##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2005
 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




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TABLE OF CONTENTS
 Forward-Looking Statements and Other 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
    
    
    27Item 4. Controls and Procedures
    
    
    29Part II. Other Information
    
    
    29Item 4. Submission of Matters to a Vote of Security Holders
    
    
    30Item 5. Other Information
    
    
    29Item 6. Exhibits
    
    
    29SIGNATURES
    
    
    31Computation 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
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##### Table of Contents



Forward-Looking Statements and Other Information
  
    
    business strategy;
    
    natural gas and oil reserves;
    
    future production;
    
    expected realized natural gas and oil prices;
    
    expected costs and expenses;
    
    anticipated capital expenditures;
    
    future operating results;
    
    future cash flows and borrowings;
    
    pursuit of potential future acquisition opportunities;
    
    identified drilling locations; and
    
    sources of funding and the timing of exploration and development activities.
  
    
    the volatility of natural gas and oil prices;
    
    the requirement to take writedowns if natural gas and oil prices decline or if
our finding and development costs continue to increase;
    
    the relatively short production lives of our reserves;
    
    our ability to find, replace, develop and acquire natural gas and oil reserves;
    
    the maturity of North American gas basins;
    
    acquisition and investment risks;
    
    our ability to manage rising costs;
    
    our ability to meet our substantial capital requirements;
    
    our outstanding indebtedness;
    
    the uncertainty of estimates of natural gas and oil reserves and production rates;
    
    the inherent hazards and risks involved in our operations;
    
    dependence upon operations concentrated in three primary areas;
    
    drilling risks;
    
    our hedging activities;
    
    compliance with environmental and other governmental regulations;
    
    the competitive nature of our industry;
    
    weather risks and other natural disasters; and
    
    our customers ability to meet their obligations.
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##### Table of Contents



Part I. Financial Information
 
 Item 1. Condensed Consolidated Financial Statements
 THE HOUSTON EXPLORATION COMPANY
 CONSOLIDATED BALANCE SHEETS
 June 30,
    
    December 31,2005
    
    2004Assets:Cash and cash equivalents
    
    $
    4,694
    
    
    $
    18,577Accounts receivable
    
    
    102,006
    
    
    
    103,069Inventories
    
    
    1,639
    
    
    
    976Deferred tax asset
    
    
    50,031
    
    
    
    24,101Prepayments and other
    
    
    2,710
    
    
    
    9,107Total current assets
    
    
    161,080
    
    
    
    155,830Natural gas and oil properties, full cost methodUnevaluated properties
    
    
    150,642
    
    
    
    122,691Properties subject to amortization
    
    
    3,029,981
    
    
    
    2,777,097Other property and equipment
    
    
    12,147
    
    
    
    11,7403,192,770
    
    
    
    2,911,528Less: Accumulated depreciation, depletion and amortization
    
    
    1,505,748
    
    
    
    1,363,2721,687,022
    
    
    
    1,548,256Other non-current assets
    
    
    17,080
    
    
    
    18,491Total Assets
    
    $
    1,865,182
    
    
    $
    1,722,577Liabilities:Accounts payable and accrued expenses
    
    $
    131,857
    
    
    $
    118,971Derivative financial instruments
    
    
    141,331
    
    
    
    68,081Asset retirement obligation
    
    
    1,486
    
    
    
    662Total current liabilities
    
    
    274,674
    
    
    
    187,714Long-term debt and notes
    
    
    330,000
    
    
    
    355,000Derivative financial instruments
    
    
    90,229
    
    
    
    7,068Deferred income taxes
    
    
    290,123
    
    
    
    288,069Asset retirement obligation
    
    
    95,506
    
    
    
    91,084Other non-current liabilities
    
    
    12,085
    
    
    
    10,722Total Liabilities
    
    
    1,092,617
    
    
    
    939,657Commitments and Contingencies (see Note 4)Stockholders Equity:Preferred Stock, $0.01 par value, 5,000,000 shares authorized and no shares issued
    
    
    
    
    
    
    Common Stock, $.01 par value, 100,000,000 shares authorized and 28,665,620 shares
issued and outstanding at June 30, 2005 and 50,000,000 shares authorized and
28,380,207 shares outstanding at December 31, 2004
    
    
    287
    
    
    
    284Additional paid-in capital
    
    
    287,176
    
    
    
    273,002Unearned compensation
    
    
    (4,215
    )
    
    
    (2,537
    )Retained earnings
    
    
    635,466
    
    
    
    558,198Accumulated other comprehensive (loss)
    
    
    (146,149
    )
    
    
    (46,027
    )Total Stockholders Equity
    
    
    772,565
    
    
    
    782,920Total Liabilities and Stockholders Equity
    
    $
    1,865,182
    
    
    $
    1,722,577
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THE HOUSTON EXPLORATION COMPANY
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended June 30,
    
    Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004Revenues:Natural gas and oil revenues
    
    $
    175,524
    
    
    $
    172,578
    
    
    $
    341,014
    
    
    $
    324,212Other
    
    
    293
    
    
    
    198
    
    
    
    523
    
    
    
    446Total revenues
    
    
    175,817
    
    
    
    172,776
    
    
    
    341,537
    
    
    
    324,658Operating expenses:Lease operating
    
    
    19,124
    
    
    
    12,499
    
    
    
    34,492
    
    
    
    25,205Severance tax
    
    
    4,530
    
    
    
    3,891
    
    
    
    7,464
    
    
    
    6,948Transportation expense
    
    
    2,993
    
    

    
    3,169
    
    
    
    5,759
    
    
    
    5,905Asset retirement accretion expense
    
    
    1,326
    
    
    
    1,190
    
    
    
    2,651
    
    
    
    2,478Depreciation, depletion and amortization
    
    
    71,944
    
    
    
    67,192
    
    
    
    142,547
    
    
    
    128,156General and administrative, net of
amounts capitalized
    
    
    6,200
    
    
    
    9,761
    
    
    
    17,323
    
    
    
    15,849Total operating expenses
    
    
    106,117
    
    
    
    97,702
    
    
    
    210,236
    
    
    
    184,541Income from operations
    
    
    69,700
    
    
    
    75,074
    
    
    
    131,301
    
    
    
    140,117Other (income) expense
    
    
    (1,067
    )
    
    
    (378
    )
    
    
    387
    
    
    
    (268
    )Interest expense, net of amounts capitalized.
    
    
    3,196
    
    
    
    2,306
    
    
    
    6,630
    
    
    
    4,593Income before income taxes
    
    
    67,571
    
    
    
    73,146
    
    
    
    124,284
    
    
    
    135,792Provision for taxes
    
    
    23,741
    
    
    
    27,796
    
    
    
    47,016
    
    
    
    50,752Net income
    
    $
    43,830
    
    
    $
    45,350
    
    
    $
    77,268
    
    
    $
    85,040Earnings per share:Net income per share  basic
    
    $
    1.53
    
    
    $
    1.49
    
    
    $
    2.70
    
    
    $
    2.74Net income per share  diluted
    
    $
    1.51
    
    
    $
    1.47
    
    
    $
    2.67
    
    
    $
    2.72Weighted average shares outstanding  basic
    
    
    28,679
    
    
    
    30,547
    
    
    
    28,589
    
    
    
    31,072Weighted average shares outstanding  diluted
    
    
    28,973
    
    
    
    30,810
    
    
    
    28,920
    
    
    
    31,262
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THE HOUSTON EXPLORATION COMPANY
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 Six Months Ended June 30,2005
    
    2004Operating Activities:Net income
    
    $
    77,268
    
    
    $
    85,040Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation, depletion and amortization
    
    
    142,547
    
    
    
    128,156Deferred income tax expense
    
    
    30,988
    
    
    
    23,642Asset retirement accretion expense
    
    
    2,651
    
    
    
    2,478Stock compensation expense
    
    
    2,022
    
    
    
    1,329Tax benefit non-qualified stock options
    
    
    1,881
    
    
    
    2,419Loss due to ineffectiveness of derivative instruments
    
    
    1,424
    
    
    
    1,700Amortization of premiums paid on derivative contracts
    
    
    
    
    
    
    3,576Debt extinguishment
    
    
    
    
    
    
    211Changes in operating assets and liabilities:Accounts receivable
    
    
    1,063
    
    
    
    (24,517
    )Inventories
    
    
    (663
    )
    
    
    (46
    )Prepayments and other
    
    
    6,397
    
    
    
    2,893Other non-current assets
    
    
    1,411
    
    
    
    (2,794
    )Accounts payable and accrued expenses
    
    
    12,886
    
    
    
    16,723Other non-current liabilities
    
    
    1,363
    
    
    
    7,109ARO liability for assets abandoned
    
    
    
    
    
    
    (2,569
    )Net cash provided by operating activities
    
    
    281,238
    
    
    
    245,350Investing Activities:Investment in property and equipment
    
    
    (278,882
    )
    
    
    (165,436
    )Dispositions and other
    
    
    165
    
    
    
    13,138Net cash used in investing activities
    
    
    (278,717
    )
    
    
    (152,298
    )Financing Activities:Proceeds from long-term borrowings
    
    
    207,000
    
    
    
    184,000Repayments of long-term borrowings
    
    
    (232,000
    )
    
    
    (201,000
    )Debt issue costs
    
    
    
    
    
    
    (1,555
    )Proceeds from issuance of common stock from exercise of stock options
    
    
    8,596
    
    
    
    16,455Proceeds from issuance of common stock
    
    
    
    
    
    
    310,567Repurchase of common stock
    
    
    
    
    
    
    (388,979
    )Net cash used in financing activities
    
    
    (16,404
    )
    
    
    (80,512
    )(Decrease) Increase in cash and cash equivalents
    
    
    (13,883
    )
    
    
    12,540Cash and cash equivalents, beginning of period
    
    
    18,577
    
    
    
    2,569Cash and cash equivalents, end of period
    
    $
    4,694
    
    
    $
    15,109Supplemental Information:Non-cash transactions:Divesture and exchange of Appalachian Basin assets
    
    $
    
    
    
    $
    60,000Cash paid during period for:Interest
    
    $
    10,494
    
    
    $
    7,817Federal and state income taxes
    
    
    10,860
    
    
    
    16,900
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1  Summary of Organization and Significant Accounting Policies
 Our Business
   Principles of Consolidation
   Interim Financial Statements
   Use of Estimates
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Business Segment Information
   Revenue Recognition and Gas Imbalances
   Net Income Per Share
  Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2005
    
    2004
    
    2005
    
    2004(in thousands, except per share data)Numerator:Net income
    
    $
    43,830
    
    
    $
    45,350
    
    
    $
    77,268
    
    
    $
    85,040Denominator:Weighted average shares outstanding
    
    
    28,679
    
    
    
    30,547
    
    
    
    28,589
    
    
    
    31,072Add dilutive securities: Stock options
    
    
    294
    
    
    
    263
    
    
    
    331
    
    
    
    190Total weighted average shares outstanding and dilutive securities
    
    
    28,973
    
    
    
    30,810
    
    
    
    28,920
    
    
    
    31,262Earnings per share  basic:
    
    $
    1.53
    
    
    $
    1.49
    
    
    $
    2.70
    
    
    $
    2.74Earnings per share  diluted:
    
    $
    1.51
    
    
    $
    1.47
    
    
    $
    2.67
    
    
    $
    2.72
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Comprehensive Income (Loss)
  Three Months Ended June 30,
    
    Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands)Net income
    
    $
    43,830
    
    
    $
    45,350
    
    
    $
    77,268
    
    
    $
    85,040Other comprehensive income (loss)Derivative instruments settled and reclassified,
net of tax
    
    
    15,720
    
    
    
    8,560
    
    
    
    24,877
    
    
    
    16,020Change in unrealized (loss) fair value of open
derivative contracts, net of tax
    
    
    11,860
    
    
    
    (22,213
    )
    
    
    (124,999
    )
    
    
    (57,782
    )Total other comprehensive income (loss)
    
    
    27,580
    
    
    
    (13,653
    )
    
    
    (100,122
    )
    
    
    (41,762
    )Comprehensive income (loss)
    
    $
    71,410
    
    
    $
    31,697
    
    
    $
    (22,854
    )
    
    $
    43,278
 Natural Gas and Oil Properties
 Full Cost Accounting
 
    
    full cost pool (including assets associated with retirement obligations); plus,
    
    estimates for future development costs (excluding asset retirement obligations); less,
    
    unevaluated properties and their related costs; less,
    
    estimates for salvage.
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Unevaluated Properties
 Asset Retirement Obligations
   Six Months EndedJune 30,2005
    
    2004(in thousands)ARO liability at January 1
    
    $
    91,746
    
    
    $
    92,357Accretion expense
    
    
    2,651
    
    
    
    2,478Liabilities incurred from drilling
    
    
    2,530
    
    
    
    3,281Liabilities incurred from assets acquired
    
    
    169
    
    

    
     ̄Liabilities settled   assets sold
    
    
    (32
    )
    
    
    (12,714
    )Liabilities settled  assets abandoned
    
    
    (870
    )
    
    
    (3,957
    )Changes in estimates
    
    
    798
    
    
    
     ̄ARO liability at June 30
    
    $
    96,992
    
    
    $
    81,445
 Derivative Instruments and Hedging Activities
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
     Accounting for Stock Options and Restricted Stock
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Three Months Ended June 30,
    
    Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands, except share data)Net income  as reported
    
    $
    43,830
    
    
    $
    45,350
    
    
    $
    77,268
    
    
    $
    85,040Add: Stock-based compensation expense included in
net income, net of tax
    
    
    428
    
    
    
    424
    
    
    
    874
    
    
    
    655Less: Stock-based compensation expense determined
using fair value method, net of tax
    
    
    (785
    )
    
    
    (1,466
    )
    
    
    (1,586
    )
    
    
    (2,733
    )Net income  pro forma
    
    $
    43,473
    
    
    $
    44,308
    
    
    $
    76,556
    
    
    $
    82,962Net income per share  basic  as reported
    
    $
    1.53
    
    
    $
    1.49
    
    
    $
    2.70
    
    
    $
    2.74Net income per share  diluted  as reported
    
    
    1.51
    
    
    
    1.47
    
    
    
    2.67
    
    
    
    2.72Net income per share  basic  pro forma
    
    $
    1.52
    
    
    $
    1.45
    
    
    $
    2.68
    
    
    $
    2.67Net income per share  diluted  pro forma
    
    
    1.50
    
    
    
    1.44
    
    
    
    2.65
    
    
    
    2.65
 
 Six Months EndedJune 30,2005
    
    2004Risk-free interest rate.
    
    
    4.0
    %
    
    
    3.9
    %Expected years until exercise
    
    
    5
    
    
    
    5Expected stock volatility
    
    
    34.7
    %
    
    
    37.1
    %Expected dividends
    
    
    
    
    
    
    
   Three Months Ended June 30,
    
    Six Months Ended June 30,2005
    
    2004
    
    2005
    
    2004(in thousands)Options
    
    $
    766
    
    
    $
    449
    
    
    $
    1,583
    
    
    $
    904Restricted stock
    
    
    244
    
    
    
    363
    
    
    
    439
    
    
    
    425Stock compensation expense, gross
    
    
    1,010
    
    
    
    812
    
    
    
    2,022
    
    
    
    1,329Amounts capitalized
    
    
    (347
    )
    
    
    (159
    )
    
    
    (669
    )
    
    
    (322
    )Stock compensation expense, net
    
    $
    663
    
    
    $
    653
    
    
    $
    1,353
    
    
    $
    1,007
 Recent Accounting Pronouncements
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
     NOTE 2  Long-Term Debt and Notes
 June 30, 2005
    
    December 31, 2004(in thousands)Senior Debt:Revolving bank credit facility, due April 1, 2008
    
    $
    155,000
    
    
    $
    180,000Subordinated Debt:7% senior subordinated notes, due June 15, 2013
    
    
    175,000
    
    
    
    175,000Total long-term debt and notes
    
    $
    330,000
    
    
    $
    355,000
  Revolving Bank Credit Facility
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   
    
    on base rate loans, at a fluctuating rate, or base rate, equal to the sum of (a)
the greater of the Federal funds rate plus 0.5% or Wachovias prime rate plus (b) a variable
margin between 0.00% and 0.50%, depending on the amount of borrowings outstanding under the
credit facility, or
    
    on fixed rate loans, a fixed rate equal to the sum of (a) a quoted LIBOR rate
divided by one minus the average maximum rate during the interest period set for certain
reserves of member banks of the Federal Reserve System in Dallas, Texas, plus (b) a variable
margin between 1.25% and 2.00%, depending on the amount of borrowings outstanding under the
credit facility.
   
    
    maintain a ratio of earnings before interest, taxes, depreciation, depletion and
amortization (EBITDA) to cash interest payments of at least 3.00 to 1.00;
    
    maintain a ratio of total debt to EBITDA of not more than 3.50 to 1.00; and
    
    not hedge more than 85% of our production during any calendar year.
  Senior Subordinated Notes
   
    
    incurrence of additional indebtedness and issuance of preferred stock;
    
    repayment of certain other indebtedness;
    
    payment of dividends or certain other distributions;
    
    investments and repurchases of equity;
    
    use of the proceeds of assets sales;
    
    transactions with affiliates;
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
    
    creation, incurrence or assumption of liens;
    
    merger or consolidation and sales or other dispositions of all or substantially all of our assets;
    
    entering into agreements that restrict the ability of our subsidiaries to make
certain distributions or payments; or
    
    guarantees by our subsidiaries of certain indebtedness.
  NOTE 3  Stockholders Equity
 Increase in Number of Shares Outstanding
  NOTE 4 Commitments and Contingencies
 Legal Proceedings
  Operating Leases
 th
 Purchase Obligations
  Letters of Credit
  Drilling Contract
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THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 5  Related Party Transactions
 Employment Agreements
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THE
HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 6  Acquisitions
 East Texas Acquisitions
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Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview of Our Business
    Source of Our Revenues
  Principal Components of Our Cost Structure
 
    
    Lease Operating Expenses.The day-to-day costs incurred to bring hydrocarbons
out of the ground and to the market, together with the daily costs incurred to maintain our
producing properties. These costs include: lease operating expense, severance tax and
transportation expense, which costs are expected to increase.
    
    Depreciation, Depletion and Amortization. The systematic expensing of the
capital costs incurred to acquire, explore and develop natural gas and oil. As a full cost
company, we capitalize all costs associated with our acquisition, exploration and
development efforts, including interest and certain general and administrative costs, and
apportion these costs to each unit of production through depreciation, depletion and
amortization expense. Generally, if reserve quantities are revised up or down, the
depreciation, depletion and amortization rate per unit of production will change inversely.
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
    
    Asset Retirement Accretion Expense.The systematic, monthly accretion of the
future abandonment costs of tangible assets such as platforms, wells, service assets,
pipelines, and other facilities.
    
    General and Administrative Expense.Overhead, including payroll and benefits
for our corporate staff, costs of maintaining our headquarters, managing our production and
development operations and legal compliance are included in our general and administrative
expense. We capitalize general and administrative expense directly related to our
acquisition, exploration and development activities.
    
    Interest.We typically finance our working capital requirements and
acquisitions with borrowings under our revolving bank credit facility, and longer term, with
publicly traded debt instruments. As a result, we incur substantial interest expense that
correlates to both fluctuations in interest rates and our acquisition activity.
Acquisitions are a critical element of our growth strategy. We expect to continue to incur
significant interest expense as we continue to grow. We capitalize interest directly
related to our unevaluated properties that are not being amortized.
    
    Income Taxes.We are subject to state and federal income taxes and are
currently in a tax paying position. We expect to continue to recognize current tax expense
as long as we are generating taxable income.
 Critical Accounting Estimates and Significant Accounting Policies
  Recent Accounting Pronouncements
   -18-




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##### Table of Contents



Overview of Results for the Second Quarter of 2005
  
    
    We generated $43.8 million in net income, a decrease of 3% from second quarter
2004;
    
    We produced approximately 30 Bcfe and our average daily production rate was 328
MMcfe per day compared to a record level of 351 MMcfe per day during the second quarter of
2004. Production levels have remained nearly flat during the first half of 2005 primarily a
result of delays in our offshore Gulf of Mexico development program caused by delays in rig
availability combined with lower production rates in South Texas;
    
    We generated $132.4 million in net cash flows from operating activities compared
to $116.7 million during the second quarter of 2004, an increase of 13%;
    
    We invested $132.2 million in natural gas and oil properties, which included $9
million for a second producing property acquisition in East Texas;
    
    We drilled 79 wells, of which 69, or 87%, were successful with five offshore,
three in East Texas, 16 in South Texas, 16 in Arkoma and 29 in the Rockies;
    
    We decreased our outstanding borrowings under our revolving bank credit facility
by a net $10 million;
    
    We successfully integrated the East Texas producing properties acquired in March
and April 2005, added two drilling rigs, successfully drilled three development wells and
increased average daily production in the area by approximately 2 Mcfe per day for the
quarter;
    
    In mid-May, we successfully completed and brought on-line the sidetrack of the
No. 1 well at High Island 47 which had been shut-in since the fourth quarter of 2004;
    
    In mid-June, drilling began on the sidetrack of the No. 1 well at High Island
115 which had been shut-in since the fourth quarter of 2004 due to a mechanical problem;
    
    We participated in the completion of a discovery at West Cameron 75, with two
subsequent discoveries in July at West Cameron 77 and West Cameron 62. All three
discoveries are located on the Outer Continental Shelf and considered deep shelf
prospects; and
    
    We completed the hook-up of 15 new wells in the DJ Basin of Eastern Colorado,
with initial production from these wells beginning the third week of July 2005.
 -19-




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##### Table of Contents



Operating and Financial Results for the Three Months Ended June 30, 2005 Compared to the Three
Months Ended June 30, 2004 and the Six Months Ended June 30, 2005 Compared to the Six Months Ended
June 30, 2004.
 Three Months Ended June 30,
    
    Six Months Ended June 30,Summary Operating Information:
    
    2005
    
    
    2004
    
    
    Variance

    
    2005
    
    
    2004
    
    
    Variance(in thousands, except average sales price)Operating revenues
    
    $
    175,817
    
    
    $
    172,776
    
    
    $
    3,041
    
    
    
    2
    %
    
    $
    341,537
    
    
    $
    324,658
    
    
    $
    16,879
    
    
    
    5
    %Operating expenses
    
    
    106,117
    
    
    
    97,702
    
    
    
    8,415
    
    
    
    9
    %
    
    
    210,236
    
    
    
    184,541
    
    
    
    25,695
    
    
    
    14
    %Income from operations
    
    
    69,700
    
    
    
    75,074
    
    
    
    (5,374
    )
    
    
    -7
    %
    
    
    131,301
    
    
    
    140,117
    
    
    
    (8,816
    )
    
    
    -6
    %Net income
    
    
    43,830
    
    
    
    45,350
    
    
    
    (1,520
    )
    
    
    -3
    %
    
    
    77,268
    
    
    
    85,040
    
    
    
    (7,772
    )
    
    
    -9
    %Production:Natural gas (MMcf)
    
    
    27,440
    
    
    
    30,138
    
    
    
    (2,698
    )
    
    
    -9
    %
    
    
    54,797
    
    
    
    58,270
    
    
    
    (3,473
    )
    
    
    -6
    %Oil (MBbls)
    
    
    406
    
    
    
    304
    
    
    
    102
    
    
    
    34
    %
    
    
    812
    
    
    
    652
    
    
    
    160
    
    
    
    25
    %Total (MMcfe) (1)
    
    
    29,876
    
    
    
    31,962
    
    
    
    (2,086
    )
    
    
    -7
    %
    
    
    59,669
    
    
    
    62,182
    
    
    
    (2,513
    )
    
    
    -4
    %Average daily production (MMcfe/d)
    
    
    328
    
    
    
    351
    
    
    
    (23
    )
    
    
    -7
    %
    
    
    330
    
    
    
    342
    
    
    
    (12
    )
    
    
    -4
    %Average Sales Prices:Natural Gas (per Mcf) realized (2)
    
    $
    5.71
    
    
    $
    5.39
    
    
    $
    0.32
    
    
    
    6
    %
    
    $
    5.57
    
    
    $
    5.19
    
    
    $
    0.38
    
    
    
    7
    %Natural Gas (per Mcf) unhedged
    
    
    6.60
    
    
    
    5.85
    
    
    
    0.75
    
    
    
    13
    %
    
    
    6.30
    
    
    
    5.65
    
    
    
    0.65
    
    
    
    12
    %Oil (per Bbl) realized
    
    
    46.32
    
    
    
    33.63
    
    
    
    12.69
    
    
    
    38
    %
    
    
    44.24
    
    
    
    33.02
    
    
    
    11.22
    
    
    
    34
    %
 
 (1)
    
    Mcfe is defined as one million cubic feet equivalent of natural gas,
determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or
natural gas liquids.(2)
    
    Average realized prices include the effect of hedges. Income from Operations
   Production Volume
  Onshore.
  -20-




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##### Table of Contents



Offshore
 Commodity Prices and Effects of Hedging
   -21-




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##### Table of Contents



Operating Expenses
 Three Months Ended June 30,
    
    Six Months Ended June 30,Operating Expenses per Mcfe
    
    2005
    
    
    2004
    
    
    Variance
    
    2005
    
    
    2004
    
    
    VarianceLease operating expense
    
    $
    0.64
    
    
    $
    0.39
    
    
    $
    0.25
    
    
    
    64
    %
    
    $
    0.58
    
    
    $
    0.41
    
    
    $
    0.17
    
    
    
    41
    %Severance tax
    
    
    0.15
    
    
    
    0.12
    
    
    
    0.03
    
    
    
    25
    %
    
    
    0.13
    
    
    
    0.11
    
    
    
    0.02
    
    
    
    18
    %Transportation expense
    
    
    0.10
    
    
    
    0.10
    
    
    
    
    
    
    
    
    
    
    
    0.10
    
    
    
    0.09
    
    
    
    0.01
    
    
    
    11
    %Asset retirement accretion expense
    
    
    0.04
    
    
    
    0.04
    
    
    
    
    
    
    
    
    
    
    
    0.04
    
    
    
    0.04
    
    
    
    
    
    
    
    Depreciation, depletion and
amortization
    
    
    2.41
    
    
    
    2.10
    
    
    
    0.31
    
    
    
    15
    %
    
    
    2.39
    
    
    
    2.06
    
    
    
    0.33
    
    
    
    16
    %General and administrative, net
    
    
    0.21
    
    
    
    0.31
    
    
    
    (0.10
    )
    
    
    -32
    %
    
    
    0.29
    
    
    
    0.25
    
    
    
    0.04
    
    
    
    16
    %Total operating expenses per
unit of production
    
    $
    3.55
    
    
    $
    3.06
    
    
    $
    0.49
    
    
    
    16
    %
    
    $
    3.53
    
    
    $
    2.96
    
    
    $
    0.57
    
    
    
    19
    %
  Lease Operating Expense
 Severance Tax
 Depreciation, Depletion and Amortization
 Asset Retirement Accretion Expense.
 -22-




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##### Table of Contents



General and Administrative Expenses, Net of Overhead Reimbursements and Capitalized General and
Administrative Expenses
 Absolute Dollars
    
    
    Unit of Production - McfeThree Months Ended June 30,
    
    
    Three Months Ended June 30,General and Administrative Expense
    
    2005
    
    
    2004
    
    
    Variance
    
    
    2005
    
    
    2004
    
    
    Variance(in thousands)Gross general and administrative expense
    
    $
    10,516
    
    
    $
    13,937
    
    
    $
    (3,421
    )
    
    
    -25
    %
    
    $
    0.35
    
    
    $
    0.44
    
    
    $
    (0.09
    )
    
    
    -20
    %Operating overhead reimbursements
    
    
    (525
    )
    
    
    (576
    )
    
    
    51
    
    
    
    -  9
    %
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    
    
    
    
    Capitalized general and administrative
    
    
    (3,791
    )
    
    
    (3,600
    )
    
    
    (191
    )
    
    
    5
    %
    
    
    (0.12
    )
    
    
    (0.11
    )
    
    
    (0.01
    )
    
    
    9
    %General and administrative expense, net
    
    $
    6,200
    
    
    $
    9,761
    
    
    $
    (3,561
    )
    
    
    -36
    %
    
    $
    0.21
    
    
    $
    0.31
    
    
    $
    (0.10
    )
    
    
    -32
    %
   Absolute Dollars
    
    
    Unit of Production - McfeSix Months Ended June 30,
    
    
    Six Months Ended June 30,General and Administrative Expense
    
    2005
    
    
    2004
    
    
    Variance
    
    
    2005
    
    
    2004
    
    
    Variance(in thousands)Gross general and administrative expense
    
    $
    26,478
    
    
    $
    24,740
    
    
    $
    1,738
    
    
    
    7
    %
    
    $
    0.44
    
    
    $
    0.40
    
    
    $
    0.04
    
    
    
    10
    %Operating overhead reimbursements
    
    
    (1,075
    )
    
    
    (1,089
    )
    
    
    14
    
    
    
    -1
    %
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    
    
    
    
    Capitalized general and administrative
    
    
    (8,080
    )
    
    
    (7,802
    )
    
    
    (278
    )
    
    
    4
    %
    
    
    (0.13
    )
    
    
    (0.13
    )
    
    
    
    
    
    
    General and administrative expense, net
    
    $
    17,323
    
    
    $
    15,849
    
    
    $
    1,474
    
    
    
    9
    %
    
    $
    0.29
    
    
    $
    0.25
    
    
    $
    0.04
    
    
    
    16
    %
  Employment Agreements
  -23-




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##### Table of Contents



Other Income and Expense, Interest and Taxes
 Other Income and Expense
 Interest Expense, Net of Capitalized Interest
 Three Months Ended June 30,
    
    Six Months Ended June 30,Interest and Average Borrowings
    
    2005
    
    
    2004
    
    
    Variance
    
    2005
    
    
    2004
    
    
    Variance(dollars in thousands)Gross interest
    
    $
    5,621
    
    
    $
    4,381
    
    
    $
    1,240
    
    
    
    28
    %
    
    $
    11,045
    
    
    $
    8,609
    
    
    $
    2,436
    
    
    
    28
    %Capitalized interest
    
    
    (2,425
    )
    
    
    (2,075
    )
    
    
    (350
    )
    
    
    17
    %
    
    
    (4,415
    )
    
    
    (4,016
    )
    
    
    (399
    )
    
    
    10
    %Interest expense, net of
capitalized interest
    
    $
    3,196
    
    
    $
    2,306
    
    
    $
    890
    
    
    
    39
    %
    
    $
    6,630
    
    
    $
    4,593
    
    
    $
    2,037
    
    
    
    44
    %Average borrowings (1)
    
    $
    345,956
    
    
    $
    263,176
    
    
    $
    82,780
    
    
    
    31
    %
    
    $
    345,354
    
    
    $
    272,304
    
    
    $
    73,050
    
    
    
    27
    %Average interest rate (1)
    
    
    6.04
    %
    
    
    5.81
    %
    
    
    0.23
    %
    
    
    4
    %
    
    
    5.94
    %
    
    
    5.70
    %
    
    
    0.24
    %
    
    
    4
    %Average bank borrowings
    
    $
    170,956
    
    
    $
    122,791
    
    
    $
    48,165
    
    
    
    39
    %
    
    $
    170,354
    
    
    $
    114,612
    
    
    $
    55,742
    
    
    
    49
    %Average bank interest rate
    
    
    5.13
    %
    
    
    3.32
    %
    
    
    1.81
    %
    
    
    55
    %
    
    
    4.88
    %
    
    
    3.30
    %
    
    
    1.58
    %
    
    
    48
    %
 
 (1)
    
    Average borrowings and average interest rate includes our $175 million
senior notes at 7% due June 2013 and average borrowings under our revolving bank credit
facility.  Income Tax Provision. Employment
Agreements
 Liquidity
 Capital Requirements
  
    
    Costs of acquiring and maintaining our lease acreage position and our seismic resources;
    
    Costs of drilling and completing new natural gas and oil wells;
 -24-




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##### Table of Contents




    
    Costs of acquiring additional reserves;
    
    Costs of installing new production infrastructure;
    
    Costs of maintaining, repairing, and enhancing existing natural gas and oil wells;
    
    Costs related to plugging and abandoning unproductive or uneconomic wells; and
    
    Indirect costs related to our exploration activities, including payroll and
other expense attributable to our exploration professional staff.
  Future Commitments
  As of June 30, 2005Payments Due by PeriodReference
    
    
    Total
    
    
    1 year or less
    
    
    2  3 years
    
    
    4  5 years
    
    
    after 5 years(in thousands)Contractual Obligations:Revolving bank credit facility, due April 2008
    
    Note 2
    
    $
    155,000
    
    
    $
    
    
    
    $
    
    
    
    $
    155,000
    
    
    $
    7% senior subordinated notes, due June 2013
    
    Note 2
    
    
    175,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175,000Derivative instruments
    
    Note 1
    
    
    231,560
    
    
    
    141,331
    
    
    
    84,113
    
    
    
    6,116
    
    
    
    Operating leases
    
    Note 4
    
    
    6,477
    
    
    
    1,540
    
    
    
    3,189
    
    
    
    1,748
    
    
    
    Seismic data purchase
    
    Note 4
    
    
    7,749
    
    
    
    7,749
    
    
    
    
    
    
    
    
    
    
    
    Drilling contract
    
    Note 4
    
    
    2,531
    
    
    
    2,531
    
    
    
    
    
    
    
    
    
    
    
    578,317
    
    
    
    153,151
    
    
    
    87,302
    
    
    
    162,864
    
    
    
    175,000Other Long-Term Obligations:Asset retirement obligations
    
    Note 1
    
    
    96,992
    
    
    
    1,486
    
    
    
    11,593
    
    
    
    6,967
    
    
    
    76,946Total contractual obligations and
commitments
    
    
    
    
    
    $
    675,309
    
    
    $
    154,637
    
    
    $
    98,895
    
    
    $
    169,831
    
    
    $
    251,946
 Capital Resources
  -25-




---



##### Table of Contents



Six Months Ended June 30,2005
    
    
    2004
    
    
    variance
    
    
    % change(in thousands)Net cash provided by operating activities
    
    $
    281,238
    
    
    $
    245,350
    
    
    $
    35,888
    
    
    
    15
    %Net cash (used) for investments in property and equipment
    
    
    (278,717
    )
    
    
    (152,298
    )
    
    
    (126,419
    )
    
    
    83
    %Net cash (used in) provided by financing activities
    
    
    (16,404
    )
    
    
    (80,512
    )
    
    
    64,108
    
    
    
    -80
    %Net change in cash
    
    $
    (13,883
    )
    
    $
    12,540
    
    
    $
    (26,423
    )
    
    
    -211
    %
  Operating Activities
 Investing Activities.
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(in thousands)Producing property acquisitions
    
    $
    9,017
    
    
    $
    
    
    
    $
    31,632
    
    
    $
    2,700Leasehold and lease acquisition costs (1)
    
    
    10,338
    
    
    
    13,006
    
    
    
    35,574
    
    
    
    26,640Development
    
    
    74,981
    
    
    
    58,600
    
    
    
    147,403
    
    
    
    116,696Exploration
    
    
    37,739
    
    
    
    8,491
    
    
    
    63,778
    
    
    
    18,699Total natural gas and oil capital expenditures
    
    
    132,075
    
    
    
    80,097
    
    
    
    278,387
    
    
    
    164,735Producing property dispositions (2)
    
    
    
    
    
    
    (59,429
    )
    
    
    (150
    )
    
    
    (72,567
    )Net natural gas and oil capital expenditures
    
    $
    132,075
    
    
    $
    20,668
    
    
    $
    278,238
    
    
    $
    92,168
 
 (1)
    
    Leasehold and lease acquisition costs include capitalized interest and
general and administrative expenses of $6.2 million and $5.7 million, respectively, for the
three months ended June 30, 2005 and 2004 and $12.5 million and $11.8 million, respectively,
for the six months ended June 30, 2005 and 2004.(2)
    
    Producing property dispositions during 2004 include $13.1 million
associated with the divestment of our South Louisiana operations in February 2004 and $59.4
million associated with the divestment of our Appalachian Basin properties as part of the
asset exchange transaction with KeySpan in June 2004. -26-




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##### Table of Contents



Financing Activities
 Access to Capital Markets
  Off-Balance Sheet Arrangements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Market Risk
  Interest Rate Market Risk
  Commodity Risk
   -27-




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##### Table of Contents



Changes in Fair Value of Derivative Instruments
  Six Months Ended June 30,2005
    
    
    2004Change in Fair Value of Derivatives Instruments:
    
    Before Tax(in thousands)Fair value of contracts at January 1
    
    $
    (75,149
    )
    
    $
    (36,862
    )Realized loss on contracts settled
    
    
    38,510
    
    
    
    24,799(Decrease) in fair value of all open contracts
    
    
    (194,921
    )
    
    
    (94,325
    )Net (decrease) during period
    
    
    (156,411
    )
    
    
    (69,526
    )Fair value of contracts outstanding at June 30
    
    $
    (231,560
    )
    
    $
    (106,388
    )
 Derivatives in Place as of the Date of Our Report
  Daily Volume
    
    
    NYMEX Price
    
    
    Floor Price
    
    
    Ceiling PriceYear
    
    
    Transaction Type
    
    (MMBtu/day)
    
    
    ($/MMBtu)
    
    
    ($/MMBtu)
    
    
    ($/MMBtu)2005
    
    
    Swap
    
    
    20,000
    
    
    $
    4.75
    
    
    
    
    
    
    
    2005
    
    
    Swap
    
    
    10,000
    
    
    
    4.77
    
    
    
    
    
    
    
    2005
    
    
    Swap
    
    
    20,000
    
    
    
    4.78
    
    
    
    
    
    
    
    2005
    
    
    Swap
    
    
    20,000
    
    
    
    6.15
    
    
    
    
    
    
    
    2005
    
    
    Swap
    
    
    10,000
    
    
    
    6.30
    
    
    
    
    
    
    
    Total swaps
    
    
    80,0002005
    
    
    Costless collar
    
    
    100,000
    
    
    
    
    
    
    $
    4.50
    
    
    $
    5.502005
    
    
    Costless collar
    
    
    30,000
    
    
    
    
    
    
    
    4.50
    
    
    
    6.052005
    
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    4.50
    
    
    
    6.062005
    
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    4.50
    
    
    
    6.072005
    
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    6.50
    
    
    
    10.152005
    
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    6.50
    
    
    
    10.19Total collars
    
    
    180,000Total daily volume 2005
    
    
    260,0002006
    
    
    Swap
    
    
    20,000
    
    
    $
    5.87
    
    
    
    
    
    
    
    2006
    
    
    Swap
    
    
    10,000
    
    
    
    5.94
    
    
    
    
    
    
    
    Total swaps
    
    
    30,0002006
    
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    $
    5.50
    
    
    $
    7.202006
    
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    5.50
    
    
    
    7.252006
    
    
    Costless collar
    
    
    40,000
    
    
    
    
    
    
    
    5.50
    
    
    
    7.262006
    
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    5.75
    
    
    
    7.202006
    
    
    Costless collar
    
    
    30,000
    
    
    
    
    
    
    
    5.80
    
    
    
    7.002006
    
    
    Costless collar
    
    
    50,000
    
    
    
    
    
    
    
    5.82
    
    
    
    7.002006
    
    
    Costless collar
    
    
    30,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.002006
    
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.022006
    
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.05Total collars
    
    
    220,000Total daily volume 2006
    
    
    250,000
 -28-




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##### Table of Contents



Daily Volume
    
    
    NYMEX Price
    
    
    Floor Price
    
    
    Ceiling PriceYear
    
    
    Transaction Type
    
    (MMBtu/day)
    
    
    ($/MMBtu)
    
    
    ($/MMBtu)
    
    
    ($/MMBtu)2007
    
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    $
    5.00
    
    
    $
    6.502007
    
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    5.00
    
    
    
    6.79Total daily volume 2007
    
    
    30,0002008
    
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    $
    5.00
    
    
    $
    5.72Total daily volume 2008
    
    
    20,000
   
 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 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
 
 Item 6. Exhibits
 EXHIBITS
    
    
    
    DESCRIPTION4.1
    
    
    
    Amendment No. 1 to Registration Statement on Form 8-A (File No. 001-11899) filed with the
Securities and Exchange Commission on May 26, 2005, and incorporated by reference herein.4.2
    
    
    
    Amendment No. 2 to Registration Statement on Form 8-A (File No. 001-11899) filed with the
Securities and Exchange Commission on May 26, 2005, and incorporated by reference herein.12.1(1)
    
    
    
    Computation of ratio of earnings to fixed charges.31.1(1)
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.31.2(1)
    
    
    
    Certification of John H. Karnes, Chief Financial Officer, as required pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
 -29-




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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION32.1(1)
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.32.2(1)
    
    
    
    Certification of John H. Karnes, Chief Financial Officer, as required pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
 
 (1) Filed herewith. -30-




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##### Table of Contents



SIGNATURES
  THE HOUSTON EXPLORATION COMPANYBy:
    
    /s/ William G. HargettDate: August 2, 2005
    
    
    
    William G. Hargett
Chairman, President and Chief Executive OfficerBy:
    
    /s/ John H. KarnesDate: August 2, 2005
    
    
    
    John H. Karnes
Senior Vice President and Chief Financial OfficerBy:
    
    /s/ James F. WestmorelandDate: August 2, 2005
    
    
    
    James F. Westmoreland
Vice President and Chief Accounting Officer
 -31-




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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION4.1
    
    
    
    Amendment No. 1 to Registration Statement on Form 8-A (File No. 001-11899) filed with the
Securities and Exchange Commission on May 26, 2005, and incorporated by reference herein.4.2
    
    
    
    Amendment No. 2 to Registration Statement on Form 8-A (File No. 001-11899) filed with the
Securities and Exchange Commission on May 26, 2005, and incorporated by reference herein.12.1(1)
    
    
    
    Computation of ratio of earnings to fixed charges.31.1(1)
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.31.2(1)
    
    
    
    Certification of John H. Karnes, Chief Financial Officer, as required pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1(1)
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.32.2(1)
    
    
    
    Certification of John H. Karnes, Chief Financial Officer, as required pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
 
 (1) Filed herewith.