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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, 2001
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 (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
1100 LOUISIANA STREET, SUITE 2000
HOUSTON, TEXAS 77002-5215
(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 31, 2001, 30,406,650 shares of Common Stock, par value
$.01 per share, were outstanding.
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THE HOUSTON EXPLORATION COMPANY
TABLE OF CONTENTS
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, 2001 and December 31, 2000 ....................4
Consolidated Statements of Operations -- Three Month and Nine Month Periods Ended
September 30, 2001 and 2000 ............................................................5
Consolidated Statements of Cash Flows -- Nine Month Periods Ended
September 30, 2001 and 2000 ............................................................6
Notes to Consolidated Financial Statements .................................................7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations .................................................................13
Item 3. Qualitative and Quantitative Disclosures About Market Risk ................................21
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K ..........................................................22
SIGNATURES ..............................................................................................23
-2-
FACTORS AFFECTING FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1993 and
Section 21E of the Securities Exchange Act of 1934. 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. These statements are
subject to certain risks and uncertainties, such as the volatility of natural
gas and oil prices, potential writedowns or impairments, inability to meet
capital requirements, uncertainty of reserve information and future net revenue
estimates, reserve replacement risks, drilling risks, operating risks of natural
gas and oil operations, acquisition risks, hedging risks, government regulation,
environmental matters, competition and potential conflicts of interests with our
majority shareholder. 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 "Risk Factors Affecting Our Business" in "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.
-3-
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
2001 2000
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(UNAUDITED)
ASSETS:
Cash and cash equivalents ............................................................ $ 2,896 $ 9,675
Accounts receivable .................................................................. 41,891 100,966
Accounts receivable -- Affiliate ..................................................... 683 13,635
Derivative financial instruments ..................................................... 68,784 --
Inventories .......................................................................... 1,733 1,923
Prepayments and other ................................................................ 2,817 1,913
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Total current assets ........................................................ 118,804 128,112
Natural gas and oil properties, full cost method
Unevaluated properties ............................................................. 168,193 142,890
Properties subject to amortization ................................................. 1,380,717 1,162,000
Other property and equipment ......................................................... 10,727 9,852
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1,559,637 1,314,742
Less: Accumulated depreciation, depletion and amortization ........................... (701,729) (609,352)
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857,909 705,390
Other assets ......................................................................... 18,534 3,882
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TOTAL ASSETS ................................................................ $ 995,247 $ 837,384
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LIABILITIES:
Accounts payable and accrued expenses ................................................ $ 99,356 $ 108,366
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Total current liabilities ................................................... 99,356 108,366
Long-term debt and notes ............................................................. 160,000 245,000
Deferred federal income taxes ........................................................ 171,806 87,040
Other deferred liabilities ........................................................... 206 236
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TOTAL LIABILITIES ........................................................... 431,368 440,642
COMMITMENTS AND CONTINGENCIES (SEE NOTE 3):
STOCKHOLDERS' EQUITY:
Common Stock, $.01 par value, 50,000,000 shares authorized and 30,388,190 shares
issued and outstanding at September 30, 2001 and 29,829,050 shares issued and
outstanding at December 31, 2000, respectively .................................... 304 298
Additional paid-in capital ........................................................... 335,699 325,205
Retained earnings .................................................................... 176,968 71,239
Unearned compensation ................................................................ (213) --
Accumulated other comprehensive income ............................................... 51,121 --
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TOTAL STOCKHOLDERS' EQUITY ................................................. 563,879 396,742
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................. $ 995,247 $ 837,384
============= ============
The accompanying notes are an integral part of
these consolidated financial statements.
-4-
THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED, NINE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2001 2000 2001 2000
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(UNAUDITED)
REVENUES:
Natural gas and oil revenues ................... $ 78,150 $ 62,479 $ 301,062 $ 168,930
Other .......................................... 345 424 1,083 1,251
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Total revenues ......................... 78,495 62,903 302,145 170,181
OPERATING EXPENSES:
Lease operating ................................ 6,436 5,331 19,440 17,420
Severance tax .................................. 1,771 2,424 9,500 6,125
Depreciation, depletion and amortization ....... 32,102 20,740 92,365 61,747
General and administrative, net ................ 3,792 1,929 14,371 6,690
---------- ---------- ---------- ----------
Total operating expenses ............... 44,101 30,424 135,676 91,982
Income from operations ........................... 34,394 32,479 166,469 78,199
Strategic review expenses ........................ -- -- 119 1,752
Interest expense, net ............................ 213 2,577 2,683 9,115
---------- ---------- ---------- ----------
Net income before income taxes ................... 34,181 29,902 163,667 67,332
Provision for federal income taxes ............... 11,651 10,236 57,938 22,889
---------- ---------- ---------- ----------
NET INCOME ....................................... $ 22,530 $ 19,666 $ 105,729 $ 44,443
========== ========== ========== ==========
Net income per share ............................. $ 0.74 $ 0.67 $ 3.50 $ 1.62
========== ========== ========== ==========
Net income per share -- assuming dilution ........ $ 0.73 $ 0.66 $ 3.45 $ 1.60
========== ========== ========== ==========
Weighted average shares outstanding .............. 30,368 29,191 30,167 27,410
Weighted average shares outstanding -- assuming
dilution ..................................... 30,769 29,664 30,609 27,729
The accompanying notes are an integral part of
these consolidated financial statements.
-5-
THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------
2001 2000
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(UNAUDITED)
OPERATING ACTIVITIES:
Net income ........................................................... $ 105,729 $ 44,443
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation, depletion and amortization ........................... 92,365 61,747
Deferred income tax expense ........................................ 58,573 23,556
Stock compensation expense ......................................... 43 --
Changes in operating assets and liabilities:
Decrease (increase) in accounts receivable ...................... 72,027 (28,180)
Decrease (increase) in inventories .............................. 190 (493)
Increase in prepayments ......................................... (904) (466)
(Increase) decrease in other assets and liabilities ............. (4,818) 781
(Decrease) increase in accounts payable and accrued expenses .... (9,010) 8,578
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Net cash provided by operating activities ............................ 314,195 109,966
INVESTING ACTIVITIES:
Investment in property and equipment ................................. (244,884) (121,732)
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Net cash used in investing activities ................................ (244,884) (121,732)
FINANCING ACTIVITIES:
Proceeds from long term borrowings ................................... 83,000 30,000
Repayments of long term borrowings ................................... (168,000) (37,000)
Proceeds from issuance of common stock ............................... 8,910 5,637
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Net cash used in financing activities ................................ (76,090) (1,363)
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Decrease in cash and cash equivalents ................................ (6,779) (13,129)
Cash and cash equivalents, beginning of period ....................... 9,675 15,502
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Cash and cash equivalents, end of period ............................. $ 2,896 $ 2,373
============ ============
Cash paid for interest ............................................... $ 13,945 $ 21,743
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Cash paid for taxes .................................................. $ -- $ --
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The accompanying notes are an integral part of
these consolidated financial statements.
-6-
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: (i) high potential offshore exploration
and exploitation; (ii) lower risk, high impact exploitation and development
drilling onshore; and (iii) selective opportunistic acquisitions both offshore
and onshore. At December 31, 2000, the Company had net proved reserves of 562
Bcfe, 94% of which were natural gas and 77% 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 an indirect wholly-owned 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, 2001, THEC Holdings Corp., an indirect wholly owned subsidiary
of KeySpan, owned approximately 68% of the outstanding shares of Houston
Exploration's common stock. KeySpan, a member of the Standard & Poor's 500
Index, is a diversified energy provider that (i) distributes natural gas to 2.5
million customers in the Brooklyn, Long Island, Queens and Staten Island areas
of New York and to customers in eastern and central Massachusetts and central
New Hampshire; (ii) generates and manages electricity transmission and
distribution through the ownership and operation of generating plants throughout
New York state and through its contract with the Long Island Power Authority to
manage electricity service to 1.1 million customers in the Long Island area; and
(iii) through its other subsidiaries is involved in various energy services and
energy related investments including wholesale and retail gas and electric
marketing, appliance service and installation, large energy-system installation
and management, fiber optic telecommunications and energy-related internet
activities.
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, 2001 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, 2000 is derived from the December 31, 2000 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, 2000.
-7-
THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In the opinion of management, all estimates and adjustments, consisting
of normal recurring accruals, necessary to present fairly the information in the
accompanying financial statements have been included. The results of operations
for such interim periods are not necessarily indicative of the results for the
full year.
Reclassifications and Use of Estimates
The preparation of 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.
New Accounting Pronouncements
The Financial Accounting Standards Board ("FASB") has recently issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," SFAS No. 142, "Goodwill and Other Intangible Assets," SFAS No.
143, "Accounting for Asset Retirement Obligations" and SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets."
SFAS No. 141, "Business Combinations," requires the use of the purchase
method of accounting for all business combinations initiated after June 30,
2001. SFAS No. 142, "Goodwill and Other Intangible Assets", addresses accounting
for the acquisition of intangible assets and accounting for goodwill and other
intangible assets after they have been initially recognized in the financial
statements. Houston Exploration does not currently have goodwill or other
similar intangible assets; therefore, the adoption of the new standard on
January 1, 2002, will not have a material effect on the Company's financial
statements.
SFAS No. 143, "Accounting for Asset Retirement Obligations," addresses
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. SFAS No.
143 will be effective for the Company January 1, 2003 and early adoption is
encouraged. SFAS No. 143 requires that the fair value of a liability for an
asset's retirement obligation be recorded in the period in which it is incurred
and the corresponding cost capitalized by increasing the carrying amount of the
related long-lived asset. The liability is accreted to its then present value
each period, and the capitalized cost is depreciated over the useful life of the
related asset. If the liability is settled for an amount other than the recorded
amount, a gain or loss is recognized. Currently, the Company does accrue for
certain dismantlement costs through depletion and is therefore evaluating the
impact the new standard will have on its financial statements.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," is effective for the Company January 1, 2002, and addresses accounting
and reporting for the impairment or disposal of long-lived assets. SFAS No. 144
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of" and APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business." SFAS No. 144 retains the fundamental provisions of SFAS No. 121 and
expands the reporting of discontinued operations to include all components of an
entity with operations that can be distinguished from the rest of the entity and
that will be eliminated from the ongoing operations of the entity in a disposal
transaction. The Company estimates that the new standard will not have a
material impact on its financial statements.
-8-
THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
THREE MONTHS ENDED, NINE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2001 2000 2001 2000
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(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net income .............................................. $ 22,530 $ 19,666 $ 105,729 $ 44,443
========== ========== ========== ==========
Weighted average shares outstanding ..................... 30,368 29,191 30,167 27,410
Add: dilutive securities
Options ....................................... 401 473 442 319
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Total weighted average shares outstanding and dilutive
securities ............................................ 30,769 29,664 30,609 27,729
========== ========== ========== ==========
Net income per share .................................... $ 0.74 $ 0.67 $ 3.50 $ 1.62
========== ========== ========== ==========
Net income per share -- assuming dilution ............... $ 0.73 $ 0.66 $ 3.45 $ 1.60
========== ========== ========== ==========
NOTE 2 -- LONG-TERM DEBT AND NOTES
SEPTEMBER 30, 2001 DECEMBER 31, 2000
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(IN THOUSANDS)
SENIOR DEBT:
Bank revolving credit facility, due 2003 ....... $ 60,000 $ 145,000
SUBORDINATED DEBT:
8 5/8% Senior Subordinated Notes, due 2008 ..... 100,000 100,000
------------------ -----------------
Total long-term debt and notes ............. $ 160,000 $ 245,000
================== =================
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, 2001, the quoted market value of the
Company's $100 million of 8 5/8% Senior Subordinated Notes was 97% of the $100
million carrying value or $97 million.
Credit Facility
The Company maintains a revolving bank credit facility (the "Credit
Facility") with a syndicate of lenders led by JP Morgan Chase, National
Association ("JP Morgan Chase). The Credit Facility, as amended, provides a
maximum commitment of $250 million, subject to borrowing base limitations. At
September 30, 2001, the Company's borrowing base was $250 million. Up to $2
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, 2001, $60 million was outstanding under the
Credit Facility and $0.4 million was outstanding in letter of credit
obligations.
-9-
THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Interest is payable on borrowings under the Credit Facility, at the
Company's option, at (i) a fluctuating rate equal to the greater of the Federal
Funds rate plus 0.5% or JP Morgan Chase's prime rate, or (ii) a 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 year on
the unused portion of the designated borrowing base, and (ii) an additional fee
equal to 33% of the commitment fee on the daily average amount by which the
total amount of commitments exceeds 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) limits to 70% of total production 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, 2001, the Company was in compliance with all
such covenants.
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. 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
Restricted Stock Grant to New President and Chief Executive
On April 4, 2001, the Company's Board of Directors appointed William G.
Hargett to serve as the Company's President and Chief Executive Officer and to
serve on its Board of Directors. Pursuant to an employment agreement entered
into on April 4, 2001 between the Company and Mr. Hargett, Mr. Hargett received
a grant of 10,000 restricted shares of Houston Exploration common stock with a
fair market value of approximately $256,000 at the time of grant. The stock is
restricted from transfer and subject to forfeiture in the event Mr. Hargett's
employment is terminated prior to April 4, 2004 and will otherwise vest, be
nonforfeitable and freely transferable in equal one-third increments on each
anniversary of the grant date. The cost of the restricted stock will be
recognized in earnings as compensation expense over the stock's three year
vesting period.
-10-
THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Termination of Employment Agreements for Executives
Effective September 30, 2001, Thomas W. Powers, the Company's Chief
Financial Officer, left the Company to pursue other interests. In connection
with the termination of his employment agreement with the Company, Mr. Powers
will receive a lump sum severance payment of up to approximately $1.5 million.
Effective March 31, 2001, the Company's President and Chief Executive Officer
and Director, James G. Floyd, and the Senior Vice President - Exploration and
Production, Randall J. Fleming, retired from the Company. Each had served in
their respective positions since the Company's inception in 1986. In connection
with their retirement as executive officers of the Company, each of Messrs.
Floyd and Fleming agreed to the termination of their respective employment
agreements. They received lump sum severance payments of $2.3 million and $1.4
million, respectively. In total, the Company has incurred approximately $5.2
million in general and administrative expenses during the nine months ended
September 30, 2001 as a result of the termination of employment contracts with
former executives.
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
two year term expiring December 31, 2000. Under the terms of the KeySpan Joint
Venture, the Company contributed all of its then undeveloped offshore acreage to
the joint venture and KeySpan received 45% of Houston Exploration's working
interest in all prospects drilled under the program. KeySpan paid 100% of actual
intangible drilling costs for the joint venture up to a specified maximum and
all additional intangible drilling costs incurred were paid 51.75% by KeySpan
and 48.25% by Houston Exploration. Revenues are shared 55% Houston Exploration
and 45% KeySpan. In addition, the Company received reimbursements from KeySpan
for a portion of its general and administrative costs.
During the initial two-year term of the joint drilling program
beginning January 1, 1999 and ending December 31, 2000, the Company, together
with KeySpan, drilled a total of 21 wells: 17 exploratory and four development,
five of which were unsuccessful. KeySpan spent a total of $82.1 million on
exploration and development, $46.5 million in 2000 and $35.6 million in 1999.
Houston Exploration received a total of $7.3 million in general and
administrative cost reimbursements, $2.5 million in 2000 and $4.8 million in
1999.
Effective December 31, 2000, the Company and KeySpan agreed not to
renew the primary or exploratory term of the KeySpan Joint Venture. As a result,
KeySpan will not participate in the Company's future offshore exploration
prospects nor will the Company receive any reimbursement from KeySpan for future
general and administrative costs. However, pursuant to the terms of the joint
venture agreement, KeySpan will continue to maintain its working interest in all
wells drilled under the KeySpan Joint Venture. For the year 2001, KeySpan has
agreed to commit approximately $17 million for the development of prospects
successfully drilled during 1999 and 2000. During the three month periods ended
September 30, 2001 and 2000, KeySpan incurred approximately $3.4 million and
$14.8 million, respectively, in capital costs under the KeySpan Joint Venture.
For the nine month periods ended September 30, 2001 and 2000, KeySpan incurred
approximately $13.5 million and $28.6 million, respectively, in capital costs.
The Company received no reimbursements for general and administrative expenses
during 2001 compared to $625,000 per quarter or $1.9 million for the first nine
months of 2000.
-11-
THE HOUSTON EXPLORATION COMPANY
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
KeySpan Credit Facility and Conversion
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. Under the terms of the KeySpan Facility, 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 68%. 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 issuance of additional shares of Company common
stock to KeySpan as a result of the conversion of the KeySpan Facility was
approved by the Company's stockholders at the Company's annual meeting held
April 27, 1999. Borrowings under the KeySpan Facility 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. Pursuant to the conversion, the
KeySpan Facility terminated on March 31, 2000. For the three months ended March
31, 2000, the Company incurred $1.5 million in interest and fees to KeySpan.
-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, 2001 and 2000. 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:
o high potential offshore exploration and exploitation;
o lower risk, high impact exploitation and development drilling
onshore; and
o selective opportunistic acquisitions both offshore and onshore.
At December 31, 2000, net proved reserves were 562 Bcfe with a
discounted present value of cash flows before income taxes ("PV-10%") of $2.8
billion. The Company's focus is natural gas and approximately 94% of its net
proved reserves at December 31, 2000 were natural gas and approximately 77% were
classified as proved developed. The Company operates approximately 85% 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 commodity prices may fluctuate
significantly 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. Under full cost accounting a quarterly ceiling test calculation is
required using commodity prices as of the end of the period. If capitalized
costs (net of accumulated depreciation, depletion and amortization) less
deferred taxes are greater than 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 (the "ceiling limitation"), a
writedown or impairment of the full cost pool is required. A writedown of the
carrying value of the full cost pool is a non-cash charge to earnings that, once
incurred, is not reversible at a later date.
The ceiling test calculation does not consider the impact of hedged
production. However, SFAS 133, "Accounting for Derivatives Instruments and
Hedging Activities", requires that if assets are impaired and derivatives have
been used to hedge the future cash inflows from those assets, the impairment
charge to earnings is to be offset by reclassifying into earnings, to the extent
available, any net gain that has been deferred in accumulated other
comprehensive income relating to the fair value of hedged production. As a
result, the impairment charge to earnings could be completely eliminated or
reduced to the extent a deferred gain on hedged production exists.
As of September 30, 2001, the Company estimated, using a September 2001
NYMEX price of $2.295, that the actual capitalized costs of its natural gas and
oil properties (the "full cost pool") exceeded the estimated future
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net revenues or the "ceiling limitation" imposed under full cost accounting
rules by approximately $32.3 million, after taxes. The estimated $32.3 million
charge to earnings would be entirely eliminated due to the reclassification of a
portion of hedging gains deferred in Accumulated Other Comprehensive Income.
However, subsequent to September 30, 2001 and prior to the filing of this
quarterly report on Form 10-Q for the third quarter of 2001, natural gas prices
increased such that the Company estimated, using a November 2001 NYMEX price of
$3.202, that a "cushion" existed whereby the carrying value of the full cost
pool was less than the ceiling limitation. As a result of the increase in
natural gas prices, the Company was not required to write down or impair its
full cost pool as of September 30, 2001. Natural gas prices continue to be
volatile and the risk that the Company will be required to writedown its full
cost pool increases when natural gas prices are depressed or if the Company has
significant downward revisions in its estimated proved reserves.
Recent Developments
Increase in Capital Expenditure Budget. At the quarterly meeting of the
Company's Board of Directors held October 25, 2001, the Company's 2001 capital
expenditure budget was increased from $300 million to $310 million.
Appointment of New Executive Officer. Effective October 22, 2001, the
Board of Directors appointed Steven L. Mueller to the newly created position of
Senior Vice President and General Manager - Onshore Division. Prior to joining
Houston Exploration, Mr. Mueller had been Senior Vice President - Exploration
and Production for Belco Oil and Gas Corp. Mr. Mueller joined Belco Oil and Gas
Corp. in 1996 and held various senior management positions involving oil and gas
exploration. From 1992 to 1996 Mr. Mueller was Exploitation Vice President for
American Exploration Company. From 1988 to 1992, Mr. Mueller was Exploration
Manager - South Louisiana for Fina Oil and Chemical Company. Mr. Mueller began
his career with Tenneco Oil Corporation in 1975 and held various geological and
engineering positions with Tenneco from 1975 to 1988. Mr. Mueller received his
B.S. in Geological Engineering from the Colorado School of Mines in 1975.
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RESULTS OF OPERATIONS
The following table sets forth the Company's historical operating data
during the periods indicated:
THREE MONTHS ENDED, NINE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
PRODUCTION:
Natural gas (MMcf) .......................... 21,332 18,693 64,722 56,509
Oil (MBbls) ................................. 117 64 328 238
Total (MMcfe) ............................... 22,034 19,077 66,690 57,937
AVERAGE SALES PRICES:
Natural gas (per Mcf) realized(1) ........... $ 3.53 $ 3.24 $ 4.53 $ 2.88
Natural gas (per Mcf) unhedged .............. 2.71 4.23 4.71 3.33
Oil (per Bbl) ............................... 24.74 29.27 24.59 26.29
OPERATING EXPENSES (PER MCFE):
Lease operating ............................. $ 0.29 $ 0.28 $ 0.29 $ 0.30
Severance tax ............................... 0.08 0.13 0.14 0.11
Depreciation, depletion and amortization .... 1.46 1.09 1.38 1.07
General and administrative, net ............. 0.17 0.10 0.22 0.12
----------
(1) Reflects the effects of hedging.
RECENT FINANCIAL AND OPERATING RESULTS
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2000 AND 2001
Production. Houston Exploration's production increased 16% from 19,077
million cubic feet equivalent (MMcfe) for the three months ended September 30,
2000 to 22,034 MMcfe for the three months ended September 30, 2001. The increase
in production was primarily attributable to newly developed offshore production
brought on-line since the end of the third quarter of 2000 at Matagorda Island
704, Galveston Island 144, 190, 241 and 389, High Island 39 and 115/133 and
North Padre Island 883. Offshore production increased a total of 29% or 29
MMcfe/day from 99 MMcfe/day during the third quarter of 2000 to 128 MMcfe/day
during the third quarter of 2001. Onshore, total production increased slightly
by 4%, from 108 MMcfe/day during the third quarter of 2000 to 112 MMcfe/day
during the third quarter of 2001. The increase in onshore production was due
primarily to a 4% increase in average daily production at the Company's Charco
Field in South Texas from 74 MMcfe/day during the third quarter of 2000 and to
77 MMcfe/day during the third quarter of 2001.
Natural Gas and Oil Revenues. Natural gas and oil revenues increased
25% from $62.5 million for the three months ended September 30, 2000 to $78.1
million for the three months ended September 30, 2001. The increase in revenues
was due to the 16% increase in production combined with a 9% increase in average
realized natural gas prices from $3.24 per Mcf for the three months ended
September 30, 2000 to $3.53 per Mcf for the three months ended September 30,
2001.
Natural Gas Prices. As a result of hedging activities, the Company
realized an average gas price of $3.53 per Mcf for the three months ended
September 30, 2001, which was 130% of the average unhedged natural gas price of
$2.71 that otherwise would have been received, resulting in natural gas and oil
revenues for the third quarter of 2001 that were $17.5 million higher than the
revenues the Company would have achieved if hedges had not been in place during
the period. For the corresponding three month period of 2000, the Company
realized an average gas price of $3.24 per Mcf, which was 77% of the average
unhedged natural gas price of $4.23 per Mcf that
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otherwise would have been received, resulting in natural gas and oil revenues
that were $18.5 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 21% from $5.3 million for the three months ended September 30, 2000 to
$6.4 million for the three months ended September 30, 2001. On an Mcfe basis,
lease operating expenses increased from $0.28 during the third quarter of 2000
to $0.29 during the third quarter of 2001. The increase in both the lease
operating expenses and lease operating expense per Mcfe during the third quarter
of 2001 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 production
onshore and offshore in state waters, decreased 25% from $2.4 million for the
three months ended September 30, 2000 to $1.8 million for the three months ended
September 30, 2001. On an Mcfe basis, severance tax decreased from $0.13 per
Mcfe during the third quarter of 2000 to $0.08 per Mcfe during the third quarter
of 2001. The decrease in severance tax expense and severance tax per Mcfe is due
to lower wellhead prices for natural gas and oil during the third quarter of
2001 as compared to wellhead prices during the corresponding period of 2000.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization expense increased 55% from $20.7 million for the three months ended
September 30, 2000 to $32.1 million for the three months ended September 30,
2001. Depreciation, depletion and amortization expense per Mcfe increased by 34%
from $1.09 for the three months ended September 30, 2000 to $1.46 for the
corresponding three months in 2001. The increase in depreciation, depletion and
amortization expense reflects the 16% increase in production during the third
quarter of 2001 as compared to the third quarter of 2000 combined with an
increase in the depletion rate. The higher depletion rate is a result of a
higher level of capital spending and higher costs during 2001 as compared to the
prior year combined with the addition of fewer new reserves since the end of the
third quarter of 2000.
General and Administrative Expenses. General and administrative
expenses, net of overhead reimbursements received from other working interest
owners of $0.9 million and $0.3 million for the three months ended September 30,
2000 and 2001, respectively, increased 100% from $1.9 million for the three
months ended September 30, 2000 to $3.8 million for the three months ended
September 30, 2001. Included in reimbursements received from working interest
owners for the third quarter of 2000 were reimbursements totaling $0.6 million
received from KeySpan pursuant to the KeySpan Joint Venture (see Note 4 --
Related Party Transactions). Effective December 31, 2000 and pursuant to the
expiration of the initial exploratory term of the KeySpan Joint Venture, the
Company no longer receives reimbursement of general and administrative expenses
from KeySpan. The Company capitalized general and administrative expenses
directly related to oil and gas exploration and development activities of $2.1
million and $2.6 million, respectively, for the three months ended September 30,
2000 and 2001. The increase in capitalized general and administrative expenses
is a result of higher aggregate general and administrative expenses during the
third quarter of 2001 as compared to the corresponding period of 2000. Aggregate
general and administrative expenses were higher during the third quarter of 2001
as a result of: (i) a one-time charge of $1.5 million in connection with the
termination of the former Chief Financial Officer's employment agreement; (ii)
expansion of the Company's workforce; and, (iii) an increase in compensation and
benefit related expenses.
On an Mcfe basis, general and administrative expenses increased 70%
from $0.10 for the three months ended September 30, 2000 to $0.17 for the three
months ended September 30, 2001. Excluding the one-time charge of $1.5 million
for the termination of a former executive's employment contract, general and
administrative expenses on a per Mcfe basis would have increased 10% from $0.10
for the three months ended September 30, 2000 to $0.11 for the three months
ended September 30, 2001. The higher rate per Mcfe during the third quarter of
2001 reflects the increase in aggregate general and administrative expenses
caused by the effect of the termination of reimbursements received pursuant to
the KeySpan Joint Venture which were $0.6 million per quarter during 2000
combined with expansion of the Company's workforce and an increase in
compensation and benefit related expenses.
Interest Expense. Interest expense, net of capitalized interest,
decreased 92% from $2.6 million for the three months ended September 30, 2000 to
$0.2 million for the three months ended September 30, 2000. Aggregate interest
expense decreased 47% from $6.0 million for the three months ended September 30,
2000 to $3.2 million
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for the corresponding three months of 2001. The decrease in aggregate interest
is due to a combination of a decrease in interest rates and the paydown of $114
million in borrowings under the revolving bank credit facility since September
30, 2000, of which $85 million was paid during the first nine months of 2001.
Capitalized interest decreased 12% from $3.4 million during the third quarter of
2000 to $3.0 million during the corresponding three months of 2001. The decrease
in capitalized interest during the third quarter of 2001 is due to the decrease
in aggregate interest expense offset in part by a higher level of exploratory
drilling during the third quarter of 2001.
Income Tax Provision. The provision for income taxes increased 15% from
$10.2 million for the three months ended September 30, 2000 to $11.7 million for
the three months ended September 30, 2001. The increase in income tax expense
for the third quarter of 2001 as compared to the third quarter of 2000 is due to
the 15% increase in pretax income for the three months ended September 30, 2001
as a result of and increase in production, higher natural gas prices and a
decrease in interest expense, offset in part by higher operating expenses.
Operating Income and Net Income. For the three months ended September
30, 2001, the 16% increase in production combined with the 9% increase in
natural gas prices, offset in part by a 45% increase in operating expense,
caused operating income to increase 6% from $32.5 million during the third
quarter of 2000 to $34.4 million during the third quarter of 2001.
Correspondingly, net income increased 14% from $19.7 million for the three
months ended September 30, 2000 to $22.5 million for the three months ended
September 30, 2001 and reflects lower interest expense and higher taxes.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 2001
Production. Houston Exploration's production increased 15% from 57,937
MMcfe for the nine months ended September 30, 2000 to 66,690 MMcfe for the nine
months ended September 30, 2001. The increase in production was primarily
attributable to newly developed offshore production brought on-line since the
end of the third quarter of 2000. Offshore production increased 32% from an
average of 95 MMcfe/day during the first nine months of 2000 to an average of
125 MMcfe/day during the first nine months of 2001. This increase is primarily
attributable to newly developed production at Matagorda Island 704, Galveston
Island 144, 190, 241 and 389, High Island 39 and 115/133 and North Padre Island
883. Onshore, daily production rates increased slightly by 2% from an average of
117 MMcfe/day during the first nine months of 2000 to an average of 119
MMcfe/day during the first nine months of 2001. The increase in onshore
production was primarily attributable to a slight increase production from the
Company's Charco Field located in South Texas.
Natural Gas and Oil Revenues. Natural gas and oil revenues increased
78% from $168.9 million for the nine months ended September 30, 2000 to $301.1
million for the nine months ended September 30, 2001 as a result of a 57%
increase in average realized natural gas prices, from $2.88 per Mcf for the nine
months ended September 30, 2000 to $4.53 per Mcf for the nine months ended
September 30, 2001, 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 $4.53 per Mcf for the nine months ended
September 30, 2001, which was 96% of the average unhedged natural gas price of
$4.71 that otherwise would have been received, resulting in natural gas and oil
revenues for the nine months ended September 30, 2001 that were $11.8 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 2000,
the Company realized an average gas price of $2.88 per Mcf, which was 86% of the
average unhedged natural gas price of $3.33 per Mcf that otherwise would have
been received, resulting in natural gas and oil revenues that were $25.2 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 11% from $17.4 million for the nine months ended September 30, 2000 to
$19.4 million for the nine months ended September 30, 2001. On an Mcfe basis,
lease operating expenses decreased from $0.30 for the nine first months of 2000
to $0.29 for the first nine months of 2001. The increase in lease operating
expenses for the nine months ended September 30, 2001 is attributable to the
continued expansion of the Company's operations combined with an increase in
service costs across the industry. The decrease in lease operating expenses per
Mcfe reflects the 15% increase in
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production volume for the first nine months of 2001. Severance tax, which is a
function of volume and revenues generated from onshore production as well as
offshore production in state waters, increased from $6.1 million for the nine
months ended September 30, 2000 to $9.5 million for the nine months ended
September 30, 2001. On an Mcfe basis, severance tax increased from $0.11 per
Mcfe for the nine month periods ended September 30, 2000 to $0.14 per Mcfe for
the corresponding period of 2001. The increase in severance tax expense and the
rate per Mcfe reflects the higher natural gas prices during the first nine
months of 2001 as compared to the first nine months of 2000 combined with newly
developed offshore production located in state waters brought on-line since the
end of the third quarter of 2000.
Depreciation, Depletion and Amortization. Depreciation, depletion and
amortization expense increased 50% from $61.7 million for the nine months ended
September 30, 2000 to $92.4 million for the nine months ended September 30,
2001. Depreciation, depletion and amortization expense per Mcfe increased 29%
from $1.07 for the nine months ended September 30, 2000 to $1.38 for the nine
months ended September 30, 2001. 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 a result of a higher level
of capital spending during first nine months of 2001 as compared to the
corresponding period of 2000 ($245 million spent for the first nine months of
2001 compared to $122 million spent in the corresponding nine months of 2000)
combined with the addition of fewer new reserves since the end of the third
quarter of 2000.
General and Administrative Expenses. General and administrative
expenses, net of overhead reimbursements received from other working interest
owners, of $2.6 million and $0.9 million for the nine months ended September 30,
2000 and 2001, respectively, increased 115% from $6.7 million for the nine
months ended September 30, 2000 to $14.4 million for the nine months ended
September 30, 2001. Included in reimbursements received from working interest
owners for the nine months ended September 30, 2000 were reimbursements totaling
$1.9 million received from KeySpan pursuant to the KeySpan Joint Venture (see
Note 4 -- Related Party Transactions). Overhead reimbursements were terminated
December 31, 2000 with the expiration of the initial exploratory term of the
KeySpan Joint Venture, and as a result the Company no longer receives
reimbursement of general and administrative expenses from KeySpan. The Company
capitalized general and administrative expenses directly related to oil and gas
exploration and development activities of $7.3 million and $10.0 million,
respectively, for the nine months ended September 30, 2000 and 2001. The
increase in capitalized general and administrative expenses is a result of
higher aggregate general and administrative expenses during the first nine
months of 2001 as compared to the corresponding period of 2000. Aggregate
general and administrative expenses are higher during the first nine months of
2001 as a result of: (i) one-time payments totaling $5.2 million in connection
with the termination of former executive officers' employment contracts during
the first and third quarters of 2001; (ii) expansion of the Company's workforce;
and (iii) an increase in incentive compensation and benefit related expenses.
On an Mcfe basis, general and administrative expenses increased 83%
from $0.12 for the nine months ended September 30, 2000 to $0.22 for the nine
months ended September 30, 2001. Excluding the one-time charges taken for the
termination of employment contracts totaling $5.2 million, general and
administrative expenses on a per Mcfe basis would have increased 17% from $0.12
for the nine months ended September 30, 2000 to $0.14 for the nine months ended
September 30, 2001. The higher rate per Mcfe during the first nine months of
2001 reflects the increase in aggregate general and administrative expenses
caused by the effects of the termination of reimbursements received pursuant to
the KeySpan Joint Venture which were $625,000 per quarter during 2000 or $1.9
million for the first nine months of 2000 combined with the expansion of the
Company's workforce and higher incentive compensation and benefit related
expenses.
Strategic Review Expenses. During the first nine months of 2001, the
Company incurred an additional $119,000 in strategic review expenses which
compares to $1.8 million in expenses that were recognized during the first nine
months of 2000. In September 1999, the Company and KeySpan, the Company's
majority stockholder, announced their intention to review strategic alternatives
for the Company and 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
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alternatives for Houston Exploration was complete. KeySpan has announced that it
considers its investment in Houston Exploration a non-core asset.
Interest Expense, Net. Interest expense, net of capitalized interest,
decreased 70% from $9.1 million for the nine months ended September 30, 2000 to
$2.7 million for the nine ended September 30, 2001. Aggregate interest expense
decreased 38% from $19.2 million for the nine months ended September 30, 2000 to
$11.9 million during the corresponding period of 2001. The decrease in aggregate
interest is due to a decrease in interest rates combined with (i) the paydown of
$114 million in borrowings under the revolving bank credit facility since
September 30, 2000, of which $85 million was paid during the first nine months
of 2001; and (ii) the March 31, 2000 conversion of $80 million in outstanding
borrowings under a revolving credit facility with KeySpan into shares of common
stock of the Company (see Note 4 -- Related Party Transactions -- KeySpan Credit
Facility and Conversion). Capitalized interest decreased 9% from $10.1 million
for the nine months ended September 30, 2000 to $9.2 million for the nine months
ended September 30, 2001 and reflects the decrease in aggregate interest expense
offset in part by a higher level of exploratory drilling during the first nine
months of 2001.
Income Tax Provision. The provision for income taxes increased from
$22.9 million for the first nine months of 2000 to $57.9 million for the first
nine months of 2001 due to the 143% increase in pretax income during the first
nine months of 2001 from $67.3 million for the nine months ended September 30,
2000 to $163.7 million for the first nine months of 2001 as a result of the
combination of higher natural gas prices, an increase in production, a decrease
in interest expense offset in part by higher operating expenses.
Operating Income and Net Income. For the nine months ended September
30, 2001, the 57% increase in natural gas prices combined with the 15% increase
in production, offset in part by a 48% increase in operating expenses, caused
operating income to increase 113% from $78.2 million during the first nine
months of 2000 to $166.5 million during the first nine months of 2001.
Correspondingly, net income increased 138% from $44.4 million for the nine
months ended September 30, 2000 to $105.7 million for the nine months ended
September 30, 2001 and reflects lower interest expense and higher taxes.
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 issuance of Company common
stock to KeySpan in connection with the conversion, KeySpan's ownership interest
in the Company increased from 64% at December 31, 1999 to 68% as of September
30, 2001.
Cash Flows From Operations. As of September 30, 2001, the Company had
working capital of $19.4 million and $189.6 million of borrowing capacity
available under its revolving bank credit facility. Net cash provided by
operating activities for the nine months ended September 30, 2001 was $314.2
million compared to $110.0 million for the nine months ended September 30, 2000.
The increase in net cash provided by operating activities is due to an increase
in net income caused by substantially higher natural gas prices and an increase
in production combined with an increase in working capital. The increase in
working capital during the first nine months of 2001 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 drilling
activity combined with an increase in operating costs. The Company's cash
position decreased during the first nine months of 2001 by a net paydown of
borrowings under its revolving bank credit facility of $85 million. In addition,
cash increased by $8.9 million during the first nine months of 2001 due to
proceeds received from the issuance of common stock as a result of the exercise
of stock options. Funds used in investing activities consisted of $244.9 million
for investments in property and equipment. As a result of these activities, cash
and cash equivalents decreased $6.8 million from $9.7 million at December 31,
2000 to $2.9 million at September 30, 2001.
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Capital Expenditures. During the nine months of 2001, the Company
invested a total of $244 million in natural gas and oil properties. This
included $67.1 million for exploration, $141.8 million for development drilling,
workovers and construction of platforms and pipelines, $35.1 million for
leasehold and leasehold acquisition costs.
At the Company's quarterly meeting of its Board of Directors held on
July 25, 2001, the Company's capital expenditure budget for the year 2001 was
increased from $225 million to $300 million. The capital budget for the year
2001 was further increased from $300 million to $310 million at the Company's
Board of Directors meeting held October 25, 2001. 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 exploration and
development costs associated with projects in progress or planned for the
current year and amounts are contingent upon drilling success. No significant
abandonment or dismantlement costs are anticipated in 2001. 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.
Shelf Registration Statement. On May 20, 2000, the Company filed a
"shelf" registration statement 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 acquisitions. The Company may not be able to consummate any
offering on acceptable terms.
Capital Structure
Revolving Bank Credit Facility. The Company maintains a revolving bank
credit facility (the "Credit Facility") with a syndicate of lenders led by JP
Morgan Chase, National Association ("JP Morgan Chase"). The Credit Facility, as
amended, provides a maximum commitment of $250 million, subject to borrowing
base limitations. At September 30, 2001, the borrowing base was $250 million. Up
to $2 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, 2001, $60 million was outstanding
under the Credit Facility and $0.4 million was outstanding in letter of credit
obligations.
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. 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.
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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, it
also limits increased future revenues as a result of favorable price movements.
The use of hedging transactions also involves the risk that the counterparties
are 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. If any ineffectiveness occurs, amounts will be
recorded directly to other income or expense.
At September 30, 2001, Company's hedge position had a positive fair
market value of approximately $78.7 million ($51.1 net of taxes). The table
below reflects the Company's position at September 30, 2001. Natural gas
production during the month of September 2001 was 7,314 MMcf (7,544 MMMbtu) or
244 MMcf/day (251 MMMBtu/day).
FIXED PRICE SWAPS COLLARS FAIR VALUE
--------------------- ------------------------------------ -------------
NYMEX NYMEX
VOLUME CONTRACT VOLUME EFFECTIVE CONTRACT PRICE
PERIOD (MMMBTU) PRICE (MMMBTU) AVG FLOOR AVG CEILING ($ THOUSANDS)
--------------- -------- -------- -------- --------- ----------- -------------
October 2001 -- -- 6,200 $ 3.840 $ 5.654 $ 12,462
November 2001 -- -- 6,000 $ 3.840 $ 5.863 $ 9,291
December 2001 -- -- 6,200 3.840 5.863 7,479
January 2002 930 $ 3.01 4,960 3.523 5.172 4,252
February 2002 840 3.01 4,480 3.523 5.172 3,913
March 2002 930 3.01 4,960 3.523 5.172 4,553
April 2002 900 3.01 4,900 3.523 5.172 4,767
May 2002 930 3.01 4,960 3.523 5.172 4,819
June 2002 900 3.01 4,900 3.523 5.172 4,459
July 2002 930 3.01 4,960 3.523 5.172 4,406
August 2002 930 3.01 4,960 3.523 5.172 4,247
September 2002 900 3.01 4,900 3.523 5.172 4,137
October 2002 930 3.01 4,960 3.523 5.172 4,196
November 2002 900 3.01 4,900 3.523 5.172 3,135
December 2002 930 3.01 4,960 3.523 5.172 2,533
These hedging transactions are settled based upon the average of the
reported settlement prices on the New York Mercantile Exchange (the "NYMEX") for
the final trading day of the month (the "settlement price").
With respect to any particular swap transaction, the counterparty is
required to make a payment to the Company in the event that the settlement price
for any settlement period is less than the swap price for such transaction, and
the Company is required to make payment to the counterparty in the event that
the settlement price for any settlement period is greater than the swap price
for such transaction. For any particular collar transaction, the counterparty
is required to make a payment to the Company if the settlement price for any
settlement period is below the floor price for such transaction, and the Company
is required to make payment to the counterparty if the settlement price for any
settlement period is above the ceiling price for such transaction. 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.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NO. DESCRIPTION
----------- -----------
10.1(1)(2) -- Employment Agreement dated July 16, 2001 between The
Houston Exploration Company and Tracy Price.
----------
(1) Filed herewith.
(2) Management contract.
(b) Reports on Form 8-K:
None
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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/ William G. Hargett
--------------------------------------------
William G. Hargett
Date: November 2, 2001 President and Chief Executive Officer
By: /s/ James F. Westmoreland
--------------------------------------------
James F. Westmoreland
Date: November 2, 2001 Vice President, Chief Accounting Officer,
Comptroller and Secretary
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INDEX TO EXHIBITS
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.1 -- Employment Agreement dated July 16, 2001 between The
Houston Exploration Company and Tracy Price.