2000................................. 4,650 2.400 2.959
September 2000.............................. 4,500 2.400 2.959
October 2000................................ 4,650 2.640 3.191
November 2000............................... 3,000 2.840 3.549
December 2000............................... 3,100 2.840 3.549
January 2001............................... 1,860 3.000 3.630
February 2001............................... 1,680 3.000 3.630
March 2001.................................. 1,860 3.000 3.630
</TABLE>
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 or the NYMEX price on
the final trading day of the month (the "settlement price").
For the months October 2000 through March 2001 the Company has 60,000
MMbtu/day hedged under no-cost collars with floating floors. The floating floor
structure allows for a higher floor price in exchange for a lower ceiling. For
example, during January 2001, if the settlement price is up to $2.50 the Company
will receive the settlement price plus $0.50. If the settlement price is between
$2.50 and $3.00 the Company will receive $3.00. If the settlement price is
between $3.00 and $3.63, the Company will receive the settlement price and if
the settlement price is above $3.63, the Company will receive $3.63 (the
ceiling).
The Company plans to adopt SFAS No. 133 "Accounting for Derivative
Instruments and Hedging Activities" effective January 1, 2001. The statement,
as amended, requires companies to report the fair value of derivatives on the
balance sheet and record in income or in comprehensive income, as appropriate,
any changes in the fair value of the derivative. The Company estimates, using
NYMEX forward prices as of July 20, 2000, that a charge of approximately $1.8
million to comprehensive income would result when the Company adopts SFAS 133 on
January 1, 2001 based on the Company's current hedge positions outstanding for
the months January 2001 through March 2001.
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. The Company
is not required to make or receive any payment in connection with a collar
transaction if the settlement price is between the floor and the ceiling. 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.
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<PAGE> 21
PART II. OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
(c) Recent Sales of Unregistered Securities
On March 31, 2000, the Company issued 5,085,177 shares of its common
stock to THEC Holdings, Inc., an indirect wholly owned subsidiary of KeySpan
Corporation, the Company's majority stockholder, as a result of the conversion
of the $80 million principal amount outstanding on March 31, 2000 under the
revolving credit facility entered into by the Company and KeySpan on November
30, 1998 (the "KeySpan Facility"). The number of shares issued was based on a
conversion price of $15.732 per share, which was 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 March 31, 2000. The conversion of the KeySpan Facility was
approved by the Company's stockholders at the Company's 1999 annual meeting held
April 27, 1999. The 5,085,177 shares of the Company's common stock issued to
THEC Holdings, Inc. are exempt from registration pursuant to Section 3(a)(9) of
the Securities Act of 1933, as amended.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On May 15, 2000, 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 nine 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 18,695,363 15,150
Robert B. Catell 18,023,658 686,855
Gordon F. Ahalt 18,695,363 15,150
David G. Elkins 18,695,363 15,150
Russell D. Gordy 18,695,363 15,150
Gerald Luterman 18,694,863 15,650
Craig G. Matthews 18,695,163 15,350
H. Neil Nichols 18,694,663 15,850
James Q. Riordan 18,695,363 15,150
Donald C. Vaughn 18,695,163 15,350
</TABLE>
2. The appointment of Arthur Andersen LLP as the Company's
independent public accountants for the fiscal year ending
December 31, 2000.
<TABLE>
<CAPTION>
VOTES FOR VOTES AGAINST ABSTAINED
--------- ------------- ---------
<S> <C> <C>
18,706,803 2,450 1,260
</TABLE>
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<PAGE> 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
* 27.1 -- Financial Data Schedule.
---------------------------
* Filed herewith.
(b) Reports on Form 8-K:
None
-22-
<PAGE> 23
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.
<TABLE>
<CAPTION>
THE HOUSTON EXPLORATION COMPANY
<S> <C>
By: /s/ James G. Floyd
---------------------------------------------
James G. Floyd
Date: July 20, 2000 President and Chief Executive Officer
By: /s/ James F. Westmoreland
--------------------------------------------
James F. Westmoreland
Date: July 20, 2000 Vice President, Chief Accounting Officer,
Comptroller and Secretary
</TABLE>
-23-
<PAGE> 24
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
---------- -----------
<S> <C>
* 27.1 Financial Data Schedule
</TABLE>
----------
* Filed herewith.
