##### 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 March 31, 2006
 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
    
    22-2674487(State or Other Jurisdiction of
    
    (IRS Employer Identification No.)Incorporation or Organization)1100 Louisiana, Suite 2000Houston, Texas
    
    77002-5215(Address of Principal Executive Offices)
    
    (Zip Code)
 (713) 830-6800
(Registrants Telephone Number, including Area Code)
 
 þ o
  Large accelerated filer þ
    
    Accelerated filer o
    
    Non-accelerated filer o
 o þ




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TABLE OF CONTENTS
  
 Forward-Looking Statements
    
    
    2Part I. Financial Information
    
    
    3Item 1. Condensed Consolidated Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    30Item 4. Controls and Procedures
    
    
    31Part II. Other Information
    
    
    32Item 1A. Risk Factors
    
    
    32Item 4. Submission of Matters to a Vote of Security Holders
    
    
    33Item 6. Exhibits
    
    
    33SIGNATURES
    
    
    34Purchase and Sale AgreementComputation 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
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Part I. Financial Information
 
 Item 1. Condensed Consolidated Financial Statements
 THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
 March 31,
    
    
    December 31,2006
    
    
    2005Assets:Cash and cash equivalents
    
    $
    19,538
    
    
    $
    7,979Accounts receivable
    
    
    115,012
    
    
    
    146,020Inventories
    
    
    3,407
    
    
    
    2,726Deferred tax asset
    
    
    38,952
    
    
    
    145,922Prepayments and other
    
    
    16,500
    
    
    
    19,709Total current assets
    
    
    193,409
    
    
    
    322,356Natural gas and oil properties, full cost methodUnevaluated properties
    
    
    82,337
    
    
    
    107,146Properties subject to amortization
    
    
    3,483,903
    
    
    
    3,556,755Other property and equipment
    
    
    13,031
    
    
    
    12,9713,579,271
    
    
    
    3,676,872Less: Accumulated depreciation, depletion and amortization
    
    
    1,742,138
    
    
    
    1,658,5321,837,133
    
    
    
    2,018,340Other non-current assets
    
    
    19,624
    
    
    
    20,928Total Assets
    
    $
    2,050,166
    
    
    $
    2,361,624Liabilities:Accounts payable and accrued expenses
    
    $
    132,234
    
    
    $
    177,159Derivative financial instruments
    
    
    103,080
    
    
    
    352,457Asset retirement obligation
    
    
    6,967
    
    
    
    7,265Total current liabilities
    
    
    242,281
    
    
    
    536,881Long-term debt and notes
    
    
    424,000
    
    
    
    597,000Derivative financial instruments
    
    
    46,370
    
    
    
    65,201Deferred income taxes
    
    
    339,190
    
    
    
    341,302Asset retirement obligation
    
    
    85,009
    
    
    
    112,406Other non-current liabilities
    
    
    13,943
    
    
    
    15,696Total Liabilities
    
    
    1,150,793
    
    
    
    1,668,486Commitments 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 29,077,472 and
28,980,128 shares issued and outstanding at March 31, 2006 and December 31, 2005,
respectively
    
    
    291
    
    
    
    289Additional paid-in capital
    
    
    303,391
    
    
    
    297,218Retained earnings
    
    
    693,139
    
    
    
    663,367Accumulated other comprehensive (loss)
    
    
    (97,448
    )
    
    
    (267,736
    )Total Stockholders Equity
    
    
    899,373
    
    
    
    693,138Total Liabilities and Stockholders Equity
    
    $
    2,050,166
    
    
    $
    2,361,624
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THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended March 31,2006
    
    
    2005Revenues:Natural gas and oil revenues
    
    $
    177,019
    
    
    $
    165,490Other
    
    
    585
    
    
    
    230Total revenues
    
    
    177,604
    
    
    
    165,720Operating expenses:Lease operating
    
    
    21,812
    
    
    
    15,368Severance tax
    
    
    6,159
    
    
    
    2,934Transportation expense
    
    
    2,771
    
    
    
    2,766Asset retirement accretion expense
    
    
    1,327
    
    
    
    1,325Depreciation, depletion and amortization
    
    
    83,761
    
    
    
    70,603General and administrative, net of amounts capitalized
    
    
    8,606
    
    
    
    11,123Total operating expenses
    
    
    124,436
    
    
    
    104,119Income from operations
    
    
    53,168
    
    
    
    61,601Other (income) expense
    
    
    (1,407
    )
    
    
    1,454Interest expense, net of amounts capitalized
    
    
    8,721
    
    
    
    3,434Income before income taxes
    
    
    45,854
    
    
    
    56,713Provision for taxes
    
    
    16,082
    
    
    
    23,275Net income
    
    $
    29,772
    
    
    $
    33,438Earnings per share:Net income per share  basic
    
    $
    1.03
    
    
    $
    1.17Net income per share  diluted
    
    $
    1.02
    
    
    $
    1.16Weighted average shares outstanding  basic
    
    
    29,042
    
    
    
    28,499Weighted average shares outstanding  diluted
    
    
    29,310
    
    
    
    28,871
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THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
 Three Months Ended March 31,2006
    
    
    2005Operating Activities:Net income
    
    $
    29,772
    
    
    $
    33,438Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation, depletion and amortization
    
    
    83,761
    
    
    
    70,603Deferred income tax expense
    
    
    11,524
    
    
    
    15,571Asset retirement accretion expense
    
    
    1,327
    
    
    
    1,325Stock compensation expense
    
    
    2,517
    
    
    
    1,012Tax benefit
from non-qualified stock options
    
    
    
    
    
    
    1,724Unrealized (gain) loss on derivative instruments
    
    
    (4,586
    )
    
    
    1,424Changes in operating assets and liabilities:Accounts receivable
    
    
    31,008
    
    
    
    7,771Inventories
    
    
    (681
    )
    
    
    (381
    )Prepayments and other
    
    
    5,409
    
    
    
    1,383Other assets
    
    
    1,304
    
    
    
    1,131Accounts payable and accrued expenses
    
    
    (37,481
    )
    
    
    (2,488
    )Other non-current liabilities
    
    
    (1,753
    )
    
    
    846Net cash provided by operating activities
    
    
    122,121
    
    
    
    133,359Investing Activities:Investment in property and equipment
    
    
    (128,391
    )
    
    
    (131,138
    )Deposit paid for property acquisition
    
    
    (2,200
    )
    
    
    Dispositions and other
    
    
    189,371
    
    
    
    150Net cash used in investing activities
    
    
    58,780
    
    
    
    (130,988
    )Financing Activities:Proceeds from long-term borrowings
    
    
    163,000
    
    
    
    85,000Repayments of long-term borrowings
    
    
    (336,000
    )
    
    
    (100,000
    )Proceeds from issuance of common stock from exercise of stock options
    
    
    3,213
    
    
    
    7,812Tax benefit from non-qualified stock options
    
    
    445
    
    
    
    Net cash used in financing activities
    
    
    (169,342
    )
    
    
    (7,188
    )Increase (decrease) in cash and cash equivalents
    
    
    11,559
    
    
    
    (4,817
    )Cash and cash equivalents, beginning of period
    
    
    7,979
    
    
    
    18,577Cash and cash equivalents, end of period
    
    $
    19,538
    
    
    $
    13,760Supplemental Information:Non-cash transactions:Investments in property and equipment accrued, not paid
    
    $
    7,444
    
    
    $
    (15,489
    )Cash paid during period for:Interest
    
    $
    6,952
    
    
    $
    1,987Federal and state income taxes
    
    
    
    
    
    
    
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1  Summary of Organization and Significant Accounting Policies
 Our Business
  Sale of Texas Gulf of Mexico
Assets Pending Sale of Louisiana Gulf of Mexico Assets
 Principles of Consolidation
  Interim Financial Statements
   Use of Estimates
  -6-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Reclassifications
  Business Segment Information
   Revenue Recognition and Gas Imbalances
   -7-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Net Income Per Share
  Three Months EndedMarch 31,2006
    
    
    2005(in thousands)Numerator:Net income
    
    $
    29,772
    
    
    $
    33,438Denominator:Weighted average shares outstanding
    
    
    29,042
    
    
    
    28,499Add dilutive securities: Stock options and restricted stock
    
    
    268
    
    
    
    372Total weighted average shares outstanding and dilutive securities
    
    
    29,310
    
    
    
    28,871Earnings per share  basic:
    
    $
    1.03
    
    
    $
    1.17Earnings per share  diluted:
    
    $
    1.02
    
    
    $
    1.16
  Comprehensive Income (Loss)
  Three Months EndedMarch 31,2006
    
    
    2005(in thousands)Net income
    
    $
    29,772
    
    
    $
    33,438Other comprehensive income (loss)Derivative contracts settled and reclassified, net of tax
    
    
    30,055
    
    
    
    9,157Change in unrealized (loss) fair value of open
contracts, net of tax
    
    
    140,233
    
    
    
    (136,859
    )Change in accumulated other comprehensive
income (loss)
    
    
    170,288
    
    
    
    (127,702
    )Comprehensive income (loss)
    
    $
    200,060
    
    
    $
    (94,264
    )
 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,
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
    
    estimates for salvage.
    Unevaluated Properties
 Asset Retirement Obligations
  Three Months Ended March 31,2006
    
    
    2005(in thousands)ARO liability at January 1,
    
    $
    119,671
    
    
    $
    91,746Accretion expense
    
    
    1,327
    
    
    
    1,325Liabilities incurred from drilling
    
    
    1,849
    
    
    
    1,449Liabilities settled   assets sold
    
    
    (30,795
    )
    
    
    Changes in estimates
    
    
    (76
    )
    
    
    798ARO liability at March 31,
    
    $
    91,976
    
    
    $
    95,318
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Derivative Instruments and Hedging Activities
    Sale of
Texas Gulf of Mexico Assets
  -10-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Accounting for Stock Options and Restricted Stock
   Three Months EndedMarch 31, 2005(in thousands)Net income  as reported
    
    $
    33,438Add: Stock-based compensation expense included in net income, net of tax
    
    
    446Less: Stock-based compensation expense determined using fair value method, net of
tax
    
    
    (802
    )Net income  pro forma
    
    $
    33,082Net income per share  basic  as reported
    
    $
    1.17Net income per share  diluted  as reported
    
    
    1.16Net income per share  basic  pro forma
    
    $
    1.16Net income per share  diluted  pro forma
    
    
    1.15
  Three Months EndedMarch 31,2006
    
    
    2005Weighted average fair value of options granted
    
    $
    12.28
    
    
    $
    21.43Risk-free interest rate
    
    
    4.55
    %
    
    
    3.97
    %Expected years until exercise
    
    
    3
    
    
    
    5Expected stock volatility
    
    
    25.6
    %
    
    
    35.6
    %Expected dividends
    
    
    
    
    
    
    
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Three Months EndedMarch 31,2006
    
    
    2005(in thousands)Options
    
    $
    1,687
    
    
    $
    817Restricted stock
    
    
    830
    
    
    
    195Stock compensation expense, gross
    
    
    2,517
    
    
    
    1,012Amounts capitalized
    
    
    (746
    )
    
    
    (322
    )Stock compensation expense, net of amounts capitalized
    
    $
    1,771
    
    
    $
    690
  Stock and Option Plans
 Stock Plans.
 Stock Options.
  -12-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  WeightedWeighted
    
    
    AverageShares
    
    
    Average
    
    
    Remaining
    
    
    AggregateUnderlying
    
    
    Exercise
    
    
    Contractual
    
    
    IntrinsicOptions
    
    
    Price
    
    
    Term
    
    
    Value(1)(shares)
    
    
    ($/share)
    
    
    (Years)
    
    
    ($ in thousands)Options outstanding January 1, 2006
    
    
    1,696,610
    
    
    $
    39.85
    
    
    
    7.8
    
    
    $
    21,971Granted
    
    
    36,950
    
    
    
    52.53
    
    
    
    
    
    
    
    Exercised
    
    
    (84,844
    )
    
    
    38.06
    
    
    
    
    
    
    
    Forfeited
    
    
    (15,830
    )
    
    
    44.51
    
    
    
    
    
    
    
    Options outstanding March 31
    
    
    1,632,886
    
    
    $
    40.19
    
    
    
    6.8
    
    
    $
    20,427Options exercisable March 31, 2006
    
    
    600,869
    
    
    $
    32.73
    
    
    
    5.7
    
    
    $
    11,999
 
 (1)
    
    The intrinsic value of an option is the amount by which the current market value
of the underlying stock exceeds the exercise price of the option: market price at
the end of the period less the exercise price. Restricted
Stock
 WeightedRestricted
    
    
    AverageShares
    
    
    Grant Price(shares)
    
    
    ($/share)Unvested restricted stock January 1, 2006(1)
    
    
    171,214
    
    
    $
    56.23Granted
    
    
    12,500
    
    
    
    54.40Vested
    
    
    
    
    
    
    Forfeited
    
    
    (2,362
    )
    
    
    58.88Unvested restricted stock March 31, 2006
    
    
    181,352
    
    
    $
    55.93
 
 (1)
    
    Includes 52,501 units granted in July 2005 pursuant to a retention bonus plan
at an average price of $58.76 per unit, of which 50% vest 18 months following the grant date
with the remaining 50% to vest 36 months following the grant date. Restricted units will
convert to shares of restricted stock at the end of the vesting period and 50,139 units under
the retention bonus plan were unvested and outstanding at March 31, 2006. NOTE 2  Long-Term Debt and Notes
 March 31, 2006
    
    
    December 31, 2005(in thousands)Senior Debt:Revolving credit facility, due November 30, 2010
    
    $
    249,000
    
    
    $
    422,000Subordinated Debt:7% senior subordinated notes, due June 15, 2013.
    
    
    175,000
    
    
    
    175,000Total long-term debt and notes
    
    $
    424,000
    
    
    $
    597,000
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Revolving Credit Facility
 st st Pending Sale of Louisiana Gulf of Mexico Assets
  
    
    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 1.00% and 1.75%, 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
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  
    
    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 proceeds of assets sales;
    
    transactions with affiliates;
    
    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; and
    
    guarantees by our subsidiaries of certain indebtedness.
   NOTE 3  Stockholders Equity
 Stock Repurchase Program
  NOTE 4 Commitments and Contingencies
 Legal Proceedings
  Operating Leases
 th
 Letters of Credit
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Drilling Contracts
  New Supplemental Executive Retirement Plan
  NOTE 5  Related Party Transactions
 Employment Agreements with New Executives
     -16-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 6  Acquisitions and Dispositions
 Sale of Texas Gulf of Mexico Assets
  East Texas Acquisition
  NOTE 7  Subsequent Events
 Pending Sale of Louisiana Gulf of Mexico Assets
  -17-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Completion of East Texas Acquisition
 Acquisitions and Dispositions
 -18-




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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
  Strategic Restructuring Plan
   Disposition of Gulf of Mexico Assets.
 -19-




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Shift in Our Hedging Strategy.
  Redeployment of Net Sales Proceeds.
  -20-




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Recent Acquisition
  Critical Accounting Estimates and Significant Accounting Policies
  Overview of Results for the First Quarter of 2006
  
    
    We generated $29.8 million in net income, a decrease of 11% from $33.4 million
in the first quarter 2005, due primarily to continued lower production volumes resulting
from Hurricanes Katrina and Rita. Specifically, we estimate deferred production for the
first three months of 2006 of approximately 3.1 Bcfe or 34 MMcfe/day, impacting revenues for
the quarter by an estimated $26.3 million;
    
    We produced approximately 28 Bcfe and our average daily production rate was 312
MMcfe per day compared to 285 MMcfe per day during the fourth quarter of 2005 and 331 MMcfe
per day during the first quarter of 2005, a 9% increase from the previous quarter and a 6%
decrease from a year ago;
    
    We generated $122.5 million in net cash flows from operating activities compared
to $133.3 million during the first quarter of 2005, a decrease of 8% primarily as a result
of lower operating income;
    
    We decreased net borrowings under our revolving credit facility by $173 million,
using proceeds from the sale of our Texas Gulf of Mexico assets to repay $158 million and
cash generated from operations to repay $15 million;
    
    We invested $122.9 million in natural gas and oil properties compared to $146.3
million during the first quarter of 2005, a decrease of 16%, as we began implementing our
strategy to focus our operations onshore which has been historically less capital intensive
than offshore;
    
    We drilled 73 wells, of which 65, or 89%, were successful, with six in East
Texas, 14 in South Texas, 20 in Arkoma and 25 in the Rockies;
 -21-




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
    
    In South Texas, we continued to integrate the producing properties acquired at
the end of November 2005, acquired a 3D seismic survey covering approximately 1,000 square
miles in the Vicksburg trend, added a seventh drilling rig and prepared to spud our first
well in Tijerina-Canales-Blucher Field in mid-April 2006; and
    
    In the Rockies, we completed a 150 square mile 3D seismic survey in the DJ
Basin, started up the second phase of our DJ Basin gathering system, brought over 45 newly
completed wells on-line to the system, and expanded our acreage position in Utah, adding
approximately 4,250 net acres.
  
    
    Effective April 1, 2006 and in connection with the completion of the sale of the
Texas portion of our Gulf of Mexico assets on March 31, 2006, the borrowing base on our
revolving credit facility was reduced by $50 million, from $600 million to $550 million;
    
    On April 7, 2006, we entered into a definitive purchase and sale agreement with
certain partnerships affiliated with Merit Energy Company, as buyer, to sell substantially
all of our Louisiana Gulf of Mexico assets for a purchase price of approximately $590
million in cash, subject to customary closing conditions and purchase price adjustments.
The sale is expected to close on May 31, 2006, with an effective date of January 1, 2006
(see Note 7  Subsequent Events  Pending Sale of Louisiana Gulf of Mexico Assets);
    
    On April 25, 2006, we acquired producing properties and acreage with an
estimated 16.2 Bcfe of proved reserves as of January 1, 2006, from Samson Lone Star Limited
Partnership for a net purchase price of $21.3 million. The properties are located in the
Willow Springs Field of Gregg County, adjacent to our existing East Texas operations (see
Note 6  Acquisitions and Dispositions  East Texas Acquisition); and
    
    On May 4, 2006, we announced our capital expenditure budget for 2006 of $521
million, of which we plan to spend $443 million onshore for exploration and development, $53
million offshore and $25 million for capitalized interest and general and administrative
expenses.
 Operating and Financial Results for the Three Months Ended March 31, 2006 Compared to the Three
Months Ended March 31, 2005.
 Three Months Ended March 31,2006
    
    2005
    
    Variance(in thousands, expect percentages and price data)Summary Operating Information:Natural gas revenues
    
    $
    198,505
    
    
    $
    163,969
    
    
    $
    34,536
    
    
    
    21
    %Oil revenues
    
    
    20,453
    
    
    
    17,120
    
    
    
    3,333
    
    
    
    19
    %Gain (loss) on settled derivatives
    
    
    (46,525
    )
    
    
    (14,175
    )
    
    
    (32,350
    )
    
    
    228
    %Unrealized gain (loss) derivatives
    
    
    4,586
    
    
    
    (1,424
    )
    
    
    6,010
    
    
    
    -422
    %Operating revenues
    
    
    177,604
    
    
    
    165,720
    
    
    
    11,884
    
    
    
    7
    %Operating expenses
    
    
    124,436
    
    
    
    104,119
    
    
    
    20,317
    
    
    
    20
    %Income from operations
    
    
    53,168
    
    
    
    61,601
    
    
    
    (8,433
    )
    
    
    -14
    %Net income
    
    
    29,772
    
    
    
    33,438
    
    
    
    (3,666
    )
    
    
    -11
    %Production:Natural gas (MMcf)
    
    
    26,023
    
    
    
    27,357
    
    
    
    (1,334
    )
    
    
    -5
    %Oil (MBbls)
    
    
    348
    
    
    
    406
    
    
    
    (58
    )
    
    
    -14
    %Total (MMcfe) (1)
    
    
    28,111
    
    
    
    29,793
    
    
    
    (1,682
    )
    
    
    -6
    %Average daily production (MMcfe/d)
    
    
    312
    
    
    
    331
    
    
    
    (19
    )
    
    
    -6
    %Average Sales Prices:Natural Gas (per Mcf) unhedged
    
    $
    7.63
    
    
    $
    5.99
    
    
    $
    1.64
    
    
    
    27
    %Natural Gas (per Mcf) realized (2)
    
    
    5.84
    
    
    
    5.48
    
    
    
    0.36
    
    
    
    7
    %Natural Gas
(per Mcf) all-in(3)
    
    
    6.02
    
    
    
    5.42
    
    
    
    0.60
    
    
    
    11
    %Oil (per Bbl) realized
    
    
    58.77
    
    
    
    42.17
    
    
    
    16.60
    
    
    
    39
    %
 
 (1)
    
    Mcfe is defined as one thousand 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 prices include gains and losses realized on
derivative contracts settled
during the period.(3)
    
    Average prices include both the effect of gains and losses realized on
derivative contracts settled during the period as well as unrealized gains and losses recognized pursuant
to accounting under SFAS 133. -22-




---



##### Table of Contents



Income from Operations
  Production Volume
  Three Months Ended March 31,Average Daily Production by Area:
    
    2006
    
    2005
    
    Variance(Natural Gas Equivalents
 MMcfe)South Texas
    
    
    145
    
    
    
    135
    
    
    
    10
    
    
    
    7
    %Arkoma
    
    
    40
    
    
    
    43
    
    
    
    (3
    )
    
    
    -7
    %East Texas
    
    
    11
    
    
    
    2
    
    
    
    9
    
    
    
    +100
    %Rockies
    
    
    6
    
    
    
    5
    
    
    
    1
    
    
    
    20
    %Other
    
    
    
    
    
    
    2
    
    
    
    (2
    )
    
    
    -100
    %Total onshore
    
    
    202
    
    
    
    187
    
    
    
    15
    
    
    
    8
    %Offshore
    
    
    110
    
    
    
    144
    
    
    
    (34
    )
    
    
    -24
    %Total company
    
    
    312
    
    
    
    331
    
    
    
    (19
    )
    
    
    -6
    %
 Onshore.
  Offshore
 Commodity Prices and Effects of Hedging
  -23-




---



##### Table of Contents



Three Months Ended March 31,2006
    
    
    2005(in thousands)Cash (loss) realized on contracts settled
    
    $
    (46,525
    )
    
    $
    (14,175
    )Non-cash unrealized gain (loss):Ineffectiveness gain (loss)
    
    
    15,790
    
    
    
    (1,424
    )Mark-to-market change in fair value gain (loss)
    
    
    38,166
    
    
    
     ̄Deferred loss prior quarter production shortfalls
    
    
    (20,600
    )
    
    
     ̄Reclass of all deferred losses relating to Texas Gulf
of Mexico production sold during quarter
    
    
    (28,770
    )
    
    
     ̄Total non-cash unrealized gain (loss)
    
    
    4,586
    
    
    
    (1,424
    )Total gain (loss) from hedging activities
    
    $
    (41,939
    )
    
    $
    (15,599
    )
  Operating Expenses
 Three Months Ended March 31,Operating Expenses per Mcfe
    
    2006
    
    2005
    
    VarianceLease operating expense
    
    $
    0.78
    
    
    $
    0.52
    
    
    $
    0.26
    
    
    
    50
    %Severance tax
    
    
    0.22
    
    
    
    0.10
    
    
    
    0.12
    
    
    
    120
    %Transportation expense
    
    
    0.10
    
    
    
    0.09
    
    
    
    0.01
    
    
    
    11
    %Asset retirement accretion expense
    
    
    0.05
    
    
    
    0.04
    
    
    
    0.01
    
    
    
    25
    %Depreciation, depletion and
amortization
    
    
    2.98
    
    
    
    2.37
    
    
    
    0.61
    
    
    
    26
    %General and administrative, net
    
    
    0.31
    
    
    
    0.37
    
    
    
    (0.06
    )
    
    
    -16
    %Total operating expenses per
unit of production
    
    $
    4.44
    
    
    $
    3.49
    
    
    $
    0.95
    
    
    
    27
    %
  Lease Operating Expense
 Severance Tax
 -24-




---



##### Table of Contents



Depreciation, Depletion and Amortization
 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
    
    2006
    
    
    2005
    
    
    Variance
    
    
    2006
    
    
    2005
    
    
    Variance(in thousands)Gross general and administrative expense
    
    $
    14,398
    
    
    $
    15,962
    
    
    $
    (1,564
    )
    
    
    -10
    %
    
    $
    0.51
    
    
    $
    0.53
    
    
    $
    (0.02
    )
    
    
    -4
    %Operating overhead reimbursements
    
    
    (598
    )
    
    
    (550
    )
    
    
    (48
    )
    
    
    9
    %
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    
    
    
    
    Capitalized general and administrative
    
    
    (5,194
    )
    
    
    (4,289
    )
    
    
    (905
    )
    
    
    21
    %
    
    
    (0.18
    )
    
    
    (0.14
    )
    
    
    (0.04
    )
    
    
    29
    %General and administrative expense, net
    
    $
    8,606
    
    
    $
    11,123
    
    
    $
    (2,517
    )
    
    
    -23
    %
    
    $
    0.31
    
    
    $
    0.37
    
    
    $
    (0.06
    )
    
    
    -16
    %
   Other Income and Expense, Interest and Taxes
 Other Income and Expense
 -25-




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##### Table of Contents



Interest Expense, Net of Capitalized Interest
 Three Months Ended March 31,Interest and Average Borrowings
    
    2006
    
    
    2005
    
    
    Variance(dollars in thousands)Gross interest
    
    $
    10,376
    
    
    $
    5,424
    
    
    $
    4,952
    
    
    
    91
    %Capitalized interest
    
    
    (1,655
    )
    
    
    (1,990
    )
    
    
    335
    
    
    
    17
    %Interest expense, net of capitalized
interest
    
    $
    8,721
    
    
    $
    3,434
    
    
    $
    5,287
    
    
    
    154
    %Average total borrowings (1)
    
    $
    619,000
    
    
    $
    345,000
    
    
    $
    274,000
    
    
    
    79
    %Average total interest rate (1)
    
    
    6.47
    %
    
    
    5.82
    %
    
    
    0.65
    %
    
    
    11
    %Average bank borrowings
    
    $
    444,000
    
    
    $
    170,000
    
    
    $
    274,000
    
    
    
    161
    %Average bank interest rate
    
    
    6.26
    %
    
    
    4.60
    %
    
    
    1.66
    %
    
    
    36
    %
 
 (1)
    
    Average total borrowings and average total interest rate includes our $175
million senior subordinated notes at 7% due June 2013 and average borrowings under our
revolving credit facility.  Liquidity
 Capital Requirements
  
    
    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
    
    Indirect costs related to our exploration activities, including payroll and
other expenses attributable to our exploration professional staff.
 Drilling Contracts
 -26-




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##### Table of Contents



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:Revolving credit facility, due November 2010
    
    Note 2
    
    $
    249,000
    
    
    $
    
    
    
    $
    
    
    
    $
    249,000
    
    
    $
    7% senior subordinated notes, due June 2013
    
    Note 2
    
    
    175,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175,000Derivative instruments
    
    Note 1
    
    
    149,450
    
    
    
    103,080
    
    
    
    46,370
    
    
    
    
    
    
    
    East Texas acquisition, remaining purchase price
    
    Note 7
    
    
    20,000
    
    
    
    20,000
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    Note 4
    
    
    6,230
    
    
    
    1,350
    
    
    
    3,763
    
    
    
    1,117
    
    
    
    Letters of credit
    
    Note 4
    
    
    300
    
    
    
    300
    
    
    
    
    
    
    
    
    
    
    
    Drilling contracts
    
    Note 4
    
    
    20,553
    
    
    
    13,548
    
    
    
    7,004
    
    
    
    
    
    
    
    620,533
    
    
    
    138,278
    
    
    
    57,137
    
    
    
    250,117
    
    
    
    175,000Other Long-Term Obligations:Asset retirement obligations
    
    Note 1
    
    
    85,009
    
    
    
    6,905
    
    
    
    17,531
    
    
    
    13,469
    
    
    
    47,104Supplemental Executive Retirement Plan
    
    Note 4
    
    
    2,229
    
    
    
    100
    
    
    
    265
    
    
    
    261
    
    
    
    1,60387,238
    
    
    
    7,005
    
    
    
    17,796
    
    
    
    13,730
    
    
    
    48,707Total contractual obligations and
Commitments:
    
    
    
    
    
    $
    707,771
    
    
    $
    145,283
    
    
    $
    74,933
    
    
    $
    263,847
    
    
    $
    223,707
 Capital Resources
   -27-




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##### Table of Contents



Three Months Ended March 31,2006
    
    
    2005
    
    
    variance(in thousands)Net cash provided by operating activities
    
    $
    122,121
    
    
    $
    133,359
    
    
    $
    (11,238
    )Net cash provided by (used in) investing activities
    
    
    58,780
    
    
    
    (130,988
    )
    
    
    189,768Net cash (used in) financing activities
    
    
    (169,342
    )
    
    
    (7,188
    )
    
    
    (162,154
    )Net increase (decrease) in cash
    
    $
    11,559
    
    
    $
    (4,817
    )
    
    $
    16,376
  Operating Activities
 Investing Activities.
 -28-




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##### Table of Contents



March 31,2006
    
    
    2005(in thousands)Natural gas and oil capital expendituresProducing property acquisitions(1)
    
    $
    (1,891
    )
    
    $
    22,615Leasehold and lease acquisition costs(2)
    
    
    18,879
    
    
    
    25,237Development
    
    
    89,668
    
    
    
    73,223Exploration
    
    
    16,277
    
    
    
    25,239Total natural gas and oil capital expenditures
    
    
    122,933
    
    
    
    146,314Producing property dispositions(3)
    
    
    (189,371
    )
    
    
    (150
    )Net natural gas and oil capital expenditures
    
    $
    (66,438
    )
    
    $
    146,164
 
 (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 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)
    
    For the three months ended March 31, 2006 and 2005, includes capitalized
interest and general and administrative expenses of $6.8 million and $6.3 million,
respectively.(3)
    
    For the three months ended March 31, 2006, includes proceeds from the sale
of our Texas Gulf of Mexico assets of $190.8 million, net of $1.5 million in fees associated
with completion of the transaction. Financing Activities
 Access to Capital Markets
   Stock Repurchase Program.
 -29-




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##### Table of Contents



Off-Balance Sheet Arrangements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Market Risk
  Interest Rate Risk
  Commodity Risk
 Derivative
Instruments and Hedging Activities
  Changes in Fair Value of Derivative Instruments
  Three Months Ended March 31,2006
    
    
    2005Change in Fair Value of Derivatives Instruments:
    
    Before Tax(in thousands)Fair value of contracts at January 1
    
    $
    (417,658
    )
    
    $
    (75,149
    )Realized loss on contracts settled during period
    
    
    46,525
    
    
    
    14,175(Decrease) increase in fair value of all open contracts
    
    
    221,683
    
    
    
    (213,281
    )Net change during period
    
    
    268,208
    
    
    
    (199,106
    )Fair value of contracts outstanding at March 31
    
    $
    (149,450
    )
    
    $
    (274,255
    )
 -30-




---



##### Table of Contents



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)2006
    
    
    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
    
    
    250,0002007
    
    
    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
  -31-




---



##### Table of Contents



Changes in Internal Control Over Financial Reporting
  
 Part II. Other Information
 
 Item 1A. Risk Factors
  Our ability to sell assets and replace revenues generated from any sale of our Gulf of Mexico
properties depends upon market conditions and numerous uncertainties.
  Our hedging activities have resulted in financial losses and reduced our income and may continue to
do so in the future.
  -32-




---



##### Table of Contents



Item 4. Submission of Matters to a Vote of Security Holders
  1.
    
    The election of the following eight Directors of our company to serve until our next annual
meeting:
 Director
    
    Votes For
    
    Votes WithheldRobert B. Catell
    
    
    14,992,187
    
    
    
    12,896,447John U. Clarke
    
    
    18,674,360
    
    
    
    9,214,274David G. Elkins
    
    
    19,621,805
    
    
    
    8,266,829William G. Hargett
    
    
    18,729,676
    
    
    
    9,158,958Harold R. Logan, Jr.
    
    
    19,245,382
    
    
    
    8,643,252Thomas A. McKeever
    
    
    19,302,906
    
    
    
    8,585,728Stephen W. McKessy
    
    
    19,621,330
    
    
    
    8,267,304Donald C. Vaughn
    
    
    19,181,813
    
    
    
    8,706,821
  2.
    
    The ratification and approval of Deloitte & Touche LLP as our independent public accountants
for the fiscal year ending December 31, 2006:
 Votes For
    
    Votes Against
    
    Abstained27,493,302
    
    
    9,967
    
    
    
    385,365
 
 Item 6. Exhibits
 EXHIBITS
    
    
    
    DESCRIPTION10.1(1)
    
    
    
    Purchase and sale agreement dated
February 28, 2006 between The Houston
Exploration Company, as seller, and Merit
Management Partners I, L.P., Merit
Management Partners II, L.P., Merit
Management Partners III, L.P., Merit
Energy Partners III, L.P., Merit Energy
Partners D-III, L.P., Merit Energy
Partners E-III, L.P. and Merit Energy
Partners F-III, L.P., collectively, as
buyer.10.2(2)
    
    
    
    Employment Agreement dated January 18, 2006 between Robert T. Ray and The
Houston Exploration Company (Exhibit 99.1 to Current Report on Form 8-K dated January 18, 2006
(File No. 001-11899) and incorporated by reference).10.3(2)
    
    
    
    Employment Agreement dated March 27, 2006 between Carolyn M. Campbell and The
Houston Exploration Company (Exhibit 99.1 to Current Report on Form 8-K dated March 27, 2006
(File No. 001-11899) and incorporated by reference).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 Robert T. Ray, 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 Robert T. Ray, Chief Financial Officer, as required pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Filed herewith.(2)
    
    Identified as a management contract or compensation plan or arrangement. -33-




---



##### Table of Contents



SIGNATURES
  THE HOUSTON EXPLORATION COMPANYBy:
    /s/ William G. HargettWilliam G. HargettDate: May 9, 2006
    
    Chairman, President and Chief Executive OfficerBy:
    /s/ Robert T. RayRobert T. RayDate: May 9, 2006
    
    Senior Vice President and Chief Financial OfficerBy:
    /s/ James F. WestmorelandJames F. WestmorelandDate: May 9, 2006
    
    Vice President and Chief Accounting Officer




---



##### Table of Contents



Index to Exhibits
 EXHIBITS
    
    
    
    DESCRIPTION10.1(1)
    
    
    
    Purchase and sale agreement dated
February 28, 2006 between The Houston
Exploration Company, as seller, and Merit
Management Partners I, L.P., Merit
Management Partners II, L.P., Merit
Management Partners III, L.P., Merit
Energy Partners III, L.P., Merit Energy
Partners D-III, L.P., Merit Energy
Partners E-III, L.P. and Merit Energy
Partners F-III, L.P., collectively, as
buyer.10.2(2)
    
    
    
    Employment Agreement dated January 18, 2006 between Robert T. Ray and The
Houston Exploration Company (Exhibit 99.1 to Current Report on Form 8-K dated January 18, 2006
(File No. 001-11899) and incorporated by reference).10.3(2)
    
    
    
    Employment Agreement dated March 27, 2006 between Carolyn M. Campbell and The
Houston Exploration Company (Exhibit 99.1 to Current Report on Form 8-K dated March 27, 2006
(File No. 001-11899) and incorporated by reference).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 Robert T. Ray, 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 Robert T. Ray, Chief Financial Officer, as required pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
 
 (1)
    
    Filed herewith.(2)
    
    Identified as a management contract or compensation plan or arrangement.