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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 SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _____________TO_____________
COMMISSION FILE NO. 001-11899
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THE HOUSTON EXPLORATION COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
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DELAWARE 22-2674487
(STATE OR OTHER JURISDICTION OF (IRS EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
</TABLE>
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)
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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 October 19, 2000, 29,355,384 shares of Common Stock, par value
$.01 per share, were outstanding.
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THE HOUSTON EXPLORATION COMPANY
TABLE OF CONTENTS
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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 -- September 30, 2000 and December 31, 1999.......................4
Consolidated Statements of Operations -- Three Month and Nine Month Periods Ended
September 30, 2000 and 1999...............................................................5
Consolidated Statements of Cash Flows -- Nine Month Periods Ended
September 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 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," "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>
SEPTEMBER 30, DECEMBER 31,
2000 1999
------------ ------------
(UNAUDITED)
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ASSETS:
Cash and cash equivalents ........................................................... $ 2,373 $ 15,502
Accounts receivable ................................................................. 66,883 34,917
Accounts receivable -- Affiliate .................................................... 8,529 12,315
Inventories ......................................................................... 1,462 969
Prepayments and other ............................................................... 1,548 1,082
------------ ------------
Total current assets ....................................................... 80,795 64,785
Natural gas and oil properties, full cost method
Unevaluated properties ............................................................ 168,876 164,377
Properties subject to amortization ................................................ 1,073,549 956,484
Other property and equipment ........................................................ 9,920 9,744
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1,252,345 1,130,605
Less: Accumulated depreciation, depletion and amortization .......................... (582,244) (520,489)
------------ ------------
670,101 610,116
Other assets ........................................................................ 2,789 3,582
------------ ------------
TOTAL ASSETS ............................................................... $ 753,685 $ 678,483
============ ============
LIABILITIES:
Accounts payable and accrued expenses ............................................... $ 64,582 $ 56,004
Subordinated note -- Affiliate ...................................................... -- 80,000
------------ ------------
Total current liabilities .................................................. 64,582 136,004
Long-term debt and notes ............................................................ 274,000 281,000
Deferred federal income taxes ....................................................... 67,292 43,736
Other deferred liabilities .......................................................... 141 153
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TOTAL LIABILITIES .......................................................... 406,015 460,893
COMMITMENTS AND CONTINGENCIES (SEE NOTE 3)
STOCKHOLDERS' EQUITY:
Common Stock, $.01 par value, 50,000,000 shares authorized and 29,348,869 shares
issued and outstanding at September 30, 2000 and 23,923,020 shares issued and
outstanding at December 31, 1999, respectively ................................... 293 239
Additional paid-in capital .......................................................... 316,953 231,370
Retained earnings (deficit) ......................................................... 30,424 (14,019)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY ................................................ 347,670 217,590
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................ $ 753,685 $ 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>
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THREE MONTHS ENDED, NINE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
(UNAUDITED)
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REVENUES:
Natural gas and oil revenues ........................ $ 62,479 $ 42,081 $ 168,930 $ 103,622
Other ............................................... 424 396 1,251 857
---------- ---------- ---------- ----------
Total revenues .............................. 62,903 42,477 170,181 104,479
OPERATING EXPENSES:
Lease operating ..................................... 5,331 5,091 17,420 13,386
Severance tax ....................................... 2,424 1,588 6,125 3,775
Depreciation, depletion and amortization ............ 20,740 18,644 61,747 53,673
General and administrative, net ..................... 1,929 960 6,690 2,909
---------- ---------- ---------- ----------
Total operating expenses .................... 30,424 26,283 91,982 73,743
Income from operations ................................ 32,479 16,194 78,199 30,736
Strategic review expenses ............................. -- -- 1,752 --
Interest expense, net ................................. 2,577 3,412 9,115 9,625
---------- ---------- ---------- ----------
Net income before income taxes ........................ 29,902 12,782 67,332 21,111
Provision for federal income taxes .................... 10,236 4,254 22,889 6,648
---------- ---------- ---------- ----------
NET INCOME ............................................ $ 19,666 $ 8,528 $ 44,443 $ 14,463
========== ========== ========== ==========
Net income per share .................................. $ 0.67 $ 0.36 $ 1.62 $ 0.61
========== ========== ========== ==========
Net income per share -- assuming dilution ............. $ 0.66 $ 0.32 $ 1.60 $ 0.58
========== ========== ========== ==========
Weighted average shares outstanding ................... 29,191 23,911 27,410 23,901
Weighted average shares outstanding -- assuming
dilution .......................................... 29,664 28,001 27,729 28,265
</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)
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NINE MONTHS ENDED SEPTEMBER 30,
------------------------------
2000 1999
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(UNAUDITED)
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OPERATING ACTIVITIES:
Net income ................................................. $ 44,443 $ 14,463
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion and amortization ................. 61,747 53,673
Deferred income tax expense .............................. 23,556 7,375
Changes in operating assets and liabilities:
Increase in accounts receivable ....................... (28,180) (23,668)
Increase in inventories ............................... (493) (192)
Increase in prepayments ............................... (466) (204)
Decrease (increase) in other assets and liabilities ... 781 (501)
Increase in accounts payable and accrued expenses ..... 8,578 12,753
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Net cash provided by operating activities .................. 109,966 63,699
INVESTING ACTIVITIES:
Investment in property and equipment ....................... (121,732) (92,814)
------------ ------------
Net cash used in investing activities ...................... (121,732) (92,814)
FINANCING ACTIVITIES:
Proceeds from long term borrowings ......................... 30,000 41,000
Repayments of long term borrowings ......................... (37,000) (14,000)
Proceeds from issuance of common stock ..................... 5,637 405
------------ ------------
Net cash (used in) provided by financing activities ........ (1,363) 27,405
------------ ------------
Decrease in cash and cash equivalents ...................... (13,129) (1,710)
Cash and cash equivalents, beginning of period ............. 15,502 4,645
------------ ------------
Cash and cash equivalents, end of period ................... $ 2,373 $ 2,935
============ ============
Cash paid for interest ..................................... $ 21,743 $ 18,308
============ ============
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 September 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 September 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, NINE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2000 1999 2000 1999
---------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
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Net income ..................................................... $ 19,666 $ 8,528 $ 44,443 $ 14,463
Interest savings on convertible debt, net of tax ........... -- 476 -- 1,856
---------- ---------- ---------- ----------
Net income, as adjusted ........................................ $ 19,666 $ 9,004 $ 44,443 $ 16,319
========== ========== ========== ==========
Weighted average shares outstanding ............................ 29,191 23,911 27,410 23,901
Add: dilutive securities
Convertible debt ..................................... -- 3,803 -- 4,183
Options .............................................. 473 287 319 181
---------- ---------- ---------- ----------
Total weighted average shares outstanding and dilutive
securities ................................................... 29,664 28,001 27,729 28,265
========== ========== ========== ==========
Net income per share ........................................... $ 0.67 $ 0.36 $ 1.62 $ 0.61
========== ========== ========== ==========
Net income per share -- assuming dilution ...................... $ 0.66 $ 0.32 $ 1.60 $ 0.58
========== ========== ========== ==========
</TABLE>
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THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 2 -- LONG-TERM DEBT AND NOTES
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SEPTEMBER 30, 2000 DECEMBER 31, 1999
------------------ ------------------
(IN THOUSANDS)
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SENIOR DEBT:
Bank revolving credit facility, due 2003 .......... $ 174,000 $ 181,000
SUBORDINATED DEBT:
8 5/8% Senior Subordinated Notes, due 2008 ........ 100,000 100,000
------------------ ------------------
Total long-term debt and notes ................ $ 274,000 $ 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 September 30, 2000, the quoted market value of the
Company's $100 million of 8 5/8% Senior Subordinated Notes was 96% of the $100
million carrying value or $96 million.
Credit Facility
The Company has entered into a revolving bank credit facility (the
"Credit Facility") with a syndicate of lenders led by The Chase Manhattan Bank,
National Association ("Chase"). The Credit Facility, as amended, provides a
maximum commitment of $250 million, subject to borrowing base limitations. At
September 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 September 30, 2000, $174 million was outstanding under the
Credit Facility and $0.4 million was outstanding in letter of credit
obligations. Subsequent to September 30, 2000, the Company borrowed an
additional $1.0 million under the Credit Facility bringing outstanding
borrowings and letters of credit under the facility to $175.4 million as of
October 19, 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 September 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
relating to the KeySpan Facility subsequent to March 31, 2000. For the three
month period ended September 30, 1999, the Company incurred $1.4 million in
interest and fees to KeySpan. For the nine month periods ended September 30,
2000 and 1999, the Company incurred $1.5 million and $4.0 million, respectively,
in interest and fees to KeySpan.
KeySpan Joint Venture
Effective January 1, 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 an initial
term expiring December 31, 2000. The agreement will be renewed for successive
one year terms unless terminated by either party upon giving written notice 30
days prior to the end of the year or if the parties fail to reach an agreement
on the annual budget for the joint venture for the upcoming calendar year. The
KeySpan Joint
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THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Venture may be terminated by mutual agreement of both parties at any time.
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, KeySpan will pay 100% of actual intangible drilling
costs for the joint venture 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 September 30, 2000 and 1999, KeySpan incurred approximately $14.8 million
and $6.8 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 nine month periods ended
September 30, 2000 and 1999, KeySpan incurred approximately $28.6 million and
$14.9 million, respectively, in exploration and development costs and the
Company received approximately $1.9 million and $3.3 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 $0.3 million and $0.2 million, respectively,
for the three month periods ended September 30, 2000 and 1999 and $0.7 million
for each of the nine month periods end September 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 nine months ended September 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 October 19, 2000, that when SFAS 133 is adopted on
January 1, 2001, a liability of approximately $7.2 million would be recorded to
reflect the fair market value of hedges currently in place for the period
subsequent to January 2001. Because the Company's hedges currently in place
qualify for hedge accounting, an offsetting entry would be made to other
comprehensive income for a substantial portion of the estimated $7.2 million
fair value.
-12-
<PAGE> 13
Recent Developments
At the Company's quarterly meeting of its Board of Directors held on
October 18, 2000, the Company's capital expenditure budget for the year 2000 was
further increased from $150 million to $175 million. Initially, the capital
expenditure budget for the year 2000 was set at $125 million. At the Company's
quarterly board meeting held in July 2000, the initial budget was increased by
$25 million to $150 million.
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, NINE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
PRODUCTION:
Natural gas (MMcf) ........................... 18,693 17,640 56,509 50,450
Oil (MBbls) .................................. 64 47 238 187
Total (MMcfe) ................................ 19,077 17,922 57,937 51,572
AVERAGE SALES PRICES:
Natural gas (per Mcf) realized(1) ............ $ 3.24 $ 2.33 $ 2.88 $ 2.00
Natural gas (per Mcf) unhedged ............... 4.23 2.47 3.33 2.05
Oil (per Bbl) ................................ 29.27 20.28 26.29 14.71
OPERATING EXPENSES (PER MCFE):
Lease operating .............................. $ 0.28 $ 0.28 $ 0.30 $ 0.26
Severance tax ................................ 0.13 0.09 0.11 0.07
Depreciation, depletion and amortization ..... 1.09 1.04 1.07 1.04
General and administrative, net .............. 0.10 0.05 0.12 0.06
</TABLE>
----------
(1) Reflects the effects of hedging.
RECENT FINANCIAL AND OPERATING RESULTS
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 2000
Production. Houston Exploration's production increased 6.5% from 17,922
million cubic feet equivalent (MMcfe) for the three months ended September 30,
1999 to 19,077 MMcfe for the three months ended September 30, 2000. The increase
in production was primarily attributable to an increase in offshore production
offset in part by a decrease in onshore production, primarily at the Charco
Field.
Offshore production increased a total of 36% or an average of 26
MMcfe/day from 73 MMcfe/day during the third quarter of 1999 to an average of 99
MMcfe/day during the third quarter of 2000. Since the end of the third quarter
1999, the Company has brought on-line new production at West Cameron 76, Mustang
A-31, East Cameron 84 and West Cameron 587. Adding to the increase from the
newly developed production was the purchase in May 2000 of incremental working
interests in existing production at Vermilion 203, Mustang 858 and West Cameron
76. In part, the offshore production increase for the third quarter of 2000 was
offset by a sharp decline in production from High Island 38 which experienced
mechanical problems in early May 2000. The Company's production at High Island
38 was reduced from an average of 12 MMcfe/day to an average of 1.5 Mmcfe/day.
-13-
<PAGE> 14
Onshore, production at the Charco Field decreased 11% or an average of
9 MMcfe/day from an average of 83 MMcfe/day during the third quarter of 1999 to
an average of 74 MMcfe/day during the third quarter of 2000. The lower
production at the Charco Field during the third quarter of 2000 was a result of
delays in bringing new wells on-line caused by a shortage of available equipment
and crews to complete wells. The Company anticipates that production from the
Charco Field will increase from third quarter levels as a third drilling rig was
added in September 2000 and completion equipment and crews have become more
readily available.
Natural Gas and Oil Revenues. Natural gas and oil revenues increased
48% from $42.1 million for the three months ended September 30, 1999 to $62.5
million for the three months ended September 30, 2000. The increase in revenues
was due to a 39% increase in average realized natural gas prices from $2.33 per
Mcf for the three months ended September 30, 1999 to $3.24 per Mcf for the three
months ended September 30, 2000 combined with the 6.5% increase in production.
Natural Gas Prices. As a result of hedging activities, the Company
realized an average gas price of $3.24 per Mcf for the three months ended
September 30, 2000, which was 77% of the average unhedged natural gas price of
$4.23 per Mcf that otherwise would have been received, resulting in natural gas
and oil revenues for the third quarter of 2000 that were $18.5 million lower
than the revenues the Company would have achieved if hedges had not been in
place during the quarter. For the corresponding three month period of 1999, the
Company realized an average gas price of $2.33 per Mcf which was 94% of the
average unhedged natural gas price of $2.47 per Mcf that otherwise would have
been received, resulting in natural gas and oil revenues for the three months
ended September 30, 1999 that were $2.5 million lower than the revenues the
Company would have achieved if hedges had not been in place during the quarter
ended September 30, 1999.
Lease Operating Expenses and Severance Tax. Lease operating expenses
increased 4% from $5.1 million for the three months ended September 30, 1999 to
$5.3 million for the three months ended September 30, 2000. On an Mcfe basis,
lease operating expenses were unchanged at $0.28 during both the third quarter
of 1999 and the third quarter of 2000. Severance tax, which is a function of
volume and revenues generated from onshore production, increased 50% from $1.6
million for the three months ended September 30, 1999 to $2.4 million for the
three months ended September 30, 2000. On an Mcfe basis, severance tax increased
from $0.09 per Mcfe, during the third quarter of 1999 to $0.13 per Mcfe, during
the third quarter of 2000. The increase in severance tax expense and severance
tax per Mcfe is due to higher natural gas prices received during the third
quarter of 2000 as compared to prices received during the corresponding period
of 1999.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization expense increased 11% from $18.6 million for the three months ended
September 30, 1999 to $20.7 million for the three months ended September 30,
2000. Depreciation, depletion and amortization expense on a per unit basis
increased 5% from $1.04 for the three months ended September 30, 1999 to $1.09
for the corresponding three months in 2000. The increase in depreciation,
depletion and amortization expense reflects the 6.5% increase in production
during the third quarter of 2000 as compared to the third quarter of 1999
combined with the increase in the depletion rate. The higher rate is a result of
a higher level of capital spending during the third quarter of 2000 as compared
to the third quarter of 1999.
General and Administrative Expenses. General and administrative
expenses, net of overhead reimbursements received from other working interest
owners, of $1.4 million and $0.9 million, for the three months ended September
30, 1999 and 2000, respectively, increased 90% from $1.0 million for the three
months ended September 30, 1999 to $1.9 million for the three months ended
September 30, 2000. Included in reimbursements received from working interest
owners were reimbursements totaling $0.6 million for the third quarter of 2000
and $1.1 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 $2.1 million, respectively, for the
three months ended September 30, 1999 and 2000. The increase in capitalized
general and administrative expenses is a result of higher aggregate general and
administrative expenses during the third quarter of 2000 as compared to the
corresponding period of
-14-
<PAGE> 15
1999. Aggregate general and administrative expenses were higher during the third
quarter of 2000 primarily as a result of expansion of the Company's technical
workforce combined with an increase in incentive compensation and benefit
related expenses. On an Mcfe basis, general and administrative expenses
increased 100% from $0.05 for the three months ended September 30, 1999 to $0.10
for the three months ended September 30, 2000. The higher rate per Mcfe during
the third 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 24% from $3.4 million for the three months ended September 30, 1999 to
$2.6 million for the three months ended September 30, 2000. As a result of an
increase in exploratory drilling, capitalized interest increased 13% from $3.0
million during the third quarter of 1999 to $3.4 million during the third
quarter of 2000. Aggregate interest expense decreased by $0.4 million and the
decrease was attributable to lower average debt levels during the third 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
offset by higher interest rates during the third quarter of 2000 as compared to
the corresponding period of 1999.
Income Tax Provision. The provision for income taxes increased from an
expense of $4.3 million for the three months ended September 30, 1999 to an
expense of $10.2 million for the three months ended September 30, 2000. The
increase in income tax expense for the third quarter of 2000 as compared to the
third quarter of 1999 is due to the increase in pretax income for the three
months ended September 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
16%, the 39% increase in realized natural gas price and the 6.5% increase in
production was significant enough to cause operating income to increase 100%
from $16.2 million during the third quarter of 1999 to $32.5 million during the
third quarter of 2000. Net income increased 132% from $8.5 million for the three
months ended September 30, 1999 to $19.7 million for corresponding three months
of September 2000 and reflects lower interest expense and higher taxes.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 2000
Production. Houston Exploration's production increased 12% from 51,572
MMcfe for the nine months ended September 30, 1999 to 57,937 MMcfe for the nine
months ended September 30, 2000. The increase in production was primarily
attributable to newly developed offshore production brought on-line since the
end of the second quarter of 1999.
Offshore production increased 32% from an average of 72 MMcfe/day
during the first nine months of 1999 to an average of 95 MMcfe/day during the
first nine months of 2000 and is primarily attributable to production from new
wells drilled during 1999 at Mustang Island A-31, West Cameron 76 and East
Cameron 84 and new wells drilled during the second quarter of 2000 at West
Cameron 587. In addition, in May 2000, the Company acquired incremental working
interests in existing production at Vermilion 203, Mustang Island 858 and West
Cameron 76.
Onshore, production decreased 2% from an average of 118 MMcfe/day
during the first nine months of 1999 to an average of 116 MMcfe/day during the
first nine months of 2000. During the third quarter of 2000, a shortage of
completion equipment and crews in South Texas caused the Company to experience
delays in bringing new wells on-line in the Charco Field. The Company expects
Charco Field production to increase during the fourth quarter 2000 as a third
drilling rig was added in September 2000 and completion crews and equipment have
become more readily available.
Natural Gas and Oil Revenues. Natural gas and oil revenues increased
63% from $103.6 million for the nine months ended September 30, 1999 to $168.9
million for the nine months ended September 30, 2000 as a result of a 44%
increase in average realized natural gas prices, from $2.00 per Mcf in the nine
months ended September 30, 1999 to $2.88 per Mcf in the nine months ended
September 30, 2000 combined with a 12% increase in production for the same
period.
-15-
<PAGE> 16
Natural Gas Prices. As a result of hedging activities, the Company
realized an average gas price of $2.88 per Mcf for the nine months ended
September 30, 2000, which was 86% of the average unhedged natural gas price of
$3.33 that otherwise would have been received, resulting in natural gas and oil
revenues for the nine months ended September 30, 2000 that were $25.2 million
lower than the revenues the Company would have achieved if hedges had not been
in place during the period. For the corresponding nine month period during 1999,
the Company realized an average gas price of $2.00 per Mcf, which was 98% of the
average unhedged natural gas price of $2.05 that otherwise would have been
received, resulting in natural gas and oil revenues that were $2.6 million lower
than the revenues the Company would have achieved if hedges had not been in
place during the period.
Lease Operating Expenses and Severance Tax. Lease operating expenses
increased 30% from $13.4 million for the nine months ended September 30, 1999 to
$17.4 million for the nine months ended September 30, 2000. On an Mcfe basis,
lease operating expenses increased from $0.26 per Mcfe for the nine first months
of 1999 to $0.30 per Mcfe for the first nine months of 2000. The increase in
lease operating expenses and lease operating expenses on a per unit basis for
the nine months ended September 30, 2000 is attributable to the continued
expansion of the Company's operations combined with an increase in service costs
across the industry during the first half of 2000. Severance tax, which is a
function of volume and revenues generated from onshore production, increased
from $3.8 million for the nine months ended September 30, 1999 to $6.1 million
for the nine months ended September 30, 2000. On an Mcfe basis, severance tax
increased from $0.07 per Mcfe for the nine month periods ended September 30,
1999 to $0.11 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 nine months of 2000 as compared to the first
nine months of 1999.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization expense increased 15% from $53.7 million for the nine months ended
September 30, 1999 to $61.7 million for the nine months ended September 30,
2000. Depreciation, depletion and amortization expense per Mcfe increased 3%
from $1.04 for the nine months ended September 30, 1999 to $1.07 for the nine
months ended September 30, 2000. The increase in depreciation, depletion and
amortization expense was a result of higher production volumes combined with a
higher depletion rate. The higher depletion rate is primarily a result of a
higher level of capital spending during first nine months of 2000 as compared to
the corresponding period of 1999.
General and Administrative Expenses. General and administrative
expenses, net of overhead reimbursements received from other working interest
owners, of $3.9 million and $2.6 million for the nine months ended September 30,
1999 and 2000, respectively, increased 131% from $2.9 million for the nine
months ended September 30, 1999 to $6.7 million for the nine months ended
September 30, 2000. Included in reimbursements received from working interest
owners were reimbursements totaling $1.9 million for the first nine months of
2000 and $3.3 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 $3.8 million and $7.3
million, respectively, for the nine months ended September 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 nine
months of 2000 as compared to the corresponding period of 1999. Aggregate
general and administrative expenses are higher during the first nine months of
2000 due to expansion of the Company's technical 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
nine months ended September 30, 1999 to $0.12 for the nine months ended
September 30, 2000. The higher rate per Mcfe during the first nine 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
-16-
<PAGE> 17
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,
decreased 5% from $9.6 million for the nine months ended September 30, 1999 to
$9.1 million for the nine ended September 30, 2000. As a result of an increase
in exploratory drilling during the current year, capitalized interest increased
17% from $8.6 million for nine months ended September 30, 1999 to $10.1 million
for the nine months ended September 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 nine months of 2000.
Income Tax Provision. The provision for income taxes increased from an
expense of $6.6 million for the first nine months of 1999 to an expense of $22.9
million for the first nine months of 2000 due to the 219% increase in pretax
income during the first nine months of 2000 from $21.1 million for the nine
months ended September 30, 1999 to $67.3 million for the first nine 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 25% increase in operating
expenses, the 12% increase in production and the 44% increase in realized
natural gas prices was significant enough to cause operating income to increase
155% from $30.7 million for the first nine months of 1999 to $78.2 million for
the first nine months of 2000. Correspondingly, net income increased 206% from
$14.5 million for the nine months ended September 30, 1999 to $44.4 million for
the nine months ended September 30, 2000. Absent the strategic review expenses
of $1.8 million ($1.2 million net of tax), net income for the first nine months
of 2000 would have been $45.6 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 September 30, 2000, the Company had
working capital of $16.2 million and $35.6 million of borrowing capacity
available under its revolving bank credit facility. Net cash provided by
operating activities for the nine ended September 30, 2000 was $110.0 million
compared to $63.7 million for the nine months ended September 30, 1999. The 73%
increase in working capital during the first nine 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 higher due to an increase in
exploration and development activity. The Company's cash position decreased
during the first nine months of 2000 by a net pay down of borrowings under its
revolving bank credit facility of $7.0 million. In addition, cash increased by
$5.6 million during the first nine months of 2000 due to the issuance of common
stock from the exercise of stock options. Funds used in investing activities
consisted of $121.7 million for investments in property and equipment. As a
result of these activities, cash and cash equivalents decreased $13.1 million
from $15.5 million at December 31, 1999 to $2.4 million at September 30, 2000.
Capital Expenditures. During the first nine months of 2000, the Company
invested a total of $121.6 million in natural gas and oil properties. This
included $17.6 million for exploration, $68.8 million for development drilling,
workovers and construction of platforms and pipelines, $23.5 million for
leasehold and leasehold acquisition costs and $11.7 million for 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. In September 2000, the Company acquired an incremental working
interest in two recently drilled wells at Vermilion 408 for $3.7 million in
cash. The Company, together with KeySpan, drilled the first exploratory well at
Vermilion 408 in December 1999 and drilled the second exploratory well during
the third quarter 2000. Initial production from the block is expected in the
fourth quarter of 2001. The Company's post-acquisition working interest in
Vermilion 408 is approximately 30.8%.
At the Company's quarterly meeting of its Board of Directors held on
October 18, 2000, the Company's capital expenditure budget for the year 2000 was
increased from $150 million to $175 million. The initial capital expenditure
budget of $125 million was increased to $150 million in July 2000. 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 remainder of 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 nine
offshore exploratory wells and to complete the development and facility
installation of the nine successful wells drilled under the KeySpan Joint
Venture during 1999. During the first nine months of 2000,
-18-
<PAGE> 19
KeySpan spent approximately $28.6 million and together with the Company
completed the drilling of five successful exploratory wells, two of which were
in progress at December 31, 1999, and three unsuccessful wells, of which one 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: Mustang
Island 317 and 726 and High Island 115. During the third quarter of 2000, the
Company and KeySpan began completion and facility installation at Galveston
Island 190 and 389 and Matagorda Island 704. Initial production is expected from
these new facilities by the end of November 2000 together with initial
production from two wells drilled under the terms of the KeySpan Joint Venture
that are currently under completion at North Padre Island 883 which is operated
by a third party.
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 The Chase
Manhattan Bank, National Association ("Chase"). The Credit Facility, as amended,
provides a maximum commitment of $250 million, subject to borrowing base
limitations. At September 30, 2000, the 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 September 30, 2000, $174 million was outstanding
under the Credit Facility and $0.4 million was outstanding in letter of credit
obligations. Subsequent to September 30, 2000, the Company borrowed an
additional $1.0 million under the Credit Facility bringing outstanding
borrowings and letters of credit under the facility to $175.4 million as of
October xx, 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 October 19, 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 September 2000 was 6,261 MMcf (6,481 million
British thermal units, or MMMbtu).
<TABLE>
<CAPTION>
COLLARS
---------------------------------------------------
NYMEX
VOLUME CONTRACT PRICE
PERIOD (MMMBTU) AVERAGE FLOOR AVERAGE CEILING
-------------------------------------------- -------- ------------- ---------------
<S> <C> <C> <C>
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 October 19, 2000, that when SFAS 133 is adopted on
January 1, 2001, a liability of approximately $7.2 million would be recorded to
reflect the fair market value of hedges currently in place for the period
subsequent to January 2001. Because the Company's hedges currently in place
qualify for hedge accounting, an offsetting entry would be made to other
comprehensive income for a substantial portion of the estimated $7.2 million
fair value.
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 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
* 10.1 -- Restated Exploration Agreement dated June 30, 2000 between The
Houston Exploration Company and KeySpan Exploration and
Production, L.L.C.
* 27.1 -- Financial Data Schedule.
----------
* Filed herewith.
(b) Reports on Form 8-K:
None
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<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: October 19, 2000 President and Chief Executive Officer
By: /s/ James F. Westmoreland
-----------------------------------------
James F. Westmoreland
Date: October 19, 2000 Vice President, Chief Accounting Officer,
Comptroller and Secretary
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<PAGE> 23
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
<S> <C>
* 10.1 -- Restated Exploration Agreement dated June 30, 2000 between The
Houston Exploration Company and KeySpan Exploration and
Production, L.L.C.
* 27.1 -- Financial Data Schedule.
</TABLE>
----------
* Filed herewith.
