##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13(a) OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2007
 OR
 o
    
    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
 
 THE HOUSTON EXPLORATION COMPANY
 (Exact name of registrant as specified in its charter)
 Delaware
(State or Other Jurisdiction of 
Incorporation or Organization)
    
    22-2674487
(IRS Employer Identification No.)1100 Louisiana, Suite 2000
Houston, Texas
(Address of Principal Executive Offices)
    
    77002-5215
(Zip Code)
 (713) 830-6800
(Registrants Telephone Number, including Area Code)
 þ o
  þ o o
 o þ




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TABLE OF CONTENTS
 Forward-Looking Statements
    
    
    2Available Information
    
    
    2Part I. Financial Information
    
    
    3Item 1. Condensed Consolidated Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    17Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4. Controls and Procedures
    
    
    31Part II. Other Information
    
    
    31Item 1. Legal Proceedings
    
    
    31Item 1A. Risk Factors
    
    
    31Item 6. Exhibits
    
    
    31SIGNATURES
    
    
    33Computation of Ratio of Earnings to Fixed ChargesCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  - 1 -




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Forward-Looking Statements
  
 Available Information
     - 2 -




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Part I. Financial Information
 
 Item 1. Condensed Consolidated Financial Statements
 THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
 March 31,
    
    
    December 31,2007
    
    
    2006Assets:Cash and cash equivalents
    
    $
    29,487
    
    
    $
    53,950Accounts receivable
    
    
    76,664
    
    
    
    86,416Derivative financial instruments
    
    
    2,494
    
    
    
    Inventories
    
    
    4,786
    
    
    
    2,900Deferred tax asset
    
    
    19,811
    
    
    
    10,244Prepayments and other
    
    
    5,506
    
    
    
    8,370Total current assets
    
    
    138,748
    
    
    
    161,880Natural gas and oil properties, full cost methodUnevaluated properties
    
    
    34,880
    
    
    
    28,317Properties subject to amortization
    
    
    3,605,097
    
    
    
    3,478,878Other property and equipment
    
    
    15,211
    
    
    
    15,1013,655,188
    
    
    
    3,522,296Less: Accumulated depreciation, depletion and amortization
    
    
    1,988,032
    
    
    
    1,930,9641,667,156
    
    
    
    1,591,332Other non-current assets
    
    
    16,368
    
    
    
    18,514Total Assets
    
    $
    1,822,272
    
    
    $
    1,771,726Liabilities:Accounts payable and accrued expenses
    
    $
    144,190
    
    
    $
    151,482Derivative financial instruments
    
    
    27,698
    
    
    
    10,151Total current liabilities
    
    
    171,888
    
    
    
    161,633Long-term debt and notes
    
    
    175,000
    
    
    
    175,000Derivative financial instruments
    
    
    14,165
    
    
    
    17,247Deferred income taxes
    
    
    377,912
    
    
    
    363,322Asset retirement obligations
    
    
    77,314
    
    
    
    72,782Other non-current liabilities
    
    
    21,243
    
    
    
    17,138Total Liabilities
    
    
    837,522
    
    
    
    807,122Commitments and Contingencies (see Note 3)Stockholders Equity:Preferred Stock, $0.01 par value, 5,000,000 shares authorized and no shares issued
    
    
    
    
    
    
    Common Stock, $0.01 par value, 100,000,000 shares authorized and 28,231,771 and
28,098,172 shares issued and outstanding at March 31, 2007 and December 31, 2006,
respectively
    
    
    282
    
    
    
    281Additional paid-in capital
    
    
    260,115
    
    
    
    253,922Retained earnings
    
    
    740,765
    
    
    
    731,150Accumulated other comprehensive income (loss)
    
    
    (16,412
    )
    
    
    (20,749
    )Total Stockholders Equity
    
    
    984,750
    
    
    
    964,604Total Liabilities and Stockholders Equity
    
    $
    1,822,272
    
    
    $
    1,771,726
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THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended March 31,2007
    
    
    2006Revenues:Natural gas and oil revenues
    
    $
    103,623
    
    
    $
    177,019Other
    
    
    208
    
    
    
    585Total revenues
    
    
    103,831
    
    
    
    177,604Operating expenses:Lease operating
    
    
    13,174
    
    
    
    21,812Severance tax
    
    
    1,843
    
    
    
    4,752Transportation expense
    
    
    2,362
    
    
    
    2,771Asset retirement accretion expense
    
    
    1,082
    
    
    
    1,327Depreciation, depletion and amortization
    
    
    57,089
    
    
    
    83,761General and administrative, net of amounts capitalized
    
    
    10,145
    
    
    
    8,606Total operating expenses
    
    
    85,695
    
    
    
    123,029Income from operations
    
    
    18,136
    
    
    
    54,575Other (income) expense
    
    
    (542
    )
    
    
    Interest expense, net of amounts capitalized
    
    
    3,105
    
    
    
    8,721Income before income taxes
    
    
    15,573
    
    
    
    45,854Provision for income taxes
    
    
    5,628
    
    
    
    16,082Net income
    
    $
    9,945
    
    
    $
    29,772Earnings per share:Net income per share  basic
    
    $
    0.36
    
    
    $
    1.03Net income per share  diluted
    
    $
    0.35
    
    
    $
    1.02Weighted average shares outstanding  basic
    
    
    27,945
    
    
    
    29,042Weighted average shares outstanding  diluted
    
    
    28,415
    
    
    
    29,310
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THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three Months Ended March 31,2007
    
    
    2006Operating Activities:Net income
    
    $
    9,945
    
    
    $
    29,772Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation, depletion and amortization
    
    
    57,089
    
    
    
    83,761Deferred income tax expense
    
    
    3,887
    
    
    
    11,524Asset retirement accretion expense
    
    
    1,082
    
    
    
    1,327Stock compensation expense
    
    
    2,421
    
    
    
    2,517Amortization of post retirement benefits
    
    
    83
    
    
    
    Unrealized loss (gain) on derivative instruments
    
    
    18,670
    
    
    
    (4,586
    )Changes in operating assets and liabilities:Accounts receivable
    
    
    9,752
    
    
    
    31,008Inventories
    
    
    (1,886
    )
    
    
    (681
    )Prepayments and other
    
    
    2,864
    
    
    
    5,409Other non-current assets
    
    
    2,146
    
    
    
    1,304Accounts payable and accrued expenses
    
    
    (1,966
    )
    
    
    (37,481
    )Other non-current liabilities
    
    
    2,465
    
    
    
    (1,753
    )Net cash provided by operating activities
    
    
    106,552
    
    
    
    122,121Investing Activities:Investment in property and equipment
    
    
    (134,789
    )
    
    
    (128,391
    )Deposit paid for property acquisition
    
    
    
    
    
    
    (2,200
    )Dispositions and other
    
    
    
    
    
    
    189,371Net cash (used in) provided by investing activities
    
    
    (134,789
    )
    
    
    58,780Financing Activities:Proceeds from long-term borrowings
    
    
    
    
    
    
    163,000Repayments of long-term borrowings
    
    
    
    
    
    
    (336,000
    )Proceeds from issuance of common stock from exercise of stock options
    
    
    3,402
    
    
    
    3,213Excess tax benefit from non-qualified stock options
    
    
    372
    
    
    
    445Net cash provided by (used in) financing activities
    
    
    3,774
    
    
    
    (169,342
    )(Decrease) increase in cash and cash equivalents
    
    
    (24,463
    )
    
    
    11,559Cash and cash equivalents, beginning of period
    
    
    53,950
    
    
    
    7,979Cash and cash equivalents, end of period
    
    $
    29,487
    
    
    $
    19,538Supplemental Information:Non-cash transactions:Change in investments in property and equipment accrued, not paid
    
    $
    5,326
    
    
    $
    7,444Exchange of natural gas and oil producing properties and acreage
    
    
    11,500
    
    
    
    Cash paid during period for:Interest
    
    $
    382
    
    
    $
    6,952Federal and state income taxes paid (refunded)
    
    
    (10,987
    )
    
    
    
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1  Summary of Organization and Significant Accounting Policies
 Overview of Our Business and Pending Merger
  Sale of Gulf of Mexico Assets  2006
    Principles of Consolidation
  Interim Financial Statements
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Use of Estimates
  Reclassifications
  Revenue Recognition and Gas Imbalances
    Cash and Cash Equivalents
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Net Income Per Share
  Three Months EndedMarch 31,2007
    
    
    2006(in thousands, except pershare amounts)Numerator:Net income
    
    $
    9,945
    
    
    $
    29,772Denominator:Weighted average shares outstanding
    
    
    27,945
    
    
    
    29,042Add potentially dilutive securities: options and restricted stock/units
    
    
    470
    
    
    
    268Total weighted average shares outstanding and dilutive securities
    
    
    28,415
    
    
    
    29,310Earnings per share  basic:
    
    $
    0.36
    
    
    $
    1.03Earnings per share  diluted:
    
    $
    0.35
    
    
    $
    1.02
  Comprehensive Income
  Three Months Ended March 31,2007
    
    
    2006(in thousands)Net income
    
    $
    9,945
    
    
    $
    29,772Other comprehensive incomeDerivative instruments settled and reclassified, net of tax
    
    
    4,284
    
    
    
    170,288Future post retirement benefit obligation, net of tax
    
    
    53
    
    
    
    Total other comprehensive income
    
    
    4,337
    
    
    
    170,288Comprehensive income
    
    $
    14,282
    
    
    $
    200,060
 Natural Gas and Oil Properties
 Full Cost Accounting
 
    
    full cost pool (including assets associated with retirement obligations); plus,
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
    
    estimates for future development costs (excluding liabilities associated with retirement obligations); less,
    
    unevaluated properties and their related costs; less,
    
    estimates for salvage.
     Unevaluated Properties
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Asset Retirement Obligations
  Three Months Ended March 31,2007
    
    
    2006(in thousands)ARO liability at January 1,
    
    $
    72,782
    
    
    $
    119,671Accretion expense
    
    
    1,082
    
    
    
    1,327Liabilities incurred  drilling
    
    
    2,110
    
    
    
    1,849Liabilities incurred  assets acquired
    
    
    1,722
    
    
    
    Liabilities settled  assets exchanged/sold
    
    
    (376
    )
    
    
    (30,795
    )Changes in estimates
    
    
    (6
    )
    
    
    (76
    )ARO liability at March 31,
    
    $
    77,314
    
    
    $
    91,976
 Derivative Instruments and Hedging Activities
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Stock-Based Compensation
  Three Months Ended March 31,2007
    
    
    2006(in thousands)Options
    
    $
    1,585
    
    
    $
    1,687Restricted stock/units
    
    
    836
    
    
    
    830Stock compensation expense, gross
    
    
    2,421
    
    
    
    2,517Amounts capitalized
    
    
    (665
    )
    
    
    (746
    )Stock compensation expense, net of amounts capitalized
    
    $
    1,756
    
    
    $
    1,771
   Pending Merger with Forest Oil Corporation
 Income Taxes
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Recent Accounting Pronouncements
   NOTE 2  Long-Term Debt and Notes
 March 31, 2007
    
    
    December 31, 2006(in thousands)Senior Debt:Revolving credit facility, due November 30, 2010
    
    $
    
    
    
    $
    Subordinated Debt:7% senior subordinated notes, due June 15, 2013
    
    
    175,000
    
    
    
    175,000Total long-term debt and notes
    
    $
    175,000
    
    
    $
    175,000
  Revolving Credit Facility
 st st
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Senior Subordinated Notes
   Tender Offer
and Consent Solicitation for $175 Million of 7% Senior Subordinated Notes due 2013
 NOTE 3 Commitments and Contingencies
 Legal Proceedings
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   Severance Tax Refund
  Operating Leases
 th
 Letters of Credit
  Drilling Contracts
  Postretirement Benefit Obligation
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 4  Acquisitions and Dispositions
 Property Exchange  2007
  Sale of Gulf of Mexico Assets  2006
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   NOTE 5  Subsequent Events
 Pending Merger Agreement with Forest Oil Corporation
  Tender Offer and Consent Solicitation for $175 Million of 7% Senior Subordinated Notes due 2013
    - 16 -




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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview of Our Business
    Derivative Instruments and Hedging Activities
  Pending Merger with Forest Oil Corporation
   - 17 -




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Critical Accounting Estimates and Significant Accounting Policies
  Recent Accounting Pronouncements
 Recent Accounting Pronouncements
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Overview of Results for the First Quarter of 2007
 Sale of Gulf of Mexico Assets  2006
  
    
    We entered into an agreement and plan of merger with Forest Oil Corporation on
January 7, 2007. Under the merger agreement, Forest will acquire all of the outstanding
            shares of Houston Exploration for a combination of cash and Forest common stock (see
Consolidated Financial Statements, Note 5  Subsequent Events  Pending Merger with Forest
Oil Corporation);
    
    We generated net income of $9.9 million, which included an unrealized loss of
$18.7 million ($11.9 million after tax) resulting from the change in the fair market value
of our open derivative contracts, compared to $29.8 million in net income during the first
quarter of 2006, which included unrealized gains from hedging activities of $4.6 million
($3.0 million after tax), a decrease of 67% quarter-over-quarter;
    
    We produced approximately 19.5 Bcfe and our average total production rate was
216 MMcfe per day, a decrease of approximately 8.7 Bcfe and 96 MMcfe per day, respectively,
from the first quarter of 2006. This decrease is primarily a result of the sale of
substantially all of our offshore assets during the first half of 2006, offset in part by an
increase in production from our onshore assets;
    
    We increased production from our onshore properties by 7%, to 216 MMcfe per day,
from 202 MMcfe per day during the first quarter of 2006;
    
    We generated $106.6 million in cash flows from operating activities, a decrease
of 13% from the $122.1 million generated during the first quarter of 2006;
    
    Using cash flow generated from operations and cash on-hand, we invested $129.3
million in natural gas and oil properties;
    
    We completed a non-cash, like-kind property exchange valued at $11.5 million,
exchanging all our reserves, producing wells and acreage located in eastern Oklahoma for
reserves, producing wells and acreage located primarily in the Willow Springs Field of East
Texas (see Consolidated Financial Statements, Note 4  Acquisitions and Dispositions); and
    
    We drilled 90 wells, of which 75, or 83%, were successful, including 40 in the
Rockies, 14 in South Texas, 12 in Arkoma, and 9 in East Texas.
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Operating and Financial Results for the three months ended March 31, 2007 compared to the three
months ended March 31, 2006.
  Three Months Ended March 31,Summary Operating Information:
    
    2007
    
    2006
    
    Change
    
    %(in thousands, except prices and percentages)Operating revenues
    
    $
    103,831
    
    
    $
    177,604
    
    
    $
    (73,773
    )
    
    
    -42
    %Operating expenses
    
    
    85,695
    
    
    
    123,029
    
    
    
    (37,334
    )
    
    
    -30
    %Income from operations
    
    
    18,136
    
    
    
    54,575
    
    
    
    (36,439
    )
    
    
    -67
    %Net income
    
    
    9,945
    
    
    
    29,772
    
    
    
    (19,827
    )
    
    
    -67
    %Production:Natural gas (MMcf)
    
    
    17,809
    
    
    
    26,023
    
    
    
    (8,214
    )
    
    
    -32
    %Oil and natural gas liquids (MBbls)
    
    
    274
    
    
    
    348
    
    
    
    (74
    )
    
    
    -21
    %Total (MMcfe)(1)
    
    
    19,453
    
    
    
    28,111
    
    
    
    (8,658
    )
    
    
    -31
    %Average daily production (MMcfe/d)
    
    
    216
    
    
    
    312
    
    
    
    (96
    )
    
    
    -31
    %Average Sales Prices:Natural Gas (per Mcf) unhedged
    
    $
    6.24
    
    
    $
    7.63
    
    
    $
    (1.39
    )
    
    
    -18
    %Natural Gas (per Mcf) realized(2)
    
    
    6.23
    
    
    
    5.84
    
    
    
    0.39
    
    
    
    7
    %Natural Gas (per Mcf) all-in(3)
    
    
    5.19
    
    
    
    6.02
    
    
    
    (0.83
    )
    
    
    -14
    %Oil and natural gas liquids (per Bbl)
realized
    
    $
    41.13
    
    
    $
    58.77
    
    
    $
    (17.64
    )
    
    
    -30
    %
 
 (1)
    
    MMcfe is defined as one million cubic feet equivalent of natural gas,
determined using the ratio of six MMcf of natural gas to one MBbl of crude oil, condensate or
natural gas liquids.(2)
    
    Includes gains and losses realized on derivative contracts settled during
the period.(3)
    
    Includes gains and losses realized on derivative contracts settled during
the period, as well as unrealized gains and losses recognized pursuant to SFAS 133,
Accounting for Derivative Instruments and Hedging Activities. Production Volume
 Three Months Ended March 31,2007
    
    
    2006
    
    
    Change
    
    
    %(in thousands, except percentages)Natural Gas (MMcf):Onshore
    
    
    17,797
    
    
    
    17,816
    
    
    
    (19
    )
    
    
    Offshore
    
    
    12
    
    
    
    8,207
    
    
    
    (8,195
    )
    
    
    -100
    %Total natural gas
    
    
    17,809
    
    
    
    26,023
    
    
    
    (8,214
    )
    
    
    -32
    %Oil and Natural Gas Liquids (MBbls):Onshore
    
    
    273
    
    
    
    67
    
    
    
    206
    
    
    
    307
    %Offshore
    
    
    1
    
    
    
    281
    
    
    
    (280
    )
    
    
    -100
    %Total oil and natural gas liquids
    
    
    274
    
    
    
    348
    
    
    
    (74
    )
    
    
    -21
    %Natural Gas Equivalent (MMcfe):Onshore
    
    
    19,435
    
    
    
    18,218
    
    
    
    1,217
    
    
    
    7
    %Offshore
    
    
    18
    
    
    
    9,893
    
    
    
    (9,875
    )
    
    
    -100
    %Total equivalents
    
    
    19,453
    
    
    
    28,111
    
    
    
    (8,658
    )
    
    
    31
    %
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Three Months Ended March 31,2007
    
    
    2006
    
    
    Change
    
    
    %Natural Gas Equivalent (MMcfe per day):South Texas
    
    
    151
    
    
    
    145
    
    
    
    6
    
    
    
    4
    %Arkoma
    
    
    39
    
    
    
    40
    
    
    
    (1
    )
    
    
    -3
    %East Texas
    
    
    15
    
    
    
    11
    
    
    
    4
    
    
    
    36
    %Rockies
    
    
    11
    
    
    
    6
    
    
    
    5
    
    
    
    83
    %Total onshore
    
    
    216
    
    
    
    202
    
    
    
    14
    
    
    
    7
    %Offshore
    
    
    
    
    
    
    110
    
    
    
    (110
    )
    
    
    -100
    %Total equivalents per day
    
    
    216
    
    
    
    312
    
    
    
    (96
    )
    
    
    -31
    %
  Onshore.
 Offshore
 Commodity Prices and Effects of Hedging Activities
 Three Months Ended March 31,2007
    
    2006
    
    Change
    
    %Average Natural Gas Prices ($  per Mcf):Onshore
    
    $
    6.21
    
    
    $
    7.35
    
    
    $
    (1.14
    )
    
    
    -16
    %Offshore
    
    
    
    
    
    
    8.24
    
    
    
    (8.24
    )
    
    
    100
    %Total Natural Gas  unhedged
    
    
    6.24
    
    
    
    7.63
    
    
    
    (1.39
    )
    
    
    -18
    %Total Natural Gas  realized (1)
    
    
    6.23
    
    
    
    5.84
    
    
    
    0.39
    
    
    
    7
    %Total Natural Gas  all-in (2)
    
    
    5.19
    
    
    
    6.02
    
    
    
    (0.83
    )
    
    
    -14
    %Average Oil and Natural Gas Liquids Prices ($  per Bbl):Onshore
    
    $
    41.14
    
    
    $
    56.63
    
    
    $
    (15.49
    )
    
    
    -27
    %Offshore
    
    
    
    
    
    
    59.28
    
    
    
    (59.28
    )
    
    
    -100
    %Total Oil and Natural Gas Liquids
    
    
    41.13
    
    
    
    58.77
    
    
    
    (17.64
    )
    
    
    -30
    %
 
 (1)
    
    Includes gains and losses realized on derivative contracts settled during the
period.(2)
    
    Includes gains and losses realized on derivative contracts settled during the
period, as well as unrealized gains and losses recognized pursuant to SFAS 133. Commodity Prices and Effects of Hedging Activities
 - 21 -




---



##### Table of Contents



Gains (Losses) from Hedging Activities
  Three Months Ended March 31,2007
    
    
    2006
    
    
    Change(in thousands)Gain (Loss) from Hedging ActivitiesCash (loss) realized on contracts settled
    
    $
    (51
    )
    
    $
    (46,525
    )
    
    $
    46,474Non-cash unrealized gain (loss):Mark-to-market change in fair value gain (loss)(1)
    
    
    (11,971
    )
    
    
    38,166
    
    
    
    (50,137
    )Recognition of deferred gain (loss) on contracts
fixed at time of loss of hedge accounting(2)
    
    
    (6,699
    )
    
    
    15,790
    
    
    
    (22,489
    )Recognition of deferred loss due to fourth quarter
2005 production shortfalls(3)
    
    
    
    
    
    
    (20,600
    )
    
    
    20,600Recognition of all deferred losses relating to
Texas Gulf of Mexico production sold(4)
    
    
    
    
    
    
    (28,770
    )
    
    
    28,770Total non-cash unrealized gain (loss)
    
    
    (18,670
    )
    
    
    4,586
    
    
    
    23,256Total gain (loss) from hedging activities
    
    $
    (18,721
    )
    
    $
    (41,939
    )
    
    $
    23,218
 
 (1)
    
    Comprised of change in fair market value of open contracts subsequent to loss of
hedge accounting, including all new contracts entered into during the first quarter of 2007.(2)
    
    Comprised of recognition of a portion of losses relating to open contracts that were
fixed and deferred in accumulated other comprehensive income at the time all of our contracts
ceased to qualify for hedge accounting. Over the next 12-month period and at the time when
sale of the related natural gas production occurs, we expect to reclassify from accumulated
other comprehensive income to earnings deferred losses totaling approximately $9.6 million,
net of tax, leaving $4.6 million to be recognized during the remainder of 2008.(3)
    
    For the first quarter of 2006, comprised of recognition of the loss related to cash
settlements made during the fourth quarter of 2005 that was deferred during the fourth quarter
of 2005 in accumulated other comprehensive income. This deferred loss resulted from offshore
production shortfalls during the fourth quarter of 2005 caused by Hurricanes Katrina and Rita.(4)
    
    For the first quarter of 2006, comprised of recognition of all losses previously
deferred in accumulated other comprehensive income for which the underlying production was
attributable to Gulf of Mexico assets sold. - 22 -




---



##### Table of Contents



Natural Gas and Oil Revenues
 Three Months Ended March 31,2007
    
    
    2006
    
    
    Change
    
    
    %(in thousands, except percentages)Natural Gas Revenues:Onshore
    
    $
    110,571
    
    
    $
    130,875
    
    
    $
    (20,304
    )
    
    
    -16%Offshore
    
    
    503
    
    
    
    67,630
    
    
    
    (67,127
    )
    
    
    -99%Gain (loss) on settled derivatives
    
    
    (51
    )
    
    
    (46,525
    )
    
    
    46,474
    
    
    
    -100%Unrealized gain (loss) on derivatives
    
    
    (18,670
    )
    
    
    4,586
    
    
    
    (23,256
    )
    
    
    -507%Total natural gas revenues
    
    
    92,353
    
    
    
    156,566
    
    
    
    (64,213
    )
    
    
    -41%Oil and Natural Gas Liquids Revenues:Onshore
    
    
    11,230
    
    
    
    3,794
    
    
    
    7,436
    
    
    
    196%Offshore
    
    
    40
    
    
    
    16,659
    
    
    
    (16,619
    )
    
    
    -100%Total oil and natural gas liquids revenues
    
    
    11,270
    
    
    
    20,453
    
    
    
    (9,183
    )
    
    
    -45%Total natural gas and oil revenues
    
    $
    103,623
    
    
    $
    177,019
    
    
    $
    (73,396
    )
    
    
    -41%
 Natural Gas Revenues.
  Oil Revenues.
 Operating Expenses
 Absolute Dollars
    
    
    Unit of Production - McfeThree Months Ended March 31,
    
    
    Three Months Ended March 31,2007
    
    
    2006
    
    
    Change
    
    
    %
    
    
    2007
    
    
    2006
    
    
    Change
    
    
    %(dollars in thousands)Lease operating expense
    
    $
    13,174
    
    
    $
    21,812
    
    
    $
    (8,638
    )
    
    
    -40%
    
    
    $
    0.68
    
    
    $
    0.78
    
    
    $
    (0.10
    )
    
    
    -13%Severance tax
    
    
    1,843
    
    
    
    4,752
    
    
    
    (2,909
    )
    
    
    -61%
    
    
    
    0.09
    
    
    
    0.17
    
    
    
    (0.08
    )
    
    
    -47%Transportation expense
    
    
    2,362
    
    
    
    2,771
    
    
    
    (409
    )
    
    
    -15%
    
    
    
    0.12
    
    
    
    0.10
    
    
    
    0.02
    
    
    
    20%Asset retirement accretion expense
    
    
    1,082
    
    
    
    1,327
    
    
    
    (245
    )
    
    
    -18%
    
    
    
    0.06
    
    
    
    0.05
    
    
    
    0.01
    
    
    
    20%Depreciation, depletion and
amortization
    
    
    57,089
    
    
    
    83,761
    
    
    
    (26,672
    )
    
    
    -32%
    
    
    
    2.93
    
    
    
    2.98
    
    
    
    (0.05
    )
    
    
    -2%General and administrative, net
    
    
    10,145
    
    
    
    8,606
    
    
    
    1,539
    
    
    
    18%
    
    
    
    0.52
    
    
    
    0.31
    
    
    
    0.21
    
    
    
    68%Total operating expenses per unit
of production
    
    $
    85,695
    
    
    $
    123,029
    
    
    $
    (37,334
    )
    
    
    -30%
    
    
    $
    4.40
    
    
    $
    4.39
    
    
    $
    0.01
    
    
    
    
 - 23 -




---



##### Table of Contents



Lease Operating Expense
 Absolute Dollars
    
    
    Unit of Production - McfeThree Months Ended March 31,
    
    
    Three Months Ended March 31,Lease Operating Expense
    
    2007
    
    
    2006
    
    
    Change
    
    
    %
    
    
    2007
    
    
    2006
    
    
    Change
    
    
    %(dollars in thousands)Onshore
    
    $
    12,791
    
    
    $
    10,177
    
    
    $
    2,614
    
    
    
    26%
    
    
    $
    0.66
    
    
    $
    0.56
    
    
    $
    0.10
    
    
    
    18%Offshore
    
    
    383
    
    
    
    11,635
    
    
    
    (11,252
    )
    
    
    -97%
    
    
    
    
    
    
    
    1.18
    
    
    
    (1.18
    )
    
    
    -100%Total lease operating expense
    
    $
    13,174
    
    
    $
    21,812
    
    
    $
    (8,638
    )
    
    
    -40%
    
    
    $
    0.68
    
    
    $
    0.78
    
    
    $
    (0.10
    )
    
    
    -13%
  Severance Tax
 Depreciation, Depletion and Amortization
 Asset Retirement Accretion Expense.
 General and Administrative Expenses, Net of Overhead Reimbursements and Capitalized General and
Administrative Expenses.
 Absolute Dollars
    
    
    Unit of Production - McfeThree Months Ended March 31,
    
    
    Three Months Ended March 31,General and Administrative Expense
    
    2007
    
    
    2006
    
    
    Change
    
    
    %
    
    
    2007
    
    
    2006
    
    
    Change
    
    
    %(dollars in thousands)Gross general and administrative expense
    
    $
    14,960
    
    
    $
    14,398
    
    
    $
    562
    
    
    
    4%
    
    
    $
    0.77
    
    
    $
    0.51
    
    
    $
    0.26
    
    
    
    51%Operating overhead reimbursements
    
    
    (447
    )
    
    
    (598
    )
    
    
    151
    
    
    
    -25%
    
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    
    
    
    
    Capitalized general and administrative(1)
    
    
    (4,368
    )
    
    
    (5,194
    )
    
    
    826
    
    
    
    -16%
    
    
    
    (0.22
    )
    
    
    (0.18
    )
    
    
    (0.04
    )
    
    
    22%General and administrative expense, net
    
    $
    10,145
    
    
    $
    8,606
    
    
    $
    1,539
    
    
    
    18%
    
    
    $
    0.53
    
    
    $
    0.31
    
    
    $
    0.22
    
    
    
    71%
 - 24 -




---



##### Table of Contents



(1)
    
    Includes only those internal general and administrative costs that are directly
associated with our acquisition, exploration and development activities, such as salaries,
benefits and incentive compensation for geological and geophysical employees and other
specifically identifiable non-payroll costs. These capitalized general and administrative
costs do not include costs related to production operations, general corporate overhead or
other activities that are not directly attributable to our acquisition, exploration and
development efforts.    Other Income and Expense, Interest and Taxes
 Other Income and Expense
 Interest Expense, Net of Amounts Capitalized
 Three Months Ended March 31,Interest and Average Borrowings
    
    2007
    
    
    2006
    
    
    Change
    
    
    %(in thousands, except percentages)Interest Expense, net:Gross interest (1)
    
    $
    3,767
    
    
    $
    10,376
    
    
    $
    (6,609
    )
    
    
    -64
    %Capitalized interest
    
    
    (662
    )
    
    
    (1,655
    )
    
    
    993
    
    
    
    -60
    %Interest expense, net
    
    $
    3,105
    
    
    $
    8,721
    
    
    $
    (5,616
    )
    
    
    -64
    %Average Borrowings:Bank credit facility
    
    $
    
    
    
    $
    444,000
    
    
    $
    (444,000
    )
    
    
    -100
    %Senior subordinated notes
    
    
    175,000
    
    
    
    175,000
    
    
    
    
    
    
    
    Total borrowings
    
    $
    175,000
    
    
    $
    619,000
    
    
    $
    (444,000
    )
    
    
    -72
    %Average Interest Rate:Bank credit facility (2)
    
    
    0.85
    %
    
    
    6.26
    %
    
    
    -5.41
    
    
    
    -86
    %Senior subordinated notes
    
    
    7.00
    %
    
    
    7.00
    %
    
    
    
    
    
    
    
 
 (1)
    
    Includes commitment fees, letter of credit fees, amortization of deferred
financing costs and other non-loan related charges. Amortization of deferred financing costs
totaled $0.3 million and $0.4 million for the three months ended March 31, 2007 and 2006,
respectively.(2)
    
    Includes letter of credit and commitment fees.   - 25 -




---



##### Table of Contents



Income Tax Provision.
 Liquidity and Capital Resources
  
    
    Drilling and completing new natural gas and oil wells;
    
    Constructing and installing new production infrastructure;
    
    Acquiring additional reserves and producing properties;
    
    Acquiring and maintaining our lease acreage position and our seismic resources;
    
    Maintaining, repairing and enhancing existing natural gas and oil wells;
    
    Plugging and abandoning depleted or uneconomic natural gas and oil wells; and
    
    General and administrative costs directly associated with our acquisition,
exploration and development activities, including payroll and other expenses attributable
solely to our geological and geophysical employees.
 Drilling Contracts
  Sources of Liquidity and Capital Resources
 Tender Offer and Consent Solicitation for $175 Million of 7% Senior
Subordinated Notes due 2013)
 - 26 -




---



##### Table of Contents



Available Liquidity
 March 31, 2007
    
    

December 31, 2006(in thousands)Available Liquidity:Revolving credit facility  borrowing base
    
    $
    500,000
    
    
    $
    500,000Outstanding borrowings
    
    
    
    
    
    
    Letters of credit
    
    
    (300
    )
    
    
    (300
    )Unused borrowing capacity
    
    
    499,700
    
    
    
    499,700Cash and cash equivalents
    
    
    29,487
    
    
    
    53,950Total available liquidity
    
    $
    529,187
    
    
    $
    553,650
  Cash Provided by Operating Activities.
  Uses of Liquidity and Capital Resources
  Capital Expenditures.
  - 27 -




---



##### Table of Contents



Three Months Ended March 31,2007
    
    
    2006(in thousands)Natural gas and oil capital expendituresProducing property acquisitions (1)
    
    $
    286
    
    
    $
    (1,891
    )Leasehold and lease acquisition costs (2)
    
    
    17,746
    
    
    
    18,879Development
    
    
    102,923
    
    
    
    89,668Exploration
    
    
    8,377
    
    
    
    16,277Total natural gas and oil capital expenditures
    
    
    129,332
    
    
    
    122,933Producing property dispositions(3)
    
    
    
    
    
    
    (189,371
    )Net natural gas and oil capital expenditures
    
    $
    129,332
    
    
    $
    (66,438
    )
 
 (1)
    
    For the three months ended March 31, 2006, includes the following: (i)
deposit of $2.2 million paid for producing properties in East Texas which acquisition closed
in April 2006; and (ii) a final purchase price adjustment and return of capital of $4.1
million representing a reduction to the $159.0 million purchase price paid for the South Texas
properties acquired on November 30, 2005 from Kerr-McGee Oil & Gas Onshore LP and Westport Oil
and Gas Company, L.P.(2)
    
    Leasehold costs include capitalized interest and general and administrative
expenses of $5.0 million and $6.8 million, respectively, for the three-month periods ended
March 31, 2007 and 2006.(3)
    
    For the three months ended March 31, 2006, includes net proceeds from the
sale of the Texas portion of our Gulf of Mexico assets of $190.8 million, net of $1.5 million
in transaction fees. See Note 4  Acquisitions and Dispositions
 Sale of Gulf of Mexico Assets  2006. Future Commitments.
  Future CommitmentsPayments Due by PeriodReference
    
    
    Total
    
    
    1 year or less
    
    
    2  3 years
    
    
    4  5 years
    
    
    after 5 years(in thousands)Contractual Obligations:Principal, 7% senior subordinated notes, due June 2013
    
    Note 2
    
    $
    175,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    175,000Interest, 7% senior subordinated notes, due June 2013
    
    Note 2
    
    
    79,625
    
    
    
    12,250
    
    
    
    24,500
    
    
    
    24,500
    
    
    
    18,375Derivative instruments
    
    Note 1
    
    
    39,369
    
    
    
    25,204
    
    
    
    14,165
    
    
    
    
    
    
    
    Drilling contracts
    
    Note 3
    
    
    5,334
    
    
    
    5,334
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    Note 3
    
    
    4,545
    
    
    
    1,936
    
    
    
    2,596
    
    
    
    13
    
    
    
    Letters of credit
    
    Note 3
    
    
    300
    
    
    
    300
    
    
    
    
    
    
    
    
    
    
    
    Unrecognized tax benefits
    
    Note 1
    
    
    1,254
    
    
    
    
    
    
    
    1,254
    
    
    
    
    
    
    
    305,427
    
    
    
    45,024
    
    
    
    42,515
    
    
    
    24,513
    
    
    
    193,375Other Long-Term Obligations:Asset retirement obligations
    
    Note 1
    
    
    77,314
    
    
    
    
    
    
    
    452
    
    
    
    178
    
    
    
    76,684Supplemental Executive Retirement Plan
    
    Note 3
    
    
    3,117
    
    
    
    100
    
    
    
    240
    
    
    
    322
    
    
    
    2,45580,431
    
    
    
    100
    
    
    
    692
    
    
    
    500
    
    
    
    79,139Total Contractual Obligations and
Commitments:
    
    
    
    
    
    $
    385,858
    
    
    $
    45,124
    
    
    $
    43,207
    
    
    $
    25,013
    
    
    $
    272,514
 - 28 -




---



##### Table of Contents



Tender Offer and Consent Solicitation for $175 Million of 7% Senior
Subordinated Notes due 2013
  Off-Balance Sheet Arrangements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Market Risk
  Interest Rate Risk
  Commodity Price Risk
 Derivative Instruments and Hedging Activities)
 - 29 -




---



##### Table of Contents



Changes in Fair Value of Derivative Instruments
  Three Months Ended March 31,2007
    
    
    2006(in thousands)Change in Fair Value of Derivative Instruments:Fair value of contracts at January 1
    
    $
    (27,398
    )
    
    $
    (417,658
    )Realized loss on contracts settled during period
    
    
    51
    
    
    
    46,525(Decrease) increase in fair value of all open contracts
    
    
    (12,022
    )
    
    
    221,683Net change during period
    
    
    (11,971
    )
    
    
    268,208Fair value of contracts outstanding at March 31,
    
    $
    (39,369
    )
    
    $
    (149,450
    )
 Derivatives in Place as of the Date of Our Report
  HSC
    
    NYMEX
    
    NYMEXPeriod
    
    
    
    
    
    Daily Volume
    
    Basis
    
    Floor Price
    
    Ceiling PriceYear
    
    (Months)
    
    Transaction Type
    
    (MMBtu/day)
    
    ($/MMBtu)
    
    ($/MMBtu)
    
    ($/MMBtu)2007
    
    Apr  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    $
    5.00
    
    
    $
    6.502007
    
    Apr  Dec
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    5.00
    
    
    
    6.792007
    
    Apr  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.102007
    
    Apr  Dec
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.122007
    
    Apr  Dec
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.202007
    
    Apr  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.252007
    
    Apr  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.302007
    
    Apr  Dec
    
    Basis swap  HSC
    
    
    20,000
    
    
    $
    0.29002007
    
    Apr  Dec
    
    Basis swap  HSC
    
    
    20,000
    
    
    $
    0.29252007
    
    Apr  Dec
    
    Basis swap  HSC
    
    
    40,000
    
    
    $
    0.30002008
    
    Jan  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    $
    5.00
    
    
    $
    5.722008
    
    Jan  Feb
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.102008
    
    Jan  Feb
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.122008
    
    Jan  Feb
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.202008
    
    Jan  Feb
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.252008
    
    Jan  Feb
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    7.75
    
    
    
    9.302008
    
    Jan  Feb
    
    Basis swap  HSC
    
    
    20,000
    
    
    $
    0.29002008
    
    Jan  Feb
    
    Basis swap  HSC
    
    
    20,000
    
    
    $
    0.29252008
    
    Jan  Feb
    
    Basis swap  HSC
    
    
    40,000
    
    
    $
    0.3000
   - 30 -




---



##### Table of Contents



Item 4. Controls and Procedures
 Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
  Changes in Internal Control Over Financial Reporting
  
 Part II. Other Information
 
 Item 1. Legal Proceedings
 Legal Proceedings
 
 Item 1A. Risk Factors
  
 Item 6. Exhibits
 EXHIBITS
    
    
    
    DESCRIPTION2.1(1)
    
    
    
    Agreement and Plan of Merger dated as of
January 7, 2007 by and among the Company,
Forest Oil Corporation and MJCO
Corporation (filed as exhibit 2.1 to our
Current Report on Form 8-K dated January
7, 2007 (file No. 001-11899) and
incorporated by reference herein).3.1(1)
    
    
    
    Restated Bylaws of The Houston Exploration Company, as amended April 23, 2007
(filed as Exhibit 3.1 to our Current Report on Form 8-K dated April 27, 2007 (File No.
001-11899) and incorporated by reference).4.1(1)
    
    
    
    Second Amendment to Rights Agreement dated as of January 7, 2007 between The Houston Exploration
Company and The Bank of New York, as Rights Agent (filed as exhibit 4.1 to our Current Report on
Form 8-K dated January 7, 2007 (file No. 001-11899) and incorporated by reference herein).10.1(1)(2)
    
    
    
    First Amendment to The Houston Exploration Company Supplemental Executive Retirement Plan (filed
as Exhibit 10.3 to our Current Report on Form 8-K dated January 7, 2007 (File No. 001-11899) and
incorporated by reference herein).10.2(1)(2)
    
    
    
    Form of Amendment No. 2 to [Amended and Restated] Employment Agreement entered into by and
between The Houston Exploration Company and each of William G. Hargett, Steven L. Mueller, James
F. Westmoreland, Roger B. Rice, Joanne C. Hresko, John E. Bergeron Jr., Jeffrey B. Sherrick,
Robert T. Ray and Carolyn M. Campbell (filed as Exhibit 10.1 to our Current Report on Form 8-K
dated January 7, 2007 (file No. 001-11899) and incorporated by reference herein).10.3(1)(2)
    
    
    
    Second Amendment to The Houston Exploration Company Change of Control Plan (filed as exhibit
10.4 to our Current Report on Form 8-K dated January 7, 2007 (file No. 001-11899) and
incorporated by reference herein).
 - 31 -




---



##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION12.1
    
    
    
    Computation of ratio of earnings to fixed charges.31.1
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certification of Robert T. Ray, Chief Financial Officer, as required pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    Certification of Robert T. Ray, Chief Financial Officer, as required pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Previously filed.(2)
    
    Identified as a management contract or compensation plan or arrangement - 32 -




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##### Table of Contents



SIGNATURES
  THE HOUSTON EXPLORATION COMPANYDate: May 8, 2007
    By:
    /s/ William G. HargettWilliam G. HargettChairman, President and Chief Executive Officer Date: May 8, 2007
    By:
    /s/ Robert T. RayRobert T. RaySenior Vice President and Chief Financial Officer Date: May 8, 2007
    By:
    /s/ James F. WestmorelandJames F. WestmorelandVice President and Chief Accounting Officer - 33 -




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##### Table of Contents



12.1
    
    
    
    Computation of ratio of earnings to fixed charges.31.1
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certification of Robert T. Ray, Chief Financial Officer, as required pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    Certification of Robert T. Ray, Chief Financial Officer, as required pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.