##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 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
(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)
 
 Securities Registered Pursuant to Section 12(b) of the Act:
 Title of Each Class
    
    Name of Each
Exchange on Which RegisteredCommon Stock, $0.01 par value 
Series A Junior Participating Preferred Stock, $0.01 par value
    
    New York Stock Exchange
New York Stock Exchange
 Securities Registered Pursuant to Section 12(g) of the Act: None
 þ o
 o þ
 þ o
 þ o
  þ o o
 o þ
  DOCUMENTS INCORPORATED BY REFERENCE




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##### Table of Contents



Forward-Looking Statements and Available Information
    
    
    2Part I.
    
    
    3Items 1. and 2. Business and Properties
    
    
    3Item 1A. Risk Factors
    
    
    14Item 1B. Unresolved Staff Comments
    
    
    21Item 3. Legal Proceedings
    
    
    22Item 4. Submission of Matters to a Vote of Security Holders
    
    
    22Part II.
    
    
    22Item 5. Market for the Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
    
    
    22Item 6. Selected Financial Data
    
    
    24Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    27Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    47Item 8. Financial Statements and Supplemental Data
    
    
    49Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    49Item 9A. Controls and Procedures
    
    
    49Item 9B. Other Information
    
    
    49Part III.
    
    
    50Item 10. Directors and Executive Officers of the Registrant
    
    
    50Item 11. Executive Compensation
    
    
    50Item 12. Security Ownership of Beneficial Owners and Management
    
    
    50Item 13. Certain Relationships and Related Transactions
    
    
    50Item 14. Principal Accounting Fees and Services
    
    
    51Part IV.
    
    
    51Item 15. Exhibits, Financial Statement Schedules
    
    
    51Signatures
    
    
    57Glossary of Natural Gas and Oil Terms
    
    
    G-1Index to Financial Statements
    
    
    F-1First Amendment to Change of Control PlanComputation of Ratio of Earnings to Fixed ChargesSubsidiariesConsent of Deloitte & Touche LLPConsent of Netherland, Sewell & AssociatesConsent of Miller and LentsCertification 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
 http://www.houstonexploration.com
 www.sec.gov
 www.houstonexploration.com www.houstonexploration.com
 The Houston Exploration Company1100 Louisiana Street, Suite 2000Houston, TX 77002  5215Attention: Corporate SecretaryTelephone: (713) 830-6800
   - 2 -




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Part I.
 
 Items 1. and 2. Business and Properties
 Overview of Our Business and Pending Merger
       - 3 -




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##### Table of Contents



Business Strategy
  
    
    Pursue Balanced Growth.We pursue a balanced strategy of exploiting our
existing reserves, exploring for new reserves and acquiring new properties. Typically, a
substantial portion of our annual capital expenditure program is dedicated to lower risk
exploitation and development projects intended to generate cash flows with which we can fund
future expansion opportunities. We supplement our exploitation activities by investing in
exploratory prospects. We enhance our exploration and exploitation activities with
acquisitions of new projects that we believe offer significant unexploited reserve potential
and that conform to our investment criteria and operating philosophy. However, the merger
agreement contains significant restrictions on our operations pending completion of the
merger, including restrictions, among others, on our ability to make capital expenditures,
including acquisitions, enter into hedging arrangements and take other specific actions
without Forests approval.
    
    Focus on Natural Gas.Our assets are concentrated in natural gas prone areas in
the United States, and our production and reserve base is primarily natural gas. As of
December 31, 2006, approximately 96% of our proved reserves were natural gas and, for the
year ended December 31, 2006, approximately 94% of our production was natural gas. On an
equivalent unit of production basis, lease operating expense is typically lower for natural
gas properties as compared to oil properties, thereby allowing a higher cash margin.
    
    Concentrated Operations.We focus our operations in four relatively
concentrated areas in order to more efficiently utilize our base of geological, engineering,
drilling and production experience and expertise in these regions. By concentrating our
operations, we believe we are able to manage a large asset base with a relatively small
number of employees and to integrate additional properties at relatively low incremental
costs. At December 31, 2006, approximately 99% of our reserves were located in four
geographic areas: South Texas, the Arkoma Basin, East Texas and the Rocky Mountains.
    
    Maintain Significant Operating Control.Whenever possible, we prefer to operate
our properties, as it gives us more control over the nature and timing of capital
expenditures and overall operating expenses. At December 31, 2006, we operated approximately
80% of our wells, and our average working interest was approximately 77%.
    
    Minimize Costs.We seek to minimize operating costs through the concentration
of assets within geographic areas where we can leverage our operating control and capture
operating efficiencies. We believe that our operating structure provides us with a
competitive advantage because it maximizes our margins and cash flows. For 2006, our
onshore lease operating expense was $0.63 per Mcfe.
    
    Employ Conservative Financial Policies.We typically have funded our
exploitation and exploration activities out of cash flows from operations, while we have
funded acquisitions with borrowings under our revolving bank credit facility and through
public debt offerings. Although our debt levels have historically increased periodically in
connection with acquisitions, we will seek to maintain conservative debt levels. Among
other things, this will
 - 4 -




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provide us with flexibility to continually review and adjust our capital expenditure program
during the year (subject to the restrictions in the merger agreement) based on operational
developments, commodity prices, service costs, acquisition opportunities and numerous other
factors.
 Manage Commodity Price Risks.
 - 5 -




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##### Table of Contents



Properties and Operating Areas
  Activity and Balances as of or for the Year Ended December 31, 2006Average
    
    
    
    
    
    
    
    
    
    PercentageDaily
    
    Total
    
    Proved
    
    Total Proved
    
    Wells DrilledArea
    
    Production
    
    Production
    
    Reserves
    
    Reserves
    
    Total
    
    Successful(MMcfe/d)
    
    (MMcfe)
    
    (MMcfe)
    
    
    
    
    
    (Gross)
    
    (Gross)South Texas
    
    
    143
    
    
    
    52,317
    
    
    
    356,023
    
    
    
    51
    %
    
    
    100
    
    
    
    90Arkoma Basin
    
    
    40
    
    
    
    14,465
    
    
    
    190,384
    
    
    
    27
    %
    
    
    72
    
    
    
    71East Texas
    
    
    12
    
    
    
    4,420
    
    
    
    86,086
    
    
    
    12
    %
    
    
    28
    
    
    
    28Rocky Mountains
    
    
    8
    
    
    
    2,961
    
    
    
    62,062
    
    
    
    10
    %
    
    
    160
    
    
    
    138Other
    
    
    1
    
    
    
    244
    
    
    
    2,563
    
    
    
    
    
    
    
    
    
    
    
    Total onshore
    
    
    204
    
    
    
    74,407
    
    
    
    697,118
    
    
    
    100
    %
    
    
    360
    
    
    
    327Gulf of Mexico
    
    
    38
    
    
    
    13,749
    
    
    
    2,210
    
    
    
    
    
    
    
    3
    
    
    
    2Total
    
    
    242
    
    
    
    88,156
    
    
    
    699,328
    
    
    
    100
    %
    
    
    363
    
    
    
    329
 South Texas.
  Arkoma Basin.
 East Texas
 Rocky Mountains.
 Gulf of Mexico.
 - 6 -




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Other.
 Natural Gas and Oil Reserves
  As of December 31,Net Proved Reserves:
    
    2006(1)
    
    
    2005(1)
    
    
    2004(1)(in thousands)Natural gas (MMcf)
    
    
    671,636
    
    
    
    793,074
    
    
    
    749,114Oil and natural gas liquids (MBbls)
    
    
    4,615
    
    
    
    11,291
    
    
    
    7,335Total (MMcfe)
    
    
    699,328
    
    
    
    860,820
    
    
    
    793,124Net present value of future cash flows, before income
taxes(2)(4)
    
    $
    1,002,692
    
    
    $
    2,877,420
    
    
    $
    2,071,976Future income taxes, discounted at 10%
    
    
    (265,466
    )
    
    
    (910,396
    )
    
    
    (631,921
    )Standardized measure of discounted future net cash flows (3)(4)
    
    $
    737,226
    
    
    $
    1,967,024
    
    
    $
    1,440,055
 
 (1)
    
    At December 31, 2006, 2005 and 2004, net proved reserves attributable to our
Gulf of Mexico assets totaled 2,210 MMcfe, 244,596 MMcfe and 291,477 Mcfe, respectively,
and included 2,070 MMcf of natural gas and 23 MBbls of oil and natural gas liquids for
2006, 196,488 MMcf of natural gas and 8,018 MBbls of oil and natural gas liquids for 2005,
and 250,383 MMcf of natural gas and 6,849 MBbls of oil and natural gas liquids for 2004.
Substantially all of our Gulf of Mexico assets were sold during 2006.(2)
    
    The net present value of future net cash flows before income tax expense
attributable to estimated net proved reserves, discounted at 10% per annum (PV10), is a
computation of the standardized measure of discounted future net cash flows on a pre-tax
basis. PV10 is not a measure of financial performance under accounting principles
generally accepted in the United States (GAAP). However, we consider PV10 to be an
important measure for evaluating the relative significance of our natural gas and oil
properties. PV10 is computed on the same basis as the standardized measure of discounted
future net cash flows, but without deducting income taxes. We believe investors and
creditors may utilize our PV10 as a basis for comparison of the relative size and value of
our reserves to other companies. The above table provides a reconciliation of PV10 to the
standardized measure; however, PV10 is not a substitute for the standardized measure.(3)
    
    The standardized measure of discounted future net cash flows has been calculated
in accordance with Statement of Financial Accounting Standards (SFAS) 69, Disclosures
about Oil and Gas Producing Activities. Additional information on the standardized
measure is presented in Consolidated Financial Statements, Note 12  Supplemental
Information on Natural Gas and Oil Exploration, Development and Production Activities
(Unaudited) and, in accordance with current SEC guidelines, does not include estimated
future cash flows from our open derivative instruments.(4)
    
    Year-end prices per Mcf of natural gas used in making the present value and
standardized measure determinations as of December 31, 2006, 2005 and 2004 were $4.94,
$8.15 and $5.68, respectively. Year-end prices per Bbl of oil used in making these same
calculations were $49.94, $53.27 and $41.67, respectively, for 2006, 2005 and 2004. These
prices should not be interpreted as a prediction of future prices, and our PV10 measure
and the standardized measure do not purport to represent the fair value of our natural gas
and oil reserves. - 7 -




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##### Table of Contents



Estimates of proved reserves and future net revenues
may change if the assumptions on which such estimates are based prove to be inaccurate.
 Drilling Activity
  Exploratory Wells
    
    Development Wells
    
    Total WellsSuccessful
    
    Dry
    
    Successful
    
    Dry
    
    Successful
    
    Dry
    
    TotalGross
    
    Net
    
    Gross
    
    Net
    
    Gross
    
    Net
    
    Gross
    
    Net
    
    Gross
    
    Net
    
    Gross
    
    Net
    
    Gross
    
    Net2006South Texas
    
    
    1
    
    
    
    1.0
    
    
    
    
    
    
    
    
    
    
    
    89
    
    
    
    76.1
    
    
    
    10
    
    
    
    8.6
    
    
    
    90
    
    
    
    77.1
    
    
    
    10
    
    
    
    8.6
    
    
    
    100
    
    
    
    85.7Arkoma Basin
    
    
    3
    
    
    
    1.2
    
    
    
    
    
    
    
    
    
    
    
    68
    
    
    
    44.5
    
    
    
    1
    
    
    
    0.3
    
    
    
    71
    
    
    
    45.7
    
    
    
    1
    
    
    
    0.3
    
    
    
    72
    
    
    
    46.0East Texas
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    28
    
    
    
    26.2
    
    
    
    
    
    
    
    
    
    
    
    28
    
    
    
    26.2
    
    
    
    
    
    
    
    
    
    
    
    28
    
    
    
    26.2Rocky Mountains
    
    
    18
    
    
    
    8.8
    
    
    
    6
    
    
    
    3.2
    
    
    
    120
    
    
    
    95.0
    
    
    
    16
    
    
    
    13.8
    
    
    
    138
    
    
    
    103.8
    
    
    
    22
    
    
    
    17.0
    
    
    
    160
    
    
    
    120.8Gulf of Mexico
    
    
    2
    
    
    
    0.5
    
    
    
    1
    
    
    
    0.2
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    0.5
    
    
    
    1
    
    
    
    0.2
    
    
    
    3
    
    
    
    0.7Total
    
    
    24
    
    
    
    11.5
    
    
    
    7
    
    
    
    3.4
    
    
    
    305
    
    
    
    241.8
    
    
    
    27
    
    
    
    22.7
    
    
    
    329
    
    
    
    253.3
    
    
    
    34
    
    
    
    26.1
    
    
    
    363
    
    
    
    279.42005South Texas
    
    
    1
    
    
    
    1.0
    
    
    
    
    
    
    
    
    
    
    
    81
    
    
    
    79.8
    
    
    
    13
    
    
    
    13.0
    
    
    
    82
    
    
    
    80.8
    
    
    
    13
    
    
    
    13.0
    
    
    
    95
    
    
    
    93.8Arkoma Basin
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    60
    
    
    
    36.8
    
    
    
    1
    
    
    
    0.8
    
    
    
    60
    
    
    
    36.8
    
    
    
    1
    
    
    
    0.8
    
    
    
    61
    
    
    
    37.6East Texas
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    16.0
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    16.0
    
    
    
    
    
    
    
    
    
    
    
    16
    
    
    
    16.0Rocky Mountains
    
    
    128
    
    
    
    96.4
    
    
    
    21
    
    
    
    15.7
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    128
    
    
    
    96.4
    
    
    
    21
    
    
    
    15.7
    
    
    
    149
    
    
    
    112.1Gulf of Mexico
    
    
    5
    
    
    
    2.4
    
    
    
    2
    
    
    
    1.3
    
    
    
    7
    
    
    
    6.1
    
    
    
    1
    
    
    
    0.5
    
    
    
    12
    
    
    
    8.5
    
    
    
    3
    
    
    
    1.8
    
    
    
    15
    
    
    
    10.3Total
    
    
    134
    
    
    
    99.8
    
    
    
    23
    
    
    
    17.0
    
    
    
    164
    
    
    
    138.7
    
    
    
    15
    
    
    
    14.3
    
    
    
    298
    
    
    
    238.5
    
    
    
    38
    
    
    
    31.3
    
    
    
    336
    
    
    
    269.82004South Texas
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1.0
    
    
    
    56
    
    
    
    54.6
    
    
    
    19
    
    
    
    18.0
    
    
    
    56
    
    
    
    54.6
    
    
    
    20
    
    
    
    19.0
    
    
    
    76
    
    
    
    73.6Arkoma Basin
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    73
    
    
    
    45.8
    
    
    
    6
    
    
    
    3.0
    
    
    
    73
    
    
    
    45.8
    
    
    
    6
    
    
    
    3.0
    
    
    
    79
    
    
    
    48.8Rocky Mountains
    
    
    26
    
    
    
    25.4
    
    
    
    3
    
    
    
    2.3
    
    
    
    2
    
    
    
    2.0
    
    
    
    
    
    
    
    
    
    
    
    28
    
    
    
    27.4
    
    
    
    3
    
    
    
    2.3
    
    
    
    31
    
    
    
    29.7Other
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    0.5
    
    
    
    5
    
    
    
    5.0
    
    
    
    
    
    
    
    
    
    
    
    5
    
    
    
    5.0
    
    
    
    1
    
    
    
    0.5
    
    
    
    6
    
    
    
    5.5Gulf of Mexico
    
    
    3
    
    
    
    1.4
    
    
    
    4
    
    
    
    2.2
    
    
    
    12
    
    
    
    9.3
    
    
    
    
    
    
    
    
    
    
    
    15
    
    
    
    10.7
    
    
    
    4
    
    
    
    2.2
    
    
    
    19
    
    
    
    12.9Total
    
    
    29
    
    
    
    26.8
    
    
    
    9
    
    
    
    6.0
    
    
    
    148
    
    
    
    116.7
    
    
    
    25
    
    
    
    21.0
    
    
    
    177
    
    
    
    143.5
    
    
    
    34
    
    
    
    27.0
    
    
    
    211
    
    
    
    170.5
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##### Table of Contents

\

Productive Wells
  As of December 31, 2006Natural Gas Wells
    
    
    Oil Wells
    
    
    Total WellsOperated
    
    
    Non-Operated
    
    
    Operated
    
    
    Non-OperatedGross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    NetSouth Texas
    
    
    827
    
    
    
    779.8
    
    
    
    115
    
    
    
    17.2
    
    
    
    13
    
    
    
    7.7
    
    
    
    
    
    
    
    
    
    
    
    955
    
    
    
    804.7Arkoma Basin
    
    
    350
    
    
    
    240.3
    
    
    
    133
    
    
    
    29.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    483
    
    
    
    269.4East Texas
    
    
    98
    
    
    
    89.3
    
    
    
    5
    
    
    
    0.8
    
    
    
    3
    
    
    
    2.1
    
    
    
    1
    
    
    
    0.4
    
    
    
    107
    
    
    
    92.6Rocky Mountains
    
    
    228
    
    
    
    227.5
    
    
    
    92
    
    
    
    45.4
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    1.0
    
    
    
    322
    
    
    
    273.9Other
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    1.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    1.1Total onshore
    
    
    1,503
    
    
    
    1,336.9
    
    
    
    347
    
    
    
    93.6
    
    
    
    16
    
    
    
    9.8
    
    
    
    3
    
    
    
    1.4
    
    
    
    1,869
    
    
    
    1,441.7Gulf of Mexico
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    0.5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    0.5Total
    
    
    1,503
    
    
    
    1,336.9
    
    
    
    349
    
    
    
    94.1
    
    
    
    16
    
    
    
    9.8
    
    
    
    3
    
    
    
    1.4
    
    
    
    1,871
    
    
    
    1,442.2
 Acreage Data
  As of December 31, 2006Undeveloped
    
    
    Developed
    
    
    Total AcreageGross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    NetSouth Texas
    
    
    9,066
    
    
    
    8,649
    
    
    
    98,892
    
    
    
    74,206
    
    
    
    107,958
    
    
    
    82,855Arkoma Basin
    
    
    27,181
    
    
    
    10,216
    
    
    
    47,239
    
    
    
    28,619
    
    
    
    74,420
    
    
    
    38,835East Texas
    
    
    4,849
    
    
    
    2,984
    
    
    
    15,941
    
    
    
    13,816
    
    
    
    20,790
    
    
    
    16,800Rocky Mountains
    
    
    906,621
    
    
    
    687,032
    
    
    
    78,914
    
    
    
    51,668
    
    
    
    985,535
    
    
    
    738,700Other onshore
    
    
    
    
    
    
    
    
    
    
    1,740
    
    
    
    620
    
    
    
    1,740
    
    
    
    620Total onshore
    
    
    947,717
    
    
    
    708,881
    
    
    
    242,726
    
    
    
    168,929
    
    
    
    1,190,443
    
    
    
    877,810Gulf of Mexico
    
    
    56,998
    
    
    
    31,936
    
    
    
    7,500
    
    
    
    750
    
    
    
    64,498
    
    
    
    32,686Total
    
    
    1,004,715
    
    
    
    740,817
    
    
    
    250,226
    
    
    
    169,679
    
    
    
    1,254,941
    
    
    
    910,496
 Undeveloped Acreage Expirations
  As of December 31, 20062007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    NetSouth Texas
    
    
    2,593
    
    
    
    2,545
    
    
    
    1,238
    
    
    
    1,161
    
    
    
    3,528
    
    
    
    3,457
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Arkoma Basin
    
    
    2,816
    
    
    
    932
    
    
    
    
    
    
    
    
    
    
    
    614
    
    
    
    238
    
    
    
    4,088
    
    
    
    1,154
    
    
    
    15,754
    
    
    
    6,994East Texas
    
    
    2,799
    
    
    
    2,172
    
    
    
    126
    
    
    
    126
    
    
    
    191
    
    
    
    169
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Rocky Mountains
    
    
    66,529
    
    
    
    56,971
    
    
    
    317,773
    
    
    
    181,999
    
    
    
    36,012
    
    
    
    28,117
    
    
    
    15,719
    
    
    
    7,145
    
    
    
    132,708
    
    
    
    120,326Total onshore
    
    
    74,737
    
    
    
    62,620
    
    
    
    319,137
    
    
    
    183,286
    
    
    
    40,345
    
    
    
    31,981
    
    
    
    19,807
    
    
    
    8,299
    
    
    
    148,462
    
    
    
    127,320Gulf of Mexico
    
    
    5,000
    
    
    
    2,500
    
    
    
    11,998
    
    
    
    4,437
    
    
    
    25,000
    
    
    
    12,500
    
    
    
    15,000
    
    
    
    12,500
    
    
    
    
    
    
    
    Total
    
    
    79,737
    
    
    
    65,120
    
    
    
    331,135
    
    
    
    187,723
    
    
    
    65,345
    
    
    
    44,481
    
    
    
    34,807
    
    
    
    20,799
    
    
    
    148,462
    
    
    
    127,320
 - 9 -




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##### Table of Contents



Marketing and Customers
   Our business depends on oil and
natural gas transportation facilities that are owned by others
 Title to Properties
  Competition
 We face strong competition
 Seasonal Nature of Business
  - 10 -




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##### Table of Contents



Employees
  Offices
 th
 Regulation
  Drilling and Production
 
    
    the location of wells;
    
    the method of drilling and casing wells;
    
    the rates of production or allowables;
    
    the surface use and restoration of properties upon which wells are drilled; and
    
    the plugging and abandoning of wells.
   - 11 -




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Natural Gas Sales and Transportation.
   Environmental Matters and Regulation
 General
 
    
    require the acquisition of a permit before drilling commences;
    
    require the installation of expensive pollution control measures;
    
    restrict the types, quantities and concentration of various substances that can
be released into the environment in connection with drilling and production activities;
    
    limit or prohibit drilling activities on lands lying within wilderness, wetlands
and other protected areas;
    
    require remedial measures to prevent pollution from former operations, such as
pit closure and plugging of abandoned wells; and
    
    impose substantial liabilities for pollution resulting from our operations.
  - 12 -




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Resource Conservation and Recovery Act
  Comprehensive Environmental Response, Compensation and Liability Act
  Oil Pollution Act
 Federal Water Pollution Control Act/Clean Water Act
 - 13 -




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Federal Clean Air Act
   - 14 -




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##### Table of Contents



Item 1A Risk Factors
 We are subject to significant business uncertainties and contractual restrictions while our merger
with Forest Oil Corporation is pending.
  The failure to complete the merger could negatively impact our stock price, future business and
financial results.
  §
    
    We may be required to pay a termination fee of $55 million if the merger agreement is
terminated under certain circumstances and we enter into an alternative transaction;§
    
    The current market price of our common stock may reflect a market assumption that the
merger will occur, and a failure to complete the merger could result in a decline in the
market price of our common stock;§
    
    We are obligated to pay certain costs relating to the merger (such as legal and financial
advisory fees) whether or not the merger is completed, and we may be required to pay a $5
million fee to Forest to cover its expenses if the merger is not consummated for certain
reasons;§
    
    There may be substantial disruption to our business and our management and employees have
been and will continue to be distracted from day-to-day operations because matters related
to the merger (including integration planning) require substantial commitments of time and
resources, which could otherwise have been devoted to other activities and business
opportunities that could have been beneficial to us and our stockholders;
    
    Our business could be adversely affected if we are unable to retain key employees or
attract qualified replacements; and§    
    We would continue to face the risks that we currently face as an independent company.
 We are subject to an ongoing shareholder lawsuit, which could result in an injunction preventing
consummation of the merger or significant monetary damages.
  - 15 -




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##### Table of Contents



The volatility of natural gas and oil prices may affect our financial results.
   §
    
    weather conditions;§
    
    the price of foreign imports;§
    
    overall domestic and global economic conditions;§
    
    terrorist attacks or military conflicts;§
    
    political conditions, economic stability, and armed conflicts in oil producing regions;§
    
    the ability of members of the Organization of Petroleum Exporting Countries to
agree to and maintain oil price and production controls;§
    
    the level of consumer demand and the price and availability of alternative fuels;§
    
    speculation in the commodity futures markets;§
    
    technological advances affecting energy consumption;§
    
    domestic and foreign governmental regulations, including regulations imposed by Native American tribes; and§
    
    approvals, proximity and capacity of natural gas and oil pipelines and other transportation facilities.
  Our ability to replace revenues generated from the sale of substantially all of our Gulf of Mexico
properties depends upon market conditions, restrictions under the pending merger agreement and
numerous uncertainties.
  A significant increase in our level of indebtedness may limit our financial flexibility.
   - 16 -




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##### Table of Contents



§
    
    a portion of our cash flows from operating activities must be used to service
our debt and is therefore not available for other purposes;§
    
    we may be at a competitive disadvantage as compared to similar companies that
have less debt;§
    
    the covenants contained in the agreements governing our outstanding debt require
us to meet certain financial tests and may limit our ability to borrow additional funds,
sell assets, repurchase shares of company stock, pay dividends and make certain investments
and may also affect our flexibility in planning for, and reacting to, changes in the economy
and in our industry;§
    
    we may not be able to easily divest or exchange our assets because they have
been mortgaged to secure borrowings under our revolving bank credit facility;§
    
    any additional financing in the future for working capital, capital
expenditures, acquisitions, general corporate or other purposes may have higher costs and
more restrictive covenants; and§
    
    changes in the credit ratings of our debt may negatively affect the cost, terms,
conditions and availability of future financing.
  We may be required to take significant writedowns if natural gas and oil prices decline.
    Lower natural gas and oil prices could negatively impact our ability to borrow.
  - 17 -




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##### Table of Contents



Our hedging activities have resulted in significant financial losses and may continue to do so in
the future.
   The high-rate production characteristics of our properties subject us to high reserve replacement
needs and require significant capital expenditures to replace our reserves at a faster rate than
companies whose reserves have longer-life production profiles.
  Rising finding and development costs may impair our profitability.
  - 18 -




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##### Table of Contents



The success of our business depends upon our ability to find, replace, develop and acquire natural
gas and oil reserves.
  Estimates of proved reserves and future net revenue may change if the assumptions on which such
estimates are based prove to be inaccurate.
  We may not be able to meet our substantial capital requirements.
  Our business involves many operating risks that can cause substantial losses; insurance may not
protect us against all these risks.
  §
    
    fires;§
    
    natural disasters, including tropical storms, hurricanes and other adverse weather conditions;§
    
    explosions;§
    
    encountering formations with abnormal pressures;
 - 19 -




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##### Table of Contents



§
    
    encountering unusual or unexpected geological formations;§
    
    blowouts;§
    
    cratering;§
    
    unexpected operational events;§
    
    equipment malfunctions;§
    
    pipeline ruptures;§
    
    spills;§
    
    compliance with environmental and government regulations; and§
    
    title problems.
  Our reserves, production and cash flow are highly dependent upon operations that are concentrated
in a small number of areas.
  Drilling natural gas and oil wells is a high risk activity and subjects us to a variety of factors
that we cannot control.
  The availability and cost of rigs, equipment, and personnel could adversely affect our
profitability and level of operations.
  Our business depends on oil and natural gas transportation facilities that are owned by others.
  - 20 -




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##### Table of Contents



Any acquisition and investment activities may be unsuccessful and costly.
  We could lose certain leasehold rights if we do not drill all the wells that are necessary to hold
our acreage, especially in the Rocky Mountains, before the initial lease terms expire.
  We may incur substantial costs to comply with costly and stringent environmental and other
governmental laws and regulations.
   We face strong competition.
  - 21 -




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##### Table of Contents



The inability of one or more of our customers to meet its obligations may adversely affect our
financial results.
  
 Item 1B. Unresolved Staff Comments
  Item 2. Properties (see Item 1. Business and Properties)
 
 Item 3. Legal Proceedings
 Legal Proceedings
 
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Part II.
 
 Item 5. Market for the Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
  Year Ended December 31, 2006
    
    High
    
    LowFirst Quarter
    
    $
    62.56
    
    
    $
    48.13Second Quarter
    
    
    62.50
    
    
    
    49.75Third Quarter
    
    
    66.21
    
    
    
    54.36Fourth Quarter
    
    
    57.75
    
    
    
    51.60
 Year Ended December 31, 2005
    
    High
    
    LowFirst Quarter
    
    $
    62.29
    
    
    $
    51.14Second Quarter
    
    
    59.40
    
    
    
    45.60Third Quarter
    
    
    71.47
    
    
    
    53.30Fourth Quarter
    
    
    67.83
    
    
    
    49.86
  - 22 -




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##### Table of Contents



Comparison of Five Year Cumulative Total Return* Among
The Houston Exploration Company, the S&P 500 Index and our Peer Group
 
 
 December 31,2001
    
    2002
    
    2003
    
    2004
    
    2005
    
    2006The Houston Exploration Company
    
    $
    100.00
    
    
    $
    91.13
    
    
    $
    108.76
    
    
    $
    167.69
    
    
    $
    157.24
    
    
    $
    154.20S&P 500
    
    $
    100.00
    
    
    $
    77.90
    
    
    $
    100.24
    
    
    $
    111.15
    
    
    $
    116.61
    
    
    $
    135.03Peer Group
    
    $
    100.00
    
    
    $
    114.49
    
    
    $
    152.85
    
    
    $
    210.69
    
    
    $
    325.88
    
    
    $
    348.57
 Dividends
 Stockholder Rights Plan
 - 23 -




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##### Table of Contents



Item 6. Selected Financial Data
  Years Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(in thousands, except per share data and ratios)Income Statement Data:Revenues:Natural gas and oil revenues
    
    $
    529,586
    
    
    $
    620,271
    
    
    $
    649,087
    
    
    $
    491,440
    
    
    $
    344,295Other
    
    
    2,011
    
    
    
    1,272
    
    
    
    1,352
    
    
    
    1,312
    
    
    
    1,086Total revenues
    
    
    531,597
    
    
    
    621,543
    
    
    
    650,439
    
    
    
    492,752
    
    
    
    345,381Expenses:Lease operating expense
    
    
    63,959
    
    
    
    67,796
    
    
    
    55,925
    
    
    
    47,072
    
    
    
    33,976Severance tax
    
    
    18,102
    
    
    
    18,121
    
    
    
    11,933
    
    
    
    15,958
    
    
    
    9,487Transportation expense
    
    
    10,636
    
    
    
    11,883
    
    
    
    11,819
    
    
    
    10,387
    
    
    
    9,317Asset retirement accretion expense(1)
    
    
    3,373
    
    
    
    5,278
    
    
    
    4,902
    
    
    
    3,668
    
    
    
    Depreciation, depletion and amortization
    
    
    253,666
    
    
    
    295,351
    
    
    
    265,148
    
    
    
    197,530
    
    
    
    171,610Writedown in carrying value
    
    
    19,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    General and administrative, net
    
    
    36,013
    
    
    
    38,378
    
    
    
    32,899
    
    
    
    19,542
    
    
    
    13,077Total operating expenses
    
    
    404,749
    
    
    
    436,807
    
    
    
    382,626
    
    
    
    294,157
    
    
    
    237,467Income from operations
    
    
    126,848
    
    
    
    184,736
    
    
    
    267,813
    
    
    
    198,595
    
    
    
    107,914Other (income) expense(2)
    
    
    (13,495
    )
    
    
    142
    
    
    
    (1,058
    )
    
    
    (15,746
    )
    
    
    (9,070
    )Interest expense, net
    
    
    25,206
    
    
    
    16,535
    
    
    
    9,455
    
    
    
    8,342
    
    
    
    7,398Income before income taxes
    
    
    115,137
    
    
    
    168,059
    
    
    
    259,416
    
    
    
    205,999
    
    
    
    109,586Income tax provision
    
    
    47,354
    
    
    
    62,890
    
    
    
    96,592
    
    
    
    72,187
    
    
    
    39,092Income before cumulative effect of change in
accounting principle
    
    $
    67,783
    
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    133,812
    
    
    $
    70,494Cumulative effect of change in accounting
principle(3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,772
    )
    
    
    Net income
    
    $
    67,783
    
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    131,040
    
    
    $
    70,494Earnings per share:Basic:Income per share before cumulative effect of
change in accounting principle change
    
    $
    2.37
    
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.30
    
    
    $
    2.31Cumulative effect of change in accounting
principle(3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.09
    )
    
    
    Net income per share  basic
    
    $
    2.37
    
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.21
    
    
    $
    2.31Diluted:Income per share before cumulative effect of
change in accounting principle
    
    $
    2.36
    
    
    $
    3.62
    
    
    $
    5.44
    
    
    $
    4.29
    
    
    $
    2.28Cumulative effect of change in accounting
principle(3)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.09
    )
    
    
    Net income per share  diluted
    
    $
    2.36
    
    
    $
    3.62
    
    
    $
    5.44
    
    
    $
    4.20
    
    
    $
    2.28Weighted average shares  basic
    
    
    28,543
    
    
    
    28,707
    
    
    
    29,616
    
    
    
    31,097
    
    
    
    30,569Weighted average shares  diluted
    
    
    28,693
    
    
    
    29,037
    
    
    
    29,932
    
    
    
    31,213
    
    
    
    30,878Ratio of earnings to fixed charges(4)
    
    
    4.7x
    
    
    
    7.2x
    
    
    
    15.0x
    
    
    
    13.6x
    
    
    
    7.6x
 - 24 -




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##### Table of Contents



Years Ended December 31,2006
    
    2005
    
    2004
    
    2003
    
    2002(in thousands)Cash Flow Data:Net cash provided by operating activities
    
    $
    416,189
    
    
    $
    460,509
    
    
    $
    527,141
    
    
    $
    381,969
    
    
    $
    243,601Net cash provided by (used) in investing
activities(5)
    
    
    105,007
    
    
    
    (727,003
    )
    
    
    (509,922
    )
    
    
    (452,959
    )
    
    
    (252,857
    )Net cash provided by (used in) financing
activities(6)
    
    
    (475,225
    )
    
    
    255,896
    
    
    
    (1,211
    )
    
    
    55,528
    
    
    
    17,668
 At December 31,2006
    
    2005
    
    2004
    
    2003
    
    2002(in thousands)Balance Sheet Data:Working capital (deficit)(7)
    
    $
    247
    
    
    $
    (214,525
    )
    
    $
    (31,884
    )
    
    $
    (36
    )
    
    $
    10,550Property, plant and equipment, net(8)
    
    
    1,591,332
    
    
    
    2,018,340
    
    
    
    1,548,256
    
    
    
    1,371,129
    
    
    
    1,022,414Total assets(8)
    
    
    1,771,726
    
    
    
    2,361,624
    
    
    
    1,722,577
    
    
    
    1,509,065
    
    
    
    1,151,068Long-term debt and notes(9)
    
    
    175,000
    
    
    
    597,000
    
    
    
    355,000
    
    
    
    302,000
    
    
    
    252,000Stockholders equity
    
    
    964,604
    
    
    
    693,138
    
    
    
    782,920
    
    
    
    735,534
    
    
    
    592,789
 
 (1)
    
    Subsequent to the adoption of SFAS 143, Accounting for Asset Retirement
Obligations, we have recognized accretion expense as the estimated future obligations that we
have recorded accrete to fair value.(2)
    
    For 2006, Other (income) expense of $13.5 million in net other income was
comprised of (i) $8.7 million of interest income earned on cash proceeds from the sale of
substantially all of our Gulf of Mexico assets during the first and second quarters of 2006,
(ii) income of $7.7 million of refunds of prior years severance tax expense that were
recognized pursuant to the receipt of a high cost/tight sand designation for a portion of
our South Texas production in July 2002; and (iii) $2.9 million of expense relating to prior
period offshore transportation expense that was billed during 2006. See Consolidated
Financial Statements, Note 9  Commitments and Contingencies.For 2005, Other (income) expense of $0.1 million in net other expenses was comprised of (i)
income of $2.7 million recognized for refunds of prior years severance tax expense and (ii)
expense of $2.8 million incurred as a result of a payout settlement at East Cameron 82/83 during
the first quarter of 2005, whereby our working interest in the A3 well was subsequently reduced
from 50% to 35%.For 2004, Other (income) expense of $1.0 million in net other income comprised of (i) income of
$1.2 million recognized for refunds of prior years severance tax expense and (ii) $0.2 million
in debt extinguishment expenses incurred during the second quarter of 2004 pursuant to the
reduction of our borrowing base from $375 million to $340 million as a result of the disposition
of our Appalachian Basin assets.For 2003, Other (income) expense of $15.5 million in net other income is comprised of (i)
income of $21.6 million recognized for refunds of prior years severance tax expense and (ii)
$5.9 million in expenses incurred pursuant to the early
redemption of our $100 million 85/8
% notes
in June 2003.For 2002, Other (income) expense is comprised of income of $9.1 million recognized for refunds
of prior years severance tax expense.(3)
    
    On January 1, 2003, we adopted SFAS 143, Accounting for Asset Retirement
Obligations, which addresses accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement costs. Pursuant
to our adoption of SFAS 143, we recognized a charge to income during the first quarter of 2003
of $2.8 million, net of tax, for the cumulative effect of the change in accounting principle.
See Consolidated Financial Statements, Note 1  Summary of Organization and Significant
Accounting Policies  Asset Retirement Obligations.(4)
    
    For purposes of determining the ratio of earnings to fixed charges,
earnings are defined as income (loss) before tax plus fixed charges, adjusted to exclude
capitalized interest. Fixed charges consist of interest expense, whether expensed or
capitalized, and an imputed or estimated interest component of rent expense. See Exhibit 12.1
filed with this Annual Report for the calculation. - 25 -




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##### Table of Contents



(5)
    
    For 2006, net cash flows provided by investing activities includes net
proceeds of $719.2 million primarily from dispositions during the year, including proceeds
from the sale of substantially all of our Gulf of Mexico assets during the first half of 2006,
net of cash used in the acquisition of property and equipment, of $614.2 million.(6)
    
    For 2006, a portion of the proceeds from the sale of substantially all of
our Gulf of Mexico assets was used to reduce borrowings under our bank credit facility by a
net $422.0 million. In addition, we used $61.6 million in cash to repurchase and retire
1,776,500 shares of our common stock.(7)
    
    The small amount ($0.2 million) of positive working capital at December 31,
2006 and the working capital deficits at December 31, 2005, 2004 and 2003 were primarily
caused by the fair value of our obligations under derivative contracts estimated to be payable
during next 12-month period, offset in part by the associated deferred tax asset during each
of these years.(8)
    
    For 2006, reflects the sale of substantially all of our Gulf of Mexico
assets.(9)
    
    For 2006, a portion of the proceeds form the sale of our substantially all
of our Gulf of Mexico assets was used to repay a net $422.0 million in outstanding borrowings
under our bank credit facility. - 26 -




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##### Table of Contents



Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview of Our Business
    Derivative Instruments and Hedging Activities
  Strategic Restructuring Plan
    - 27 -




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Pending Merger with Forest Oil Corporation
      Disposition of Gulf of Mexico Assets
   - 28 -




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Acquisitions
    - 29 -




---



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Critical Accounting Estimates
  Proved Reserves
 Unevaluated Properties
 Asset Retirement Obligations.
 Derivative Instruments.
  - 30 -




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Taxes.
 Stock Compensation Expense.
  Recent Accounting Pronouncements
 Recent Accounting Pronouncements
 Overview of 2006 Results
   - 31 -




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§
    
    We generated $67.8 million in net income, a decrease of 36% from $105.2 million
in 2005;§
    
    We produced 88 Bcfe compared to 114 Bcfe produced in 2005, and our average daily
production rate was 242 MMcfe per day compared to 313 Mcfe/day during 2005, a decrease of
23%;§
    
    Our net proved reserves totaled 699 Bcfe at year-end 2006, a decrease of 19%
from 861 Bcfe at year-end 2005. We sold offshore assets representing 234 Bcfe and we added
a net 161 Bcfe, which included 160 Bcfe added through the drill bit plus 32 Bcfe added
through acquisitions less 31 Bcfe in downward revisions due primarily to quantities becoming
uneconomic at the lower market prices in effect at December 31, 2006. With the total net
additions of 161 Bcfe, we replaced 183% of the 88 Bcfe produced in 2006;§
    
    We generated net cash proceeds from the sale of substantially all of our Gulf of
Mexico assets of $721.6 million. Initially, we used $374 million to repay bank debt,
escrowed $323.7 million with qualified intermediaries for potential reinvestment in
like-kind exchange transactions under Section 1031 of the Internal Revenue Code and used the
balance or, approximately $23.9 million, for working capital purposes;§
    
    Effective June 1, 2006, and following the completion of the sale of our Gulf of
Mexico assets, the borrowing base on our bank credit facility was reduced from $600 million
to $500 million, where it remained at December 31, 2006;§
    
    During the third and fourth quarters, we withdrew previously escrowed funds from
the sale of our Gulf of Mexico assets, of which $2.2 million was reinvested in qualified
natural gas and oil assets and the balance, or $321.5 million, was released from escrow due
to the expiration of the 180-day qualified reinvestment periods;§
    
    Upon release of the remaining escrowed funds in November, we repaid all
outstanding borrowings under our bank credit facility, thereby reducing total bank
borrowings by a net $422 million during the year;
 - 32 -




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##### Table of Contents



§
    
    Following the release of the escrowed funds for which qualified reinvestments in
natural gas and oil properties were not achieved, we recognized a taxable gain on the sale
of our Gulf of Mexico assets of $264 million and utilized all of our net operating loss
carryforwards to partially offset the taxable gain. As a result, in November, we made a
cash payment for estimated federal income taxes for 2006 of $34.0 million;§
    
    We generated $416.2 million in net cash flows from operating activities compared
to $460.5 million during 2005, a decrease of 10%;§
    
    We spent $612.8 million under our 2006 capital program for investments in
natural gas and oil properties, a decrease of 18% from 2005. Our 2006 expenditures included
$64.7 million for producing property acquisitions compared to $197.7 million spent on
acquisitions in 2005, a decrease of 67%;§
    
    We drilled 363 wells, of which 329, or 91%, were successful with 2 offshore, 28
in East Texas, 71 in Arkoma, 90 in South Texas and 138 in the Rockies;§
    
    In South Texas, we integrated the producing properties acquired in November 2005
from Kerr-McGee, acquired a 3D seismic survey covering approximately 1,000 square miles in
the Vicksburg trend, and began our drilling program on the acquired properties during April
2006, successfully completing 36 wells within the Rincon, Tijerina-Canales-Blucher and
Vaquillas Ranch Fields by year end. In December, we acquired a 100% working interest in ten
producing wells located in Webb County, Texas, from Legend Natural Gas, for $4.3 million,
with estimated proved reserves of 1.8 Bcfe;§
    
    In Arkoma, we continued to expand our developmental drilling program and
implemented successful recompletion and compression programs designed to improve operating
efficiencies and minimize production downtime. In addition, we participated with a 40%
working interest in eight successful wells, adding approximately 20 new locations for future
drilling, in the new Rich Mountain Field located in close proximity to our Chismville Field
in Logan County, Arkansas;§
    
    In East Texas, we continued the expansion of our operating base begun in 2005
and focused our drilling efforts on properties acquired in 2005. In April 2006, we acquired
additional producing properties and acreage adjacent to our Willow Springs Field 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;§
    
    In the Rocky Mountains, we completed and began processing a 150 square mile 3D
seismic survey in the DJ Basin and successfully drilled and completed 100 new wells within
the Niobrara Trend. During the first quarter of 2006, we initiated the second phase of our
DJ Basin gathering system, bringing on-line more than 50 wells drilled during 2005. For the
year, we added a net 24 Bcfe through the drill bit, which includes downward revisions of 4
Bcfe, primarily as a result of price economics. Average daily production increased
approximately 60% to 8 MMcfe per day. In December, we acquired incremental working
interests and interests in new producing properties and undeveloped acreage located in the
DJ Basin with an estimated 14.2 Bcfe of proved reserves as of November 1, 2006, from Santos
TOG Corp. for a net purchase price of $21.4 million;§
    
    During May and June, we repurchased 1,176,500 shares, or approximately 4%, of
our outstanding common stock, in the open market for approximately $61.6 million. These
repurchases were funded with cash on hand and borrowings under our bank credit facility;§
    
    During June, we paid $14.3 million to liquidate and settle derivative contracts
covering 60,000 MMBtu per day for each of the months July through December 2006, reducing
our volume hedged from 250,000 MMBtu per day to 190,000 MMBtu per day as required by our
bank credit facility in connection with our Gulf of Mexico sale. In addition, during
August, we paid $0.9 million to liquidate and settle derivative contracts covering 20,000
MMBtu per day for each of the months September and October 2006, for a total of $15.2
million paid to liquidate derivative contracts during 2006;§
    
    As a result of the settlement and liquidation of derivative contracts during
2006, combined with significantly lower market prices for natural gas and fewer open
contracts covering 2007 and 2008 production volumes at year-end 2006, the fair market value
of our open derivatives contracts decreased from a liability of $417.7 million ($269.8
million net of tax) at December 31, 2005 to a liability of $27.4 million ($17.5 million net
of tax) at December 31, 2006. The decline of natural gas prices during the third and fourth
quarters was a key factor in the decline in our losses from hedging activities that totaled
$64.5 million for 2006 compared to a total net loss of $264.5 million incurred during 2005,
of which $116.5 million was incurred during the fourth quarter of 2005; and§
    
    At December 31, 2006, due to the cumulative effect of higher finding and
development costs during recent years, combined with higher estimated future operating and
development costs at year-end 2006, we recorded a writedown in the carrying value of our
natural gas and oil properties, taking a non-cash charge and reduction to earnings in the
fourth quarter of approximately $19.0 million ($12.3 million net of tax).
 - 33 -




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##### Table of Contents



Operating and Financial Results for 2006 compared to 2005 and Operating and Financial Results for
2005 compared to 2004.
   Year Ended December 31,
    
    Year Ended December 31,Summary Operating Information:
    
    2006
    
    2005
    
    Change
    
    %
    
    2005
    
    2004
    
    Change
    
    %(in thousands, except prices and percentages)Operating revenues
    
    $
    531,597
    
    
    $
    621,543
    
    
    $
    (89,946
    )
    
    
    -14
    %
    
    $
    621,543
    
    
    $
    650,439
    
    
    $
    (28,896
    )
    
    
    -4
    %Operating expenses
    
    
    404,749
    
    
    
    436,807
    
    
    
    (32,058
    )
    
    
    -7
    %
    
    
    436,807
    
    
    
    382,626
    
    
    
    54,181
    
    
    
    14
    %Income from operations
    
    
    126,848
    
    
    
    184,736
    
    
    
    (57,888
    )
    
    
    -31
    %
    
    
    184,736
    
    
    
    267,813
    
    
    
    (83,077
    )
    
    
    -31
    %Net income
    
    
    67,783
    
    
    
    105,169
    
    
    
    (37,386
    )
    
    
    -36
    %
    
    
    105,169
    
    
    
    162,824
    
    
    
    (57,655
    )
    
    
    -35
    %Production:Natural gas (MMcf)
    
    
    82,528
    
    
    
    105,809
    
    
    
    (23,281
    )
    
    
    -22
    %
    
    
    105,809
    
    
    
    115,855
    
    
    
    (10,046
    )
    
    
    -9
    %Oil (MBbls)
    
    
    938
    
    
    
    1,417
    
    
    
    (479
    )
    
    
    -34
    %
    
    
    1,417
    
    
    
    1,355
    
    
    
    62
    
    
    
    5
    %Total (MMcfe) (1)
    
    
    88,156
    
    
    
    114,311
    
    
    
    (26,155
    )
    
    
    -23
    %
    
    
    114,311
    
    
    
    123,985
    
    
    
    (9,674
    )
    
    
    -8
    %Average daily production (MMcfe/d)
    
    
    242
    
    
    
    313
    
    
    
    (71
    )
    
    
    -23
    %
    
    
    313
    
    
    
    339
    
    
    
    (26
    )
    
    
    -8
    %Average Sales Prices:Natural Gas (per Mcf) unhedged
    
    $
    6.56
    
    
    $
    7.71
    
    
    $
    (1.15
    )
    
    
    -15
    %
    
    $
    7.71
    
    
    $
    5.78
    
    
    $
    1.93
    
    
    
    33
    %Natural Gas (per Mcf) realized (2)
    
    
    5.72
    
    
    
    5.21
    
    
    
    0.51
    
    
    
    10
    %
    
    
    5.21
    
    
    
    5.19
    
    
    
    0.02
    
    
    
    Natural Gas (per Mcf) all-in(3)
    
    
    5.77
    
    
    
    5.21
    
    
    
    0.56
    
    
    
    11
    %
    
    
    5.21
    
    
    
    5.17
    
    
    
    0.04
    
    
    
    1
    %Oil (per Bbl) realized
    
    
    56.56
    
    
    
    48.43
    
    
    
    8.13
    
    
    
    17
    %
    
    
    48.43
    
    
    
    36.85
    
    
    
    11.58
    
    
    
    31
    %
 
 (1)
    
    MMcfe is defined as one million cubic feet equivalent of natural gas,
determined using the ratio of six MMcf of natural gas to one MBbl of crude oil, condensate or
natural gas liquids.(2)
    
    Includes gains and losses realized on derivative contracts settled during
the period.(3)
    
    Includes gains and losses realized on derivative contracts settled during
the period, as well as unrealized gains and losses recognized pursuant to SFAS 133,
Accounting for Derivative Instruments and Hedging Activities. - 34 -




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##### Table of Contents



Production Volume
 Year Ended December 31,
    
    
    Year Ended December 31,2006
    
    
    2005
    
    
    Change
    
    
    %
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    %(in thousands, except percentages)Natural Gas Production (MMcf):Onshore
    
    
    71,377
    
    
    
    68,009
    
    
    
    3,368
    
    
    
    5
    %
    
    
    68,009
    
    
    
    67,477
    
    
    
    532
    
    
    
    1
    %Offshore
    
    
    11,151
    
    
    
    37,800
    
    
    
    (26,649
    )
    
    
    -71
    %
    
    
    37,800
    
    
    
    48,378
    
    
    
    (10,578
    )
    
    
    -22
    %Total natural gas
    
    
    82,528
    
    
    
    105,809
    
    
    
    (23,281
    )
    
    
    -22
    %
    
    
    105,809
    
    
    
    115,855
    
    
    
    (10,046
    )
    
    
    -9
    %Oil (MBbls):Onshore
    
    
    505
    
    
    
    102
    
    
    
    403
    
    
    
    395
    %
    
    
    102
    
    
    
    70
    
    
    
    32
    
    
    
    46
    %Offshore
    
    
    433
    
    
    
    1,315
    
    
    
    (882
    )
    
    
    -67
    %
    
    
    1,315
    
    
    
    1,285
    
    
    
    30
    
    
    
    2
    %Total oil
    
    
    938
    
    
    
    1,417
    
    
    
    (479
    )
    
    
    -34
    %
    
    
    1,417
    
    
    
    1,355
    
    
    
    62
    
    
    
    5
    %Natural Gas Equivalent (MMcfe):Onshore
    
    
    74,407
    
    
    
    68,621
    
    
    
    5,786
    
    
    
    8
    %
    
    
    68,621
    
    
    
    67,897
    
    
    
    724
    
    
    
    1
    %Offshore
    
    
    13,749
    
    
    
    45,690
    
    
    
    (31,941
    )
    
    
    -70
    %
    
    
    45,690
    
    
    
    56,088
    
    
    
    (10,398
    )
    
    
    -19
    %Total equivalents
    
    
    88,156
    
    
    
    114,311
    
    
    
    (26,155
    )
    
    
    -23
    %
    
    
    114,311
    
    
    
    123,985
    
    
    
    (9,674
    )
    
    
    -8
    %
  Year Ended December 31,
    
    
    Year Ended December 31,2006
    
    
    2005
    
    
    Change
    
    
    %
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    %Natural Gas Equivalent (MMcfe per day):South Texas
    
    
    143
    
    
    
    134
    
    
    
    9
    
    
    
    7
    %
    
    
    134
    
    
    
    142
    
    
    
    (8
    )
    
    
    -6
    %Arkoma
    
    
    40
    
    
    
    43
    
    
    
    (3
    )
    
    
    -7
    %
    
    
    43
    
    
    
    38
    
    
    
    5
    
    
    
    13
    %East Texas
    
    
    12
    
    
    
    5
    
    
    
    7
    
    
    
    140
    %
    
    
    5
    
    
    
    2
    
    
    
    3
    
    
    
    150
    %Rockies
    
    
    8
    
    
    
    5
    
    
    
    3
    
    
    
    60
    %
    
    
    5
    
    
    
    1
    
    
    
    4
    
    
    
    400
    %Other
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    3
    
    
    
    (2
    )
    
    
    -67
    %Total onshore
    
    
    204
    
    
    
    188
    
    
    
    16
    
    
    
    8
    %
    
    
    188
    
    
    
    186
    
    
    
    2
    
    
    
    1
    %Offshore
    
    
    38
    
    
    
    125
    
    
    
    (87
    )
    
    
    -70
    %
    
    
    125
    
    
    
    153
    
    
    
    (28
    )
    
    
    -19
    %Total
    
    
    242
    
    
    
    313
    
    
    
    (71
    )
    
    
    -23
    %
    
    
    313
    
    
    
    339
    
    
    
    (26
    )
    
    
    -8
    %
 Production Volume for 2006 compared to 2005.
 Onshore.
 Offshore
 -35-




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##### Table of Contents



Production Volume for 2005 compared to 2004.
 Onshore.
 Offshore
 Commodity Prices and Effects of Hedging Activities
 Year Ended December 31,
    
    Year Ended December 31,2006
    
    2005
    
    Change
    
    %
    
    2005
    
    2004
    
    Change
    
    %Average Natural Gas Prices ($  per Mcf):Onshore
    
    $
    6.33
    
    
    $
    7.44
    
    
    $
    (1.11
    )
    
    
    -15
    %
    
    $
    7.44
    
    
    $
    5.61
    
    
    $
    1.83
    
    
    
    33
    %Offshore
    
    
    7.97
    
    
    
    8.21
    
    
    
    (0.24
    )
    
    
    -3
    %
    
    
    8.21
    
    
    
    6.01
    
    
    
    2.20
    
    
    
    37
    %Total Natural Gas  unhedged
    
    
    6.56
    
    
    
    7.71
    
    
    
    (1.15
    )
    
    
    -15
    %
    
    
    7.71
    
    
    
    5.78
    
    
    
    1.93
    
    
    
    33
    %Total Natural Gas  realized (1)
    
    
    5.72
    
    
    
    5.21
    
    
    
    0.51
    
    
    
    10
    %
    
    
    5.21
    
    
    
    5.19
    
    
    
    0.02
    
    
    
    Total Natural Gas  all-in (2)
    
    
    5.77
    
    
    
    5.21
    
    
    
    0.56
    
    
    
    11
    %
    
    
    5.21
    
    
    
    5.17
    
    
    
    0.04
    
    
    
    1
    %Average Oil Prices ($  per Bbl):Onshore
    
    $
    54.31
    
    
    $
    53.59
    
    
    $
    0.72
    
    
    
    1
    %
    
    $
    53.59
    
    
    $
    37.73
    
    
    $
    15.86
    
    
    
    42
    %Offshore
    
    
    59.18
    
    
    
    48.03
    
    
    
    11.15
    
    
    
    23
    %
    
    
    48.03
    
    
    
    36.81
    
    
    
    11.22
    
    
    
    30
    %Total Oil
    
    
    56.56
    
    
    
    48.43
    
    
    
    8.13
    
    
    
    17
    %
    
    
    48.43
    
    
    
    36.85
    
    
    
    11.58
    
    
    
    31
    %
 
 (1)
    
    Includes gains and losses realized on derivative contracts settled during the
period.(2)
    
    Includes both gains and losses realized on derivative contracts settled during the
period, as well as unrealized gains and losses recognized pursuant to SFAS 133. Commodity Prices and Effects of Hedging Activities for 2006 compared to 2005
 Commodity Prices and Effects of Hedging Activities for 2005 compared to 2004
 -36-




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##### Table of Contents



Gains (Losses) from Hedging Activities
 Year Ended December 31,
    
    
    Year Ended December 31,2006
    
    
    2005
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    Change(in thousands)Gain (Loss) from Hedging ActivitiesCash (loss) realized on contracts settled(1)
    
    $
    (69,208
    )
    
    $
    (265,236
    )
    
    $
    196,028
    
    
    $
    (265,236
    )
    
    $
    (68,195
    )
    
    $
    (197,041
    )Non-cash unrealized gain (loss):Ineffectiveness gain (loss)(2)
    
    
    45,912
    
    
    
    (46,000
    )
    
    
    91,912
    
    
    
    (46,000
    )
    
    
    (1,950
    )
    
    
    (44,050
    )Mark-to-market change in fair value gain (loss)(3)
    
    
    37,660
    
    
    
    26,094
    
    
    
    11,566
    
    
    
    26,094
    
    
    
    
    
    
    
    26,094Deferred gain (loss) due to fourth quarter 2005
production shortfalls(4)
    
    
    (20,600
    )
    
    
    20,600
    
    
    
    (41,200
    )
    
    
    20,600
    
    
    
    
    
    
    
    20,600Recognition of all deferred losses relating to
Gulf of Mexico production sold(5)
    
    
    (58,215
    )
    
    
    
    
    
    
    (58,215
    )
    
    
    
    
    
    
    
    
    
    
    Total non-cash unrealized gain (loss)
    
    
    4,757
    
    
    
    694
    
    
    
    4,063
    
    
    
    694
    
    
    
    (1,950
    )
    
    
    2,644Total gain (loss) from hedging activities
    
    $
    (64,451
    )
    
    $
    (264,542
    )
    
    $
    200,091
    
    
    $
    (264,542
    )
    
    $
    (70,145
    )
    
    $
    (194,397
    )
 
 (1)
    
    For 2006, also includes (i) $14.3 million paid during the second quarter of 2006 to
liquidate and settle contracts covering 60,000 MMBtu per day for each of the months July
through December 2006, which liquidiation was made following the completion of the sale of
our Gulf of Mexico assets on June 1, 2006 and was required under the terms of our bank credit
facility; and (ii) $0.9 million paid during the third quarter of 2006 to liquidate and settle
contracts covering 20,000 MMBtu per day for each of the months September and October 2006.(2)
    
    For 2006, 2005 and 2004, includes ineffective portion of open contracts recognized
at the end of the period that were not eligible for deferral under SFAS 133.(3)
    
    For 2006, includes change in fair market value of open contracts subsequent to loss
of hedge accounting during the first quarter. For 2005, includes change in fair market value
of open contracts allocated to the Houston Ship Channel index that lost correlation with the
NYMEX price during the fourth quarter of 2005 caused by Hurricanes Katrina and Rita.(4)
    
    For 2006, includes recognition of the loss related to cash settlements made during
the fourth quarter of 2005 that was deferred during the fourth quarter of 2005 in accumulated
other comprehensive income. This deferred loss resulted from offshore production shortfalls
during the fourth quarter of 2005 caused by Hurricanes Katrina and Rita.(5)
    
    For 2006, includes recognition in earnings of all losses previously deferred in
accumulated other comprehensive for which the underlying production was attributable to Gulf
of Mexico assets sold. -37-




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##### Table of Contents



Natural Gas and Oil Revenues
 Year Ended December 31,
    
    
    Year Ended December 31,2006
    
    
    2005
    
    
    Change
    
    
    %
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    %(in thousands, except percentages)Natural Gas Revenues:Onshore
    
    $
    452,166
    
    
    $
    505,719
    
    
    $
    (53,553
    )
    
    
    -11
    %
    
    $
    505,719
    
    
    $
    378,450
    
    
    $
    127,269
    
    
    
    34
    %Offshore
    
    
    88,819
    
    
    
    310,463
    
    
    
    (221,644
    )
    
    
    -71
    %
    
    
    310,463
    
    
    
    290,844
    
    
    
    19,619
    
    
    
    7
    %Gain (loss) on settled derivatives
    
    
    (69,208
    )
    
    
    (265,236
    )
    
    
    196,028
    
    
    
    -74
    %
    
    
    (265,236
    )
    
    
    (68,195
    )
    
    
    (197,041
    )
    
    
    289
    %Unrealized gain (loss) on derivatives
    
    
    4,757
    
    
    
    694
    
    
    
    4,063
    
    
    
    585
    %
    
    
    694
    
    
    
    (1,950
    )
    
    
    2,644
    
    
    
    -136
    %Total natural gas revenues
    
    
    476,534
    
    
    
    551,640
    
    
    
    (75,106
    )
    
    
    -14
    %
    
    
    551,640
    
    
    
    599,149
    
    
    
    (47,509
    )
    
    
    -8
    %Oil Revenues:Onshore
    
    
    27,428
    
    
    
    5,466
    
    
    
    21,962
    
    
    
    402
    %
    
    
    5,466
    
    
    
    2,641
    
    
    
    2,825
    
    
    
    107
    %Offshore
    
    
    25,624
    
    
    
    63,165
    
    
    
    (37,541
    )
    
    
    -59
    %
    
    
    63,165
    
    
    
    47,297
    
    
    
    15,868
    
    
    
    34
    %Total oil revenues
    
    
    53,052
    
    
    
    68,631
    
    
    
    (15,579
    )
    
    
    -23
    %
    
    
    68,631
    
    
    
    49,938
    
    
    
    18,693
    
    
    
    37
    %Total natural gas and oil revenues
    
    $
    529,586
    
    
    $
    620,271
    
    
    $
    (90,685
    )
    
    
    -15
    %
    
    $
    620,271
    
    
    $
    649,087
    
    
    $
    (28,816
    )
    
    
    -4
    %
       -38-




---



##### Table of Contents



Operating Expenses
 Year Ended December 31,
    
    
    Year Ended December 31,2006
    
    
    2005
    
    
    Change
    
    
    %
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    %($ per MMcfe, except percentages)Lease operating expense
    
    $
    0.73
    
    
    $
    0.59
    
    
    $
    0.14
    
    
    
    24
    %
    
    $
    0.59
    
    
    $
    0.45
    
    
    $
    0.14
    
    
    
    31
    %Severance tax
    
    
    0.21
    
    
    
    0.16
    
    
    
    0.05
    
    
    
    31
    %
    
    
    0.16
    
    
    
    0.10
    
    
    
    0.06
    
    
    
    60
    %Transportation expense
    
    
    0.12
    
    
    
    0.10
    
    
    
    0.02
    
    
    
    20
    %
    
    
    0.10
    
    
    
    0.10
    
    
    
    
    
    
    
    
    %Asset retirement accretion expense
    
    
    0.04
    
    
    
    0.05
    
    
    
    (0.01
    )
    
    
    -20
    %
    
    
    0.05
    
    
    
    0.04
    
    
    
    0.01
    
    
    
    25
    %Depreciation, depletion and amortization
    
    
    2.88
    
    
    
    2.58
    
    
    
    0.30
    
    
    
    12
    %
    
    
    2.58
    
    
    
    2.14
    
    
    
    0.44
    
    
    
    21
    %Writedown in carrying value
    
    
    0.22
    
    
    
    
    
    
    
    0.22
    
    
    
    100
    %
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    General and administrative, net
    
    
    0.41
    
    
    
    0.34
    
    
    
    0.07
    
    
    
    21
    %
    
    
    0.34
    
    
    
    0.27
    
    
    
    0.07
    
    
    
    26
    %Total operating expenses per unit of
production
    
    $
    4.61
    
    
    $
    3.82
    
    
    $
    0.79
    
    
    
    21
    %
    
    $
    3.82
    
    
    $
    3.10
    
    
    $
    0.72
    
    
    
    23
    %
   Lease Operating Expense
 Year Ended December 31,
    
    
    Year Ended December 31,2006
    
    
    2005
    
    
    Change
    
    
    %
    
    
    2005
    
    
    2004
    
    
    Change
    
    
    %(in thousands, except percentages)Onshore
    
    $
    47,077
    
    
    $
    27,868
    
    
    $
    19,209
    
    
    
    70
    %
    
    $
    27,686
    
    
    $
    22,075
    
    
    $
    5,611
    
    
    
    25
    %Offshore
    
    
    16,882
    
    
    
    39,928
    
    
    
    (23,046
    )
    
    
    -58
    %
    
    
    39,928
    
    
    
    33,850
    
    
    
    6,078
    
    
    
    18
    %Total
    
    $
    63,959
    
    
    $
    67,796
    
    
    $
    (3,837
    )
    
    
    -6
    %
    
    $
    67,796
    
    
    $
    55,925
    
    
    $
    11,871
    
    
    
    21
    %Onshore per Mcfe
    
    $
    0.63
    
    
    $
    0.41
    
    
    $
    0.22
    
    
    
    54
    %
    
    $
    0.41
    
    
    $
    0.33
    
    
    $
    0.08
    
    
    
    24
    %Offshore per Mcfe
    
    
    1.23
    
    
    
    0.87
    
    
    
    0.36
    
    
    
    41
    %
    
    
    0.87
    
    
    
    0.60
    
    
    
    0.27
    
    
    
    45
    %Total
    
    
    0.73
    
    
    
    0.59
    
    
    
    0.14
    
    
    
    24
    %
    
    
    0.59
    
    
    
    0.45
    
    
    
    0.14
    
    
    
    31
    %
  -39-




---



##### Table of Contents



Severance Tax
 Depreciation, Depletion and Amortization
  Writedown in Carrying Value of Natural Gas and Oil Properties.
 Asset Retirement Accretion Expense.
 -40-




---



##### Table of Contents



General and Administrative Expenses, Net of Overhead Reimbursements and Capitalized General and
Administrative Expenses.
 Absolute Dollars
    
    
    Unit of Production - McfeYear Ended December 31,
    
    
    Year Ended December 31,General and Administrative Expense
    
    2006
    
    
    2005
    
    
    Variance
    
    
    2006
    
    
    2005
    
    
    Variance(dollars in thousands)Gross general and administrative expense
    
    $
    58,422
    
    
    $
    57,412
    
    
    $
    1,010
    
    
    
    2
    %
    
    $
    0.66
    
    
    $
    0.50
    
    
    $
    0.16
    
    
    
    32
    %Operating overhead reimbursements
    
    
    (2,194
    )
    
    
    (2,158
    )
    
    
    (36
    )
    
    
    2
    %
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    
    
    
    
    
    %Capitalized general and administrative (1)
    
    
    (20,215
    )
    
    
    (16,876
    )
    
    
    (3,339
    )
    
    
    20
    %
    
    
    (0.23
    )
    
    
    (0.14
    )
    
    
    (0.09
    )
    
    
    64
    %General and administrative expense, net
    
    $
    36,013
    
    
    $
    38,378
    
    
    $
    (2,365
    )
    
    
    -6
    %
    
    $
    0.41
    
    
    $
    0.34
    
    
    $
    0.07
    
    
    
    21
    %
 
 (1)
    
    Includes only those internal general and administrative costs that are directly
associated with our acquisition, exploration and development activities, such as salaries,
benefits and incentive compensation for geological and geophysical employees and other
specifically identifiable non-payroll costs. These capitalized general and administrative
costs do not include costs related to production operations, general corporate overhead or
other activities that are not directly attributable to our acquisition, exploration and
development efforts. 2006 compared to 2005.  Employment Agreements
   Absolute Dollars
    
    
    Unit of Production - McfeYear Ended December 31,
    
    
    Year Ended December 31,General and Administrative Expense
    
    2005
    
    
    2004
    
    
    Variance
    
    
    2005
    
    
    2004
    
    
    Variance(dollars in thousands)Gross general and administrative expense
    
    $
    57,412
    
    
    $
    49,924
    
    
    $
    7,488
    
    
    
    15
    %
    
    $
    0.50
    
    
    $
    0.40
    
    
    $
    0.10
    
    
    
    25
    %Operating overhead reimbursements
    
    
    (2,158
    )
    
    
    (2,188
    )
    
    
    30
    
    
    
    -1
    %
    
    
    (0.02
    )
    
    
    (0.01
    )
    
    
    (0.01
    )
    
    
    100
    %Capitalized general and administrative(1)
    
    
    (16,876
    )
    
    
    (14,837
    )
    
    
    (2,039
    )
    
    
    14
    %
    
    
    (0.14
    )
    
    
    (0.12
    )
    
    
    (0.02
    )
    
    
    17
    %General and administrative expense, net
    
    $
    38,378
    
    
    $
    32,899
    
    
    $
    5,479
    
    
    
    17
    %
    
    $
    0.34
    
    
    $
    0.27
    
    
    $
    0.07
    
    
    
    26
    %
 
 (1)
    
    Includes only those internal general and administrative costs that are directly
associated with our acquisition, exploration and development activities, such as salaries,
benefits and incentive compensation for geological and geophysical employees and other
specifically identifiable non-payroll costs. These capitalized general and -41-




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##### Table of Contents



administrative costs do not include costs related to production operations, general corporate
overhead or other activities that are not directly attributable to our acquisition,
exploration and development efforts. 2005 compared to 2004.  Employment Agreements
 
KeySpan Exchange and Offering
   Other Income and Expense, Interest and Taxes
 Other Income and Expense
 -42-




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##### Table of Contents



Interest Expense, Net of Amounts Capitalized
 Year Ended December 31,
    
    
    Year Ended December 31,Interest and Average Borrowings
    
    2006
    
    
    2005
    
    
    Change
    
    
    2005
    
    
    2004
    
    
    Change(in thousands, except percentages)Interest Expense, net:Gross interest (1)
    
    $
    29,661
    
    
    $
    25,301
    
    
    $
    4,360
    
    
    
    17
    %
    
    $
    25,301
    
    
    $
    17,813
    
    
    $
    7,488
    
    
    
    42
    %Capitalized interest
    
    
    (4,455
    )
    
    
    (8,766
    )
    
    
    4,311
    
    
    
    -49
    %
    
    
    (8,766
    )
    
    
    (8,358
    )
    
    
    (408
    )
    
    
    5
    %Interest expense, net
    
    $
    25,206
    
    
    $
    16,535
    
    
    $
    8,671
    
    
    
    52
    %
    
    $
    16,535
    
    
    $
    9,455
    
    
    $
    7,080
    
    
    
    75
    %Average Borrowings:Bank credit facility
    
    $
    227,000
    
    
    $
    211,000
    
    
    $
    16,000
    
    
    
    8
    %
    
    $
    211,000
    
    
    $
    112,000
    
    
    $
    99,000
    
    
    
    88
    %Senior subordinated notes
    
    
    175,000
    
    
    
    175,000
    
    
    
    
    
    
    
    
    
    
    
    175,000
    
    
    
    175,000
    
    
    
    

    
    
    
    Total borrowings
    
    $
    402,000
    
    
    $
    386,000
    
    
    $
    16,000
    
    
    
    4
    %
    
    $
    386,000
    
    
    $
    287,000
    
    
    $
    99,000
    
    
    
    34
    %Average Interest Rate:Bank credit facility (2)
    
    
    6.81
    %
    
    
    5.54
    %
    
    
    1.27
    
    
    
    23
    %
    
    
    5.54
    %
    
    
    3.75%
    
    
    
    1.79
    
    
    
    48
    %Senior subordinated notes
    
    
    7.00
    %
    
    
    7.00
    %
    
    
    
    
    
    
    
    
    
    
    7.00
    %
    
    
    7.00%
    
    
    
        
    
    
    
 
 (1)
    
    Includes commitment fees, letter of credit fees, amortization of deferred
financing costs and other non-loan related charges of $1.9 million, $1.2 million and $1.3
million for years ended December 31, 2006, 2005 and 2004, respectively.(2)
    
    Includes letter of credit and commitment fees. 2006 compared to 2005.
   2005 compared to 2004.
 -43-




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##### Table of Contents



Income Tax Provision.
 Employment Agreements
 Liquidity and Capital Resources
  §
    
    Drilling and completing new natural gas and oil wells;§
    
    Constructing and installing new production infrastructure;§
    
    Acquiring additional reserves and producing properties;§
    
    Acquiring and maintaining our lease acreage position and our seismic resources;§
    
    Maintaining, repairing and enhancing existing natural gas and oil wells;§
    
    Plugging and abandoning depleted or uneconomic natural gas and oil wells; and§
    
    General and administrative costs directly associated with our acquisition,
exploration and development activities, including payroll and other expenses attributable
solely to our geological and geophysical employees.
 Drilling Contracts
  Sources of Liquidity and Capital Resources
  -44-




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##### Table of Contents



Available Liquidity
 December 31,2006
    
    
    2005(in thousands)Available Liquidity:Revolving credit facility  borrowing base
    
    $
    500,000
    
    
    $
    600,000Outstanding borrowings
    
    
    
    
    
    
    (422,000
    )Letters of credit
    
    
    (300
    )
    
    
    (300
    )Unused borrowing capacity
    
    
    499,700
    
    
    
    177,700Cash and cash equivalents
    
    
    53,950
    
    
    
    7,979Total available liquidity
    
    $
    553,650
    
    
    $
    185,679
 Cash Designated for Investment
 Cash Provided by Operating Activities.
  Uses of Liquidity and Capital Resources
  Capital Expenditures.
 -45-




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##### Table of Contents



Years Ended December 31,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002(in thousands)Natural gas and oil capital expendituresProducing property acquisitions (1)
    
    $
    64,680
    
    
    $
    197,680
    
    
    $
    149,599
    
    
    $
    175,420
    
    
    $
    73,351Leasehold and lease acquisition costs (2)
    
    
    50,300
    
    
    
    66,113
    
    
    
    57,741
    
    
    
    56,076
    
    
    
    36,458Development
    
    
    426,615
    
    
    
    366,902
    
    
    
    245,971
    
    
    
    162,235
    
    
    
    122,036Exploration
    
    
    71,195
    
    
    
    112,634
    
    
    
    63,646
    
    
    
    66,259
    
    
    
    26,536Total natural gas and oil capital expenditures
    
    
    612,790
    
    
    
    743,329
    
    
    
    516,957
    
    
    
    459,990
    
    
    
    258,381Producing property dispositions(3)
    
    
    (719,234
    )
    
    
    (1,864
    )
    
    
    (72,712
    )
    
    
    
    
    
    
    (5,309
    )Net natural gas and oil capital expenditures
    
    $
    (106,444
    )
    
    $
    741,465
    
    
    $
    444,245
    
    
    $
    459,990
    
    
    $
    253,072Proved reserve additions, net of revisions (MMcfe)
    
    
    161,090
    
    
    
    183,787
    
    
    
    225,633
    
    
    
    212,969
    
    
    
    144,291
 
 (1)
    
    For 2006, includes (i) East Texas producing properties acquired in April
for a net $21.1 million; (ii) $21.0 million paid in August for a net profits interest to the
predecessor owner of certain offshore properties acquired by us in October 2003, which payment
was accelerated by the sale of certain offshore Louisiana assets completed June 1, 2006; (iii)
DJ Basin incremental working interests and producing properties acquired in December for a net
$21.4 million; (iv) South Texas producing properties acquired in December for $4.3 million;
(v) a final purchase price adjustment and return of capital of approximately $3.5 million,
representing a reduction to the $159.0 million net purchase price paid for the South Texas
properties acquired on November 30, 2005 from affiliates of Kerr-McGee; and (vi) $0.4 million
for various other producing properties.(2)
    
    For 2006, 2005, 2004, 2003 and 2002, leasehold costs include capitalized
interest and general and administrative expenses of $24.7 million, $25.7 million, $23.2
million, $20.2 million and $21.1 million, respectively.(3)
    
    For 2006, dispositions include (i) net proceeds from the sale of our
Louisiana Gulf of Mexico assets of $530.8 million, net of $4.4 million in fees associated with
completion of the transaction and $4.4 million in purchase price adjustments; (ii) net
proceeds from the sale of the Texas portion of our Gulf of Mexico assets of $190.8 million,
net of $1.5 million in transaction fees; and (iii) $7.9 million in net proceeds for the sale
of other assets.For 2004, dispositions include (i) the exchange of our Appalachian Basin assets for
$60 million; plus (ii) the sale of our onshore South Louisiana assets for a net
$13.1 million; less (iii) $0.4 million related to various other properties. Debt Repayments
 Stock Repurchases.
 Future Commitments.
  -46-




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##### Table of Contents



Future CommitmentsPayments Due by PeriodReference
    
    
    Total
    
    
    1 year or less
    
    
    2  3 years
    
    
    4  5 years
    
    
    after 5 years(in thousands)Contractual Obligations:Principal 7% senior subordinated notes, due June 2013
    
    Note 2
    
    $
    175,000
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    175,000Interest 7% senior subordinated notes, due 2013
    
    Note 2
    
    
    79,625
    
    
    
    12,250
    
    
    
    24,500
    
    
    
    24,500
    
    
    
    18,375Derivative instruments
    
    Note 7
    
    
    27,398
    
    
    
    10,151
    
    
    
    17,247
    
    
    
    
    
    
    
    Operating leases
    
    Note 9
    
    
    4,997
    
    
    
    1,913
    
    
    
    3,061
    
    
    
    23
    
    
    
    Letters of credit
    
    Note 9
    
    
    300
    
    
    
    300
    
    
    
    
    
    
    
    
    
    
    
    North Dakota lease option
    
    Note 9
    
    
    3,819
    
    
    
    3,819
    
    
    
    
    
    
    
    
    
    
    
    Drilling contracts
    
    Note 9
    
    
    8,666
    
    
    
    7,886
    
    
    
    780
    
    
    
    
    
    
    
    Seismic contracts
    
    Note 9
    
    
    1,512
    
    
    
    1,512
    
    
    
    
    
    
    
    
    
    
    
    301,317
    
    
    
    37,831
    
    
    
    45,588
    
    
    
    24,523
    
    
    
    193,375Other Long-Term Obligations:Asset retirement obligations
    
    Note 1
    
    
    72,782
    
    
    
    
    
    
    
    451
    
    
    
    191
    
    
    
    72,140Supplemental Executive Retirement Plan
    
    Note 4
    
    
    3,117
    
    
    
    100
    
    
    
    240
    
    
    
    322
    
    
    
    2,45575,899
    
    
    
    100
    
    
    
    691
    
    
    
    513
    
    
    
    74,595Total Contractual Obligations and
Commitments:
    
    
    
    
    
    $
    377,216
    
    
    $
    37,931
    
    
    $
    46,279
    
    
    $
    25,036
    
    
    $
    267,970
  Off-Balance Sheet Arrangements
  
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk
 Market Risk
  Interest Rate Market Risk
  -47-




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##### Table of Contents



Commodity Price Risk
 Derivative Instruments and Hedging Activities)
  Changes in Fair Value of Derivative Instruments
  Year Ended December 31,2006
    
    
    2005Change in Fair Value of Derivatives Instruments:
    
    Before Tax(in thousands)Fair value of contracts at January 1 (liability)
    
    $
    (417,658
    )
    
    $
    (75,149
    )Realized loss on contracts settled (1)
    
    
    69,208
    
    
    
    265,236Fair value of new contracts when entered into
    
    
    
    
    
    
    Increase (decrease) in fair value of all open contracts
    
    
    321,052
    
    
    
    (607,745
    )Net increase (decrease) during period
    
    
    390,260
    
    
    
    (342,509
    )Fair value of contracts outstanding at December 31 (liability)
    
    $
    (27,398
    )
    
    $
    (417,658
    )
 
 (1)
    
    Includes $15.2 million paid during 2006 to liquidate and settle contracts.
In June 2006, we paid $14.3 million to liquidate and settle contracts covering
60,000 MMBtu per day for each of the months July through December 2006. This
liquidation and settlement was made following the completion of the sale of
substantially all of our Gulf of Mexico assets on June 1, 2006 and was required
under the terms of our revolving credit facility. In August 2006, we elected to
liquidate and settle open derivative contracts representing 20,000 MMBtu per day of
hedged production for each of the months September and October 2006. The cost to
liquidate and settle these contracts was approximately $0.9 million. -48-




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##### Table of Contents



Derivatives in Place as of the Date of Our Report
  HSC
    
    NYMEX
    
    NYMEXPeriod
    
    
    
    Daily Volume
    
    Basis
    
    Floor Price
    
    Ceiling PriceYear
    
    (Months)
    
    Transaction Type
    
    (MMBtu/day)
    
    ($/MMBtu)
    
    ($/MMBtu)
    
    ($/MMBtu)2007
    
    Jan  Dec
    
    Costless collar
    
    20,000
    
    
    
    $5.00
    
    $6.502007
    
    Jan  Dec
    
    Costless collar
    
    10,000
    
    
    
    5.00
    
    6.792007
    
    Mar  Dec (1)
    
    Costless collar
    
    20,000
    
    
    
    7.75
    
    9.102007
    
    Mar  Dec (1)
    
    Costless collar
    
    10,000
    
    
    
    7.75
    
    9.122007
    
    Mar  Dec (1)
    
    Costless collar
    
    10,000
    
    
    
    7.75
    
    9.202007
    
    Mar  Dec (1)
    
    Costless collar
    
    20,000
    
    
    
    7.75
    
    9.252007
    
    Mar  Dec (1)
    
    Costless collar
    
    20,000
    
    
    
    7.75
    
    9.302007
    
    Mar  Dec (1)
    
    Basis swap  HSC
    
    20,000
    
    $0.29002007
    
    Mar  Dec (1)
    
    Basis swap  HSC
    
    20,000
    
    $0.29252007
    
    Mar  Dec (1)
    
    Basis swap  HSC
    
    40,000
    
    $0.30002008
    
    Jan  Dec
    
    Costless collar
    
    20,000
    
    
    
    $5.00
    
    $5.722008
    
    Jan  Feb (1)
    
    Costless collar
    
    20,000
    
    
    
    7.75
    
    9.102008
    
    Jan  Feb (1)
    
    Costless collar
    
    10,000
    
    
    
    7.75
    
    9.122008
    
    Jan  Feb (1)
    
    Costless collar
    
    10,000
    
    
    
    7.75
    
    9.202008
    
    Jan  Feb (1)
    
    Costless collar
    
    20,000
    
    
    
    7.75
    
    9.252008
    
    Jan  Feb (1)
    
    Costless collar
    
    20,000
    
    
    
    7.75
    
    9.302008
    
    Jan  Feb (1)
    
    Basis swap  HSC
    
    20,000
    
    $0.29002008
    
    Jan  Feb (1)
    
    Basis swap  HSC
    
    20,000
    
    $0.29252008
    
    Jan  Feb (1)
    
    Basis swap  HSC
    
    40,000
    
    $0.3000
 
 (1)
    
    Transaction executed subsequent to December 31, 2006.   
 Item 8 . Financial Statements and Supplemental Data
  
 Item 9 . Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
  
 Item 9A . Controls and Procedures
 Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
  -49-




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##### Table of Contents



Design and Evaluation of Internal Control Over Financial Reporting
  Changes in Internal Control Over Financial Reporting
  
 Item 9B. Other Information.
  
 Part III.
 
 Item 10. Directors and Executive Officers of Houston Exploration
  
 Item 11. Executive Compensation
  
 Item 12. Security Ownership of Beneficial Owners and Management
  
 Item 13. Certain Relationships and Related Transactions
  -50-




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##### Table of Contents



Item 14. Principal Accounting Fees and Services
  
 Part IV.
 
 Item 15 . Exhibits, Financial Statement Schedules
  1. Financial Statements:
 PAGEIndex to Financial Statements
    
    F-1Managements Report on Internal Controls Over Financial Reporting
    
    F-2Report of Independent Registered Public Accounting Firm
    
    F-3Consolidated Balance Sheets as of December 31, 2006 and 2005
    
    F-4Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005 and 2004
    
    F-5Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) for the Period
January 1, 2004 to December 31, 2006
    
    F-6Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
    
    F-7Notes to Consolidated Financial Statements
    
    F-8Supplemental Information on Natural Gas and Oil Exploration, Development and
Production Activities (unaudited)
    
    F-31Quarterly Financial Information (Unaudited)
    
    F-35
  2. Exhibits:
 INDEX TO EXHIBITS
 EXHIBITS
    
    
    
    DESCRIPTION2.1
    
    
    
    Agreement and Plan of Merger dated as of January 7, 2007 by
and among the Company, Forest Oil Corporation and MJCO
Corporation (filed as exhibit 2.1 to our Current Report on
Form 8-K dated January 7, 2007 (file No. 001-11899) and
incorporated by reference herein).3.1
    
    
    
    Restated Certificate of Incorporation, as amended,
including the Certificate of Amendment thereto dated April
26, 2005 (filed as exhibit 3.1 to our Quarterly Report on
Form 10-Q for the period ended March 31, 2005 (file No.
001-11899) and incorporated by reference herein).3.2
    
    
    
    Restated Bylaws of The Houston Exploration Company (filed
as Exhibit 3.2 to our Annual Report on Form 10-K for the
year ended December 31, 2005 (File No.001-11899) and
incorporated by reference).4.1
    
    
    
    Indenture, dated as of June 10, 2003, between The Houston
Exploration Company and the Bank of New York, as Trustee,
with respect to the 7% Senior Subordinated Notes due 2013
(filed as Exhibit 4.2 to our Registration Statement on Form
S-4 (Registration No. 333-106836) and incorporated by
reference).4.2
    
    
    
    Rights Agreement, dated as of August 12, 2004, between The
Houston Exploration Company and The Bank of New York, as
Rights Agent (filed as Exhibit 4.1 to our Current Report on
Form 8-K dated August 13, 2004 (File No. 001-11899) and
incorporated by reference).4.3
    
    
    
    First Amendment dated as of May 2, 2005, to the Rights
Agreement dated as of August 12, 2004 between The Houston
Exploration Company and The Bank of New York, as Rights
Agent (filed as exhibit 4.1 to
 -51-




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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTIONour Quarterly Report on Form 10-Q for the period ended March 31, 2005 (file No.
001-11899) and incorporated by reference herein).4.4
    
    
    
    Second Amendment to Rights Agreement dated as of January 7, 2007 between The Houston
Exploration Company and The Bank of New York, as Rights Agent (filed as exhibit 4.1 to our
Current Report on Form 8-K dated January 7, 2007 (file No. 001-11899) and incorporated by
reference herein).4.5
    
    
    
    Form of Certificate of Designation of Series A Junior Participating Preferred Stock of The
Houston Exploration Company (filed as Exhibit 4.2 to our Current Report on Form 8-K dated
August 13, 2004 (File No. 001-11899) and incorporated by reference).10.1
    
    
    
    Amended and Restated Credit Agreement dated November 30, 2005 among The Houston Exploration
Company and Wachovia Bank, National Association, as Issuing Bank and Administrative Agent;
The Bank of Nova Scotia and Bank of America as Co-Syndication Agents; and BNP Paribas and
Comerica Bank as Co-Documentation Agents (filed as exhibit 99.1 to our Current Report on
Form 8-K dated November 30, 2005 (File No. 001-11899) and incorporated by reference).10.2
    
    
    
    First Amendment to Amended and Restated Credit Agreement effective May 31, 2006 among The
Houston Exploration Company and Wachovia Bank, National Association, as Issuing Bank and
Administrative Agent; The Bank of Nova Scotia and Bank of America as Co-Syndication Agents;
and BNP Paribas and Comerica Bank as Co-Documentation Agents (filed as Exhibit 10.1 to our
Quarterly Report on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and
incorporated by reference).10.3
    
    
    
    Purchase and Sale Agreement, dated September 3, 2003, by and among Transworld Exploration
and Production, Inc., as Seller, and The Houston Exploration Company, as Buyer (filed as
Exhibit 2.1 to our Current Report on Form 8-K dated October 15, 2003 (file No. 001-11899)
and incorporated by reference).10.4
    
    
    
    Asset Contribution Agreement dated June 2, 2004 between The Houston Exploration Company and
Seneca-Upshur Petroleum, Inc. (filed as Exhibit 99.3 to our Current Report on Form 8-K dated
June 30, 2004 (File No. 001-11899) and incorporated by reference).10.5
    
    
    
    Tax Matters Agreement dated as of June 2, 2004 by and among The Houston Exploration Company,
Seneca-Upshur Petroleum, Inc., THEC Holdings Corp., and KeySpan Corporation (filed as
Exhibit 99.4 to our Current Report on Form 8-K dated June 30, 2004 (File No. 001-11899) and
incorporated by reference).10.6
    
    
    
    Distribution Agreement dated as of June 2, 2004 by and among The Houston Exploration
Company, Seneca-Upshur Petroleum, Inc., THEC Holdings Corp. and KeySpan Corporation (filed
as Exhibit 99.2 to our Current Report on Form 8-K dated June 30, 2004 (File No. 001-11899)
and incorporated by reference).10.7
    
    
    
    Purchase and Sale Agreement, dated September 17, 2004, between The Houston Exploration
Company and Orca Energy, L.P. (filed as Exhibit 2.1 to our Current Report on Form 8-K dated
November 1, 2004 (File No. 001-11899) and incorporated by reference).10.8
    
    
    
    Purchase and Sale Agreement dated October 21, 2005 by and between Kerr-McGee Oil & Gas
Onshore LP D/B/A KMOG Onshore LP and Westport Oil and Gas Company, L.P., as sellers, and The
Houston Exploration Company, as buyer, (filed as exhibit 99.2 to our Current Report on Form
8-K dated November 30, 2005 (File No. 001-11899) and incorporated by reference).10.9
    
    
    
    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 (filed as Exhibit 10.1 to our Quarterly Report on Form 10-Q for the period ended
March 31, 2006 (File No. 001-11899) and incorporated by reference).
 -52-




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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION10.10
    
    
    
    Purchase and Sale Agreement dated April 7, 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 (filed as Exhibit 99.1 to our Current Report on Form 8-K dated June 2, 2006 (File
No. 001-11899) and incorporated by reference).10.11(2)
    
    
    
    Deferred Compensation Plan for Non-Employee Directors (filed as Exhibit 10.24 to our Annual
Report on Form 10-K for the year ended December 31, 1997 (File No. 001-11899) and
incorporated by reference).10.12(2)
    
    
    
    Amendment dated April 26, 2005, but effective as of December 31, 2004, to The Houston
Exploration Company Non-Employee Director Deferred Compensation Plan (filed as Exhibit 10.4
to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and incorporated
by reference).10.13(2)
    
    
    
    The Houston Exploration Company Post-2004, AJCA Compliant Deferred Compensation Plan for
Non-Employee Directors dated April 26, 2005, effective as of January 1, 2005 (filed as
Exhibit 10.5 to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and
incorporated by reference).10.14(2)
    
    
    
    Compensation Table for Non-Employee Directors, effective January 1, 2006 (filed as exhibit
99.2 to our Current Report on Form 8-K dated January 6, 2006.10.15(2)
    
    
    
    Amended and Restated 1996 Stock Option Plan (filed as Exhibit 10.1 to our Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998 (File No. 001-11899) and incorporated by
reference).10.16(2)
    
    
    
    1999 Non-Qualified Stock Option Plan dated October 26, 1999 (filed as Exhibit 10.24 to our
Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 001-11899) and
incorporated by reference).10.17(2)
    
    
    
    Amended and Restated 2002 Long-Term Incentive Plan effective May 17, 2002, adopted October
26, 2003 (filed as Exhibit 10.31 to our Annual Report on Form 10-K for the year ended
December 31, 2003 (file No. 001-11899) and incorporated by reference).10.18(2)
    
    
    
    Amended and Restated 2004 Long Term Incentive Plan (filed as exhibit 99.1 to our Current
Report on Form 8-K dated January 31, 2006 (File No. 001-11899) and incorporated by
reference).10.19(2)
    
    
    
    Supplemental Executive Pension Plan dated May 1, 1996 (filed as exhibit 10.23 to our
Registration Statement on Form S-1/A (Amendment No. 2) (Registration No. 333-4437) and
incorporated by reference).10.20(2)
    
    
    
    The Houston Exploration Company Supplemental Executive Retirement Plan (Amended and Restated
on July 25, 2006) (filed as Exhibit 10.1 to our Current Report on Form 8-K dated July 31,
2006 (File No. 001-11899) and incorporated by reference).10.21(2)
    
    
    
    First Amendment to The Houston Exploration Company Supplemental Executive Retirement Plan
(filed as exhibit 10.3 to our Current Report on Form 8-K dated January 7, 2007 (file No.
001-11899) and incorporated by reference herein).10.22(2)
    
    
    
    Executive Deferred Compensation Plan dated January 1, 2002 (filed as Exhibit 10.28 to our
Annual Report on Form 10-K for the year ended December 31, 2002 (File No. 001-11899) and
incorporated by reference).10.23(2)
    
    
    
    Amendment [No. 1] to The Houston Exploration Company Executive Deferred Compensation Plan
(filed as exhibit 99.2 to our Current Report on Form 8-K dated January 31, 2006 (File No.
001-11899) and incorporated by reference).10.24(2)
    
    
    
    Amendment No. 2 dated July 25, 2006, but effective as of December 31, 2004, to The Houston
Exploration Company Executive Deferred Compensation Plan (filed as Exhibit 10.2 to our
Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and incorporated by
reference).
 -53-




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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION10.25(2)
    
    
    
    The Houston Exploration Company 2005 Executive Deferred Compensation Plan (filed as Exhibit
10.3 to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and
incorporated by reference).10.26(2)
    
    
    
    Amended and Restated Employment Agreement dated February 8, 2005 between The Houston
Exploration Company and William G. Hargett (filed as Exhibit 10.1 to our Current Report on
Form 8-K dated February 8, 2005 (File No. 001-11899) and incorporated by reference).10.27(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and William G. Hargett (filed
as Exhibit 10.1 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.38(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and Steven
L. Mueller dated February 8, 2005 (filed as Exhibit 10.19 to our Annual Report on Form 10-K
for the year ended December 31, 2004 (File No. 001-11899) and incorporated by reference).10.29(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and Steven L. Mueller (filed
as Exhibit 10.2 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.30(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and John
H. Karnes dated February 8, 2005 (filed as Exhibit 10.20 to our Annual Report on Form 10-K
for the year ended December 31, 2004 (File No. 001-11899) and incorporated by reference).10.31(2)
    
    
    
    Separation Agreement and General Release dated December 8, 2005 between The Houston
Exploration Company and John H. Karnes (filed as exhibit 99.1 to our Current Report on Form
8-K dated December 12, 2005 (File No. 001-11899) and incorporated by reference).10.32(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and James
F. Westmoreland dated February 8, 2005 (filed as Exhibit 10.21 to our Annual Report on Form
10-K for the year ended December 31, 2004 (File No. 001-11899) and incorporated by
reference).10.33(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and James F. Westmoreland
(filed as Exhibit 10.7 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.34(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and Roger
B. Rice dated February 8, 2005 (filed as Exhibit 10.22 to our Annual Report on Form 10-K for
the year ended December 31, 2004 (File No. 001-11899) and incorporated by reference).10.35(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and Roger B. Rice (filed as
Exhibit 10.5 to our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899)
and incorporated by reference).10.36(2)
    
    
    
    Employment Agreement dated February 10, 2005 between The Houston Exploration Company and
Joanne C. Hresko (filed as Exhibit 10.3 to our Current Report on Form 8-K dated February 8,
2005 (File No. 001-11899) and incorporated by reference).10.37(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated February 10,
2005, between The Houston Exploration Company and Joanne C. Hresko (filed as Exhibit 10.8 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated
by reference).10.38(2)
    
    
    
    Employment Agreement effective March 10, 2005, between The Houston Exploration Company and
John E. Bergeron, Jr. (filed as exhibit 99.2 to our Current Report on Form 8-K dated March
10, 2005 (File No. 001-11899) and incorporated by reference).
 -54-




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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION10.39(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated March 10, 2005,
between The Houston Exploration Company and John E. Bergeron, Jr. (filed as Exhibit 10.9 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated
by reference).10.40(2)
    
    
    
    Employment Agreement effective April 13, 2005, between The Houston Exploration Company and
Jeffrey B. Sherrick (filed as exhibit 99.2 to our Current Report on Form 8-K dated April 13,
2005 (File No. 001-11899) and incorporated by reference).10.41(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated April 13, 2005,
between The Houston Exploration Company and Jeffrey B. Sherrick (filed as Exhibit 10.6 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated
by reference).10.42(2)
    
    
    
    Employment Agreement dated January 18, 2006 between The Houston Exploration Company and
Robert T. Ray (filed as exhibit 99.1 to our Current Report on Form 8-K dated January 18,
2006 (File No. 001-11899) and incorporated by reference).10.43(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated January 18, 2006,
between The Houston Exploration Company and Robert T. Ray (filed as Exhibit 10.3 to our
Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated by
reference).10.44(2)
    
    
    
    Employment Agreement dated March 27, 2006 between The Houston Exploration Company and
Carolyn M. Campbell (filed as Exhibit 99.1 to our Current Report on Form 8-K dated March 27,
2006 (File No. 001-11899) and incorporated by reference).10.45(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated March 27, 2006,
between The Houston Exploration Company and Carolyn M. Campbell (filed as Exhibit 10.4 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated
by reference).10.46
    
    
    
    Form of Amendment No. 2 to [Amended and Restated] Employment Agreement entered into by and
between The Houston Exploration Company and each of William G. Hargett, Steven L. Mueller,
James F. Westmoreland, Roger B. Rice, Joanne C. Hresko, John E. Bergeron Jr., Jeffrey B.
Sherrick, Robert T. Ray and Carolyn M. Campbell (filed as Exhibit 10.1 to our Current Report
on Form 8-K dated January 7, 2007 (file No. 001-11899) and incorporated by reference
herein).10.47(2)
    
    
    
    Change of Control Plan dated October 26, 1999 (filed as Exhibit 10.25 to our Annual Report
on Form 10-K for the year ended December 31, 1999 (File No. 001-11899) and incorporated by
reference).10.48(1)(2)
    
    
    
    First Amendment to The Houston Exploration Company Change of Control Plan dated May 17, 2002.10.49(2)
    
    
    
    Second Amendment to The Houston Exploration Company Change of Control Plan (filed as exhibit
10.4 to our Current Report on Form 8-K dated January 7, 2007 (file No. 001-11899) and
incorporated by reference herein).10.50(2)
    
    
    
    Form of Indemnification Agreement for Directors and Executive Officers (filed as Exhibit
10.8 to our Quarterly Report on Form 10-Q for the period ended June 30, 2006 (File No.
001-11899) and incorporated by reference).10.51(2)
    
    
    
    Form of Non-Qualified Stock Option Agreement (filed as Exhibit 10.9 to our Quarterly Report
on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and incorporated by
reference).10.52(2)
    
    
    
    Form of Director Restricted Stock Award Agreement (filed as Exhibit 10.10 to our Quarterly
Report on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and incorporated
by reference).10.53(2)
    
    
    
    Form of Employee Restricted Stock Award Agreement (filed as Exhibit 10.11 to our Quarterly
Report on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and incorporated
by reference).12.1(1)
    
    
    
    Computation of ratio of earnings to fixed charges.
 -55-




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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION21.1(1)
    
    
    
    Subsidiaries of The Houston Exploration Company.23.1(1)
    
    
    
    Consent of Deloitte & Touche LLP.23.2(1)
    
    
    
    Consent of Netherland, Sewell & Associates.23.3(1)
    
    
    
    Consent of Miller and Lents.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)
    
    Management contract or compensation plan. -56-




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##### Table of Contents



SIGNATURES
  THE HOUSTON EXPLORATION COMPANYBy:
    /s/ William G. HargettWilliam G. HargettDate: February 28, 2007
    
    President and Chief Executive Officer -57-




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##### Table of Contents



POWER OF ATTORNEY
   Signature
    
    Title
    
    Date/s/ William G. Hargett

William G. Hargett
    
    Chairman of the Board of Directors,
President and Chief Executive Officer
(Principal Executive Officer)
    
    February 28, 2007/s/ Robert T. Ray
    
    Senior Vice President and Chief Financial
Officer
    
    February 28, 2007Robert T. Ray
    
    (Principal Financial Officer)/s/ James F. Westmoreland
    
    Vice President and Chief Accounting Officer
    
    February 28, 2007James F. Westmoreland
    
    (Principal Accounting Officer)/s/ Robert B. Catell
    
    Director
    
    February 28, 2007Robert B. Catell/s/ John U. Clarke
    
    Director
    
    February 28, 2007John U. Clarke/s/ David G. Elkins
    
    Director
    
    February 28, 2007David G. Elkins/s/ Harold R. Logan, Jr.
    
    Director
    
    February 28, 2007Harold R. Logan, Jr./s/ Thomas A. McKeever
    
    Director
    
    February 28, 2007Thomas A. McKeever/s/ Stephen W. McKessy
    
    Director
    
    February 28, 2007Stephen W. McKessy/s/ Donald C. Vaughn
    
    Director
    
    February 28, 2007Donald C. Vaughn
 -58-




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##### Table of Contents



Glossary of Oil and Gas Terms
  Bbl
 Bbl/d
 Bcf.
 Bcfe
 Btu
 Completion
 Developed acreage
 Developed well
 Dry hole or well.
 Equivalents.
 Exploratory well.
 Farm-in or farm-out
 Field
 Gross acres or gross wells
 Intangible Drilling and Development Costs.
 Lease Operating Expense.
 MBbls
 MBbls/d
 Mcf
 Mcf/d
 G-1




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##### Table of Contents



Mcfe
 Mcfe/d
 MMBbls
 MMbtu
 MMMbtu
 MMcf
 MMcf/d
 MMcfe
 Net acres or net wells.
 Net revenue interest.
 Oil.
 Present value or PV10
 Productive well
 Proved developed nonproducing reserves
 Proved developed producing reserves
 Proved reserves http://www.sec.gov/divisions/corpfin/forms/regsx.htm#gas
 Proved undeveloped location
 Proved undeveloped reserves
 Recompletion.
 Reservoir
 Royalty interest
 G-2




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##### Table of Contents



Tangible Drilling and Development Costs.
 Undeveloped acreage
 Working interest
 Workover
 G-3




---



##### Table of Contents



Index to Financial Statements
 PAGEManagements Report on Internal Controls Over Financial Reporting
    
    
    F-2Report of Independent Registered Public Accounting Firm
    
    
    F-3Consolidated Balance Sheets as of December 31, 2006 and 2005
    
    
    F-4Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005and 2004.
    
    
    F-5Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) for the
Period January 1, 2004 to December 31, 2006
    
    
    F-6Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8Supplemental Information on Natural Gas and Oil Exploration, Development and Production
Activities (Unaudited)
    
    
    F-31Quarterly Financial Information (Unaudited)
    
    
    F-35
 F-1




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##### Table of Contents



MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
 
 Internal Control  Integrated Framework
 Internal Control  Integrated
Framework
  
 /s/ William G. Hargett
    
    /s/ Robert T. RayWilliam G. Hargett
    
    Robert T. RayChairman, President and Chief Executive Officer
    
    Senior Vice President and Chief Financial Officer
 F-2




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##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 Internal
ControlIntegrated Framework
    Internal
ControlIntegrated Framework Internal ControlIntegrated Framework .
   
 F-3




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 
 CONSOLIDATED BALANCE SHEETS
  December 31,2006
    
    
    2005Assets:Cash and cash equivalents
    
    $
    53,950
    
    
    $
    7,979Accounts receivable
    
    
    86,416
    
    
    
    146,020Inventories
    
    
    2,900
    
    
    
    2,726Deferred tax asset
    
    
    10,244
    
    
    
    145,922Prepayments and other
    
    
    8,370
    
    
    
    19,709Total current assets
    
    
    161,880
    
    
    
    322,356Natural gas and oil properties, full cost methodUnevaluated properties
    
    
    28,317
    
    
    
    107,146Properties subject to amortization
    
    
    3,478,878
    
    
    
    3,556,755Other property and equipment
    
    
    15,101
    
    
    
    12,9713,522,296
    
    
    
    3,676,872Less: Accumulated depreciation, depletion and amortization
    
    
    1,930,964
    
    
    
    1,658,5321,591,332
    
    
    
    2,018,340Other non-current assets
    
    
    18,514
    
    
    
    20,928Total Assets
    
    $
    1,771,726
    
    
    $
    2,361,624Liabilities:Accounts payable and accrued expenses
    
    $
    151,482
    
    
    $
    177,159Derivative financial instruments
    
    
    10,151
    
    
    
    352,457Asset retirement obligation
    
    
    
    
    
    
    7,265Total current liabilities
    
    
    161,633
    
    
    
    536,881Long-term debt and notes
    
    
    175,000
    
    
    
    597,000Derivative financial instruments
    
    
    17,247
    
    
    
    65,201Deferred federal income taxes
    
    
    363,322
    
    
    
    341,302Asset retirement obligation
    
    
    72,782
    
    
    
    112,406Other non-current liabilities
    
    
    17,138
    
    
    
    15,696Total Liabilities
    
    
    807,122
    
    
    
    1,668,486Commitments and Contingencies (see Note 9)Stockholders Equity:Preferred Stock, $0.01 par value, 5,000,000 shares authorized and no shares issued
    
    
    
    
    
    
    Common Stock, $0.01 par value, 100,000,000 shares authorized and 28,098,172 and
28,980,128 shares issued and outstanding at December 31, 2006 and 2005,
respectively
    
    
    281
    
    
    
    289Additional paid-in capital
    
    
    253,922
    
    
    
    297,218Retained earnings
    
    
    731,150
    
    
    
    663,367Accumulated other comprehensive (loss)
    
    
    (20,749
    )
    
    
    (267,736
    )Total Stockholders Equity
    
    
    964,604
    
    
    
    693,138Total Liabilities and Stockholders Equity
    
    $
    1,771,726
    
    
    $
    2,361,624
  F-4




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
  For the Years Ended December 31,2006
    
    
    2005
    
    
    2004Revenues:Natural gas and oil revenues
    
    $
    529,586
    
    
    $
    620,271
    
    
    $
    649,087Other
    
    
    2,011
    
    
    
    1,272
    
    
    
    1,352Total revenues
    
    
    531,597
    
    
    
    621,543
    
    
    
    650,439Operating expenses:Lease operating
    
    
    63,959
    
    
    
    67,796
    
    
    
    55,925Severance tax
    
    
    18,102
    
    
    
    18,121
    
    
    
    11,933Transportation expense
    
    
    10,636
    
    
    
    11,883
    
    
    
    11,819Asset retirement accretion expense
    
    
    3,373
    
    
    
    5,278
    
    
    
    4,902Depreciation, depletion and amortization
    
    
    253,666
    
    
    
    295,351
    
    
    
    265,148Writedown in carrying value of natural gas and oil properties
    
    
    19,000
    
    
    
    
    
    
    
    General and administrative, net of amounts capitalized
    
    
    36,013
    
    
    
    38,378
    
    
    
    32,899Total operating expenses
    
    
    404,749
    
    
    
    436,807
    
    
    
    382,626Income from operations
    
    
    126,848
    
    
    
    184,736
    
    
    
    267,813Other (income) expense
    
    
    (13,495
    )
    
    
    142
    
    
    
    (1,058
    )Interest expense, net of amounts capitalized
    
    
    25,206
    
    
    
    16,535
    
    
    
    9,455Income before income taxes
    
    
    115,137
    
    
    
    168,059
    
    
    
    259,416Provision for income taxes
    
    
    47,354
    
    
    
    62,890
    
    
    
    96,592Net income
    
    $
    67,783
    
    
    $
    105,169
    
    
    $
    162,824Earnings per share:Net income per share  basic
    
    $
    2.37
    
    
    $
    3.66
    
    
    $
    5.50Net income per share  diluted
    
    $
    2.36
    
    
    $
    3.62
    
    
    $
    5.44Weighted average shares outstanding  basic
    
    
    28,543
    
    
    
    28,707
    
    
    
    29,616Weighted average shares outstanding  diluted
    
    
    28,693
    
    
    
    29,037
    
    
    
    29,932
  F-5




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 
 CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY
 AND COMPREHENSIVE INCOME (LOSS)
  AccumulatedAdditional
    
    
    
    
    
    
    Other
    
    
    TotalCommon Stock
    
    
    Paid-In
    
    
    Retained
    
    
    Comprehensive
    
    
    ShareholdersShares
    
    
    $ Value
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss)
    
    
    EquityBalance January 1, 2004
    
    
    31,437,581
    
    
    $
    315
    
    
    $
    365,973
    
    
    $
    395,374
    
    
    $
    (26,128
    )
    
    $
    735,534Common shares issued  stock options
    
    
    873,626
    
    
    
    9
    
    
    
    25,586
    
    
    
    
    
    
    
    
    
    
    
    25,595Common shares issued  restricted stock
    
    
    49,000
    
    
    
    
    
    
    
     ̄
    
    
    
    
    
    
    
    
    
    
    
     ̄Common shares issued  public offering
    
    
    6,820,000
    
    
    
    68
    
    
    
    310,659
    
    
    
    
    
    
    
    
    
    
    
    310,727Common shares repurchased from KeySpan
and retired
    
    
    (10,800,000
    )
    
    
    (108
    )
    
    
    (441,471
    )
    
    
    
    
    
    
    
    
    
    
    (441,579
    )Amortization of restricted stock
    
    
    
    
    
    
    
    
    
    
    1,126
    
    
    
    
    
    
    
    
    
    
    
    1,126Stock compensation expense
    
    
    
    
    
    
    
    
    
    
    3,670
    
    
    
    
    
    
    
    
    
    
    
    3,670Tax benefit non-qualified stock options
    
    
    
    
    
    
    
    
    
    
    4,922
    
    
    
    
    
    
    
    
    
    
    
    4,922Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    162,824
    
    
    
    
    
    
    
    162,824Other comprehensive income (loss)Derivative settlements
reclassified to income, net of tax
of $24,141
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,054
    
    
    
    44,054Unrealized loss change in fair
value of derivatives, net of tax of
$42,529
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (63,953
    )
    
    
    (63,953
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142,925Balance December 31, 2004
    
    
    28,380,207
    
    
    $
    284
    
    
    $
    270,465
    
    
    $
    558,198
    
    
    $
    (46,027
    )
    
    $
    782,920Common shares issued  stock options
    
    
    510,316
    
    
    
    5
    
    
    
    16,285
    
    
    
    
    
    
    
    
    
    
    
    16,290Common shares issued  restricted stock
    
    
    89,605
    
    
    
    
    
    
    
     ̄
    
    
    
    
    
    
    
    
    
    
    
     ̄Amortization of restricted stock
    
    
    
    
    
    
    
    
    
    
    2,882
    
    
    
    
    
    
    
    
    
    
    
    2,882Stock compensation expense
    
    
    
    
    
    
    
    
    
    
    4,229
    
    
    
    
    
    
    
    
    
    
    
    4,229Tax adjustment to 2004 benefit from
non-qualified stock options
    
    
    
    
    
    
    
    
    
    
    (180
    )
    
    
    
    
    
    
    
    
    
    
    (180
    )Tax benefit non-qualified stock options
    
    
    
    
    
    
    
    
    
    
    3,537
    
    
    
    
    
    
    
    
    
    
    
    3,537Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    105,169
    
    
    
    
    
    
    
    105,169Other comprehensive income (loss)Derivative settlements
reclassified to income, net of tax
of $93,894
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    171,342
    
    
    
    171,342Unrealized loss change in fair
value of derivatives, net of tax
of $214,694
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (393,051
    )
    
    
    (393,051
    )Total comprehensive (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (116,540
    )Balance December 31, 2005
    
    
    28,980,128
    
    
    $
    289
    
    
    $
    297,218
    
    
    $
    663,367
    
    
    $
    (267,736
    )
    
    $
    693,138Common shares issued  stock options
    
    
    214,868
    
    
    
    3
    
    
    
    7,497
    
    
    
    
    
    
    
    
    
    
    
    7,500Common shares issued  restricted stock
and units
    
    
    79,676
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
     ̄Common shares repurchased and retired
    
    
    (1,176,500
    )
    
    
    (12
    )
    
    
    (61,626
    )
    
    
    
    
    
    
    
    
    
    
    (61,638
    )Amortization of restricted stock
    
    
    
    
    
    
    
    
    
    
    3,939
    
    
    
    
    
    
    
    
    
    
    
    3,939Stock compensation expense
    
    
    
    
    
    
    
    
    
    
    5,783
    
    
    
    
    
    
    
    
    
    
    
    5,783Tax benefit non-qualified stock options
    
    
    
    
    
    
    
    
    
    
    1,112
    
    
    
    
    
    
    
    
    
    
    
    1,112Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    67,783
    
    
    
    
    
    
    
    67,783Other comprehensive income (loss)Derivative settlements
reclassified to income, net of tax
of $24,500
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,708
    
    
    
    44,708Unrealized gain change in fair
value of derivatives, net of tax
of $116,524
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    204,528
    
    
    
    204,528Unfunded future post retirement
benefit obligation, net of tax of
$1,271
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,249
    )
    
    
    (2,249
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    314,770Balance December 31, 2006
    
    
    28,098,172
    
    
    $
    281
    
    
    $
    253,922
    
    
    $
    731,150
    
    
    $
    (20,749
    )
    
    $
    964,604
  F-6




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Years Ended December 31,2006
    
    
    2005
    
    
    2004Operating Activities:Net income
    
    $
    67,783
    
    
    $
    105,169
    
    
    $
    162,824Adjustments to reconcile net income to net cash provided by
operating activities:Deferred income tax expense
    
    
    22,702
    
    
    
    57,555
    
    
    
    50,500Depreciation, depletion and amortization
    
    
    253,666
    
    
    
    295,351
    
    
    
    265,148Writedown in carrying value of natural gas and oil properties
    
    
    19,000
    
    
    
    
    
    
    
    Asset retirement accretion expense
    
    
    3,373
    
    
    
    5,278
    
    
    
    4,902Stock compensation expense
    
    
    9,722
    
    
    
    7,111
    
    
    
    4,796Tax benefit (loss) non-qualified stock options
    
    
    
    
    
    
    (180
    )
    
    
    4,922Unrealized (gain) loss on derivative instruments
    
    
    (4,757
    )
    
    
    (694
    )
    
    
    1,950Amortization of premiums paid on derivative contracts
    
    
    
    
    
    
    
    
    
    
    5,287Debt extinguishment expense
    
    
    572
    
    
    
    
    
    
    
    211Changes in operating assets and liabilities:Accounts receivable
    
    
    59,604
    
    
    
    (42,951
    )
    
    
    (8,387
    )Inventories
    
    
    (174
    )
    
    
    (1,750
    )
    
    
    95Prepayments and other
    
    
    11,339
    
    
    
    (11,714
    )
    
    
    (3,289
    )Other assets
    
    
    2,041
    
    
    
    (43
    )
    
    
    (6,218
    )Accounts payable and accrued expenses
    
    
    (25,108
    )
    
    
    42,403
    
    
    
    39,693Other non-current liabilities
    
    
    (3,574
    )
    
    
    4,974
    
    
    
    7,276ARO liability for assets abandoned
    
    
    
    
    
    
    
    
    
    
    (2,569
    )Net cash provided by operating activities
    
    
    416,189
    
    
    
    460,509
    
    
    
    527,141Investing Activities:Investment in property and equipment
    
    
    (614,228
    )
    
    
    (728,882
    )
    
    
    (523,205
    )Cash designated for investment
    
    
    (323,675
    )
    
    
    
    
    
    
    Withdrawal of cash designated for investment
    
    
    323,675
    
    
    
    
    
    
    
    Dispositions and other
    
    
    719,235
    
    
    
    1,879
    
    
    
    13,283Net cash provided by (used in) investing activities
    
    
    105,007
    
    
    
    (727,003
    )
    
    
    (509,922
    )Financing Activities:Proceeds from long-term borrowings
    
    
    525,000
    
    
    
    831,000
    
    
    
    420,000Repayments of long-term borrowings
    
    
    (947,000
    )
    
    
    (589,000
    )
    
    
    (367,000
    )Debt issuance costs
    
    
    (199
    )
    
    
    (2,394
    )
    
    
    (1,555
    )Proceeds from issuance of common stock from exercise of stock options
    
    
    7,500
    
    
    
    16,290
    
    
    
    25,596Tax benefit non-qualified stock options
    
    
    1,112
    
    
    
    
    
    
    
    Proceeds from issuance of common stock
    
    
    
    
    
    
    
    
    
    
    310,727Repurchase of common stock
    
    
    (61,638
    )
    
    
    
    
    
    
    (388,979
    )Net cash provided by (used in) financing activities
    
    
    (475,225
    )
    
    
    255,896
    
    
    
    (1,211
    )Increase (decrease) in cash and cash equivalents
    
    
    45,971
    
    
    
    (10,598
    )
    
    
    16,008Cash and cash equivalents, beginning of year
    
    
    7,979
    
    
    
    18,577
    
    
    
    2,569Cash and cash equivalents, end of year
    
    $
    53,950
    
    
    $
    7,979
    
    
    $
    18,577Supplemental Information:Non-cash transactions:Change in investments in property and equipment accrued, not paid
    
    $
    (927
    )
    
    $
    (15,785
    )
    
    $
    4,705Divesture and exchange of Appalachian Basin assets
    
    
    
    
    
    
    
    
    
    
    60,000Deferred tax benefit exchange of Appalachian Basin assets
    
    
    
    
    
    
    
    
    
    
    7,400Cash paid during period for:Interest
    
    $
    28,015
    
    
    $
    23,858
    
    
    $
    16,385Federal and state income taxes, net payments and refunds
    
    
    16,635
    
    
    
    19,297
    
    
    
    41,854
  F-7




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1  Summary of Organization and Significant Accounting Policies (
 Our Business
   Recent Events
       F-8




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   Principles of Consolidation
   Use of Estimates
  Reclassifications
  Business Segment Information
   F-9




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Revenue Recognition and Gas Imbalances
    Cash and Cash Equivalents
  Cash Designated for Investment
   Financial Instruments
  F-10




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Net Income Per Share
  Years Ended December 31,2006
    
    
    2005
    
    
    2004(in thousands, except per share data)Numerator:Net income
    
    $
    67,783
    
    
    $
    105,169
    
    
    $
    162,824Denominator:Weighted average shares outstanding
    
    
    28,543
    
    
    
    28,707
    
    
    
    29,616Add potentially dilutive securities: restricted stock/units and options
    
    
    150
    
    
    
    330
    
    
    
    316Total weighted average shares outstanding and dilutive securities
    
    
    28,693
    
    
    
    29,037
    
    
    
    29,932Earnings per share:Net income per share  basic
    
    $
    2.37
    
    
    $
    3.66
    
    
    $
    5.50Net income per share  diluted
    
    $
    2.36
    
    
    $
    3.62
    
    
    $
    5.44
  Comprehensive Income
  For the Year Ended December 31,2006
    
    
    2005
    
    
    2004(in thousands)Net income
    
    $
    67,783
    
    
    $
    105,169
    
    
    $
    162,824Other comprehensive income (loss)Derivative instruments settled and reclassified, net of tax
    
    
    44,708
    
    
    
    171,342
    
    
    
    44,054Unrealized change in fair value of open derivative
contracts, net of tax
    
    
    204,528
    
    
    
    (393,051
    )
    
    
    (63,953
    )Future post retirement benefit obligation, net of tax
    
    
    (2,249
    )
    
    
    
    
    
    
    Total other comprehensive income (loss)
    
    
    246,987
    
    
    
    (221,709
    )
    
    
    (19,899
    )Comprehensive income (loss)
    
    $
    314,770
    
    
    $
    (116,540
    )
    
    $
    142,925
 Natural Gas and Oil Properties
 Full Cost Accounting
 F-11




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
    
    our full cost pool (including assets associated with retirement obligations); plus
    
    estimates for future development costs (excluding liabilities associated with retirement obligations); less
    
    unevaluated properties and their related costs; less
    
    estimates for salvage.
     Unevaluated Properties
 F-12




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
    Asset Retirement Obligations
  st
 Years Ended December 31,2006
    
    
    2005(in thousands)ARO liability at January 1,
    
    $
    119,671
    
    
    $
    91,746Accretion expense
    
    
    3,373
    
    
    
    5,278Liabilities incurred from drilling
    
    
    7,656
    
    
    
    7,520Liabilities incurred  assets acquired
    
    
    1,312
    
    
    
    5,783Liabilities settled   assets sold
    
    
    (88,375
    )
    
    
    (32
    )Liabilities settled  assets abandoned
    
    
    
    
    
    
    (971
    )Changes in estimates
    
    
    29,145
    
    
    
    10,347ARO liability at December 31,
    
    $
    72,782
    
    
    $
    119,671
 Other Property and Equipment
  F-13




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Inventories
  Income Taxes
  
    
    intangible drilling and development costs associated with natural gas and oil
properties, which are capitalized and amortized for financial reporting purposes and
expensed as incurred for tax reporting purposes; and
    
    provisions for depreciation and amortization for financial reporting purposes
that differ from those used for income tax reporting purposes.
 General and Administrative Costs and Expenses
   Capitalization of Interest
 Natural Gas and Oil Properties  Unevaluated Properties
 Concentration of Credit Risk
   F-14




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Derivative Instruments and Hedging Activities
    Sale of Texas Gulf of Mexico Assets
   F-15




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Accounting for Stock Options
 Stock Compensation Expense
 Accounting for Postretirement Benefits
 st
 Supplemental Executive Retirement Plan
 Before Adopting
    
    
    Adjustment to
    
    
    After AdoptingSFAS 158
    
    
    adopt SFAS 158
    
    
    SFAS 158(in thousands)Assets:Other current assets  current tax benefit
    
    $
    
    
    
    $
    36
    
    
    $
    36Total assets
    
    
    
    
    
    
    36
    
    
    
    36Liabilities:Accounts payable and accrued liabilities
    
    
    1,596
    
    
    
    (1,496
    )
    
    
    100Other non-current liabilities
    
    
    
    
    
    
    5,016
    
    
    
    5,016Deferred tax liability (benefit)
    
    
    
    
    
    
    (1,235
    )
    
    
    (1,235
    )Total liabilities
    
    
    1,596
    
    
    
    2,285
    
    
    
    3,881Stockholders equity:Accumulated other comprehensive income (loss)
    
    
    
    
    
    
    (2,249
    )
    
    
    (2,249
    )Total stockholders equity
    
    $
    
    
    
    $
    (2,249
    )
    
    $
    (2,249
    )
 Recent Accounting Pronouncements
  F-16




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   NOTE 2  Long-Term Debt and Notes
 As of December 31,2006
    
    
    2005(in thousands)Senior Debt:Revolving bank credit facility, due November 30, 2010
    
    $
    
    
    
    $
    422,000Subordinated Debt:7% senior subordinated notes, due June 15, 2013
    
    
    175,000
    
    
    
    175,000Total long-term debt and notes
    
    $
    175,000
    
    
    $
    597,000
  After2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011
    
    
    2012(in thousands)Revolving bank credit facility
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    7% senior Subordinated Notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175,000Total maturities
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    175,000
 Revolving Credit Facility
 st st
 F-17




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##### Table of Contents



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 1.00% 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
    
    hedge no more than 85% of our projected 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;
    
    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 subsidiary to make certain distributions or payments; or
    
    guarantees by our subsidiary of certain indebtedness.
 F-18




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
  NOTE 3  Stockholders Equity
 Stock Repurchase Program
  Stockholder Rights Plan
 Pending Merger with Forest Oil
Corporation
 Increase in Number of Shares Outstanding
  KeySpans Divesture of Our Common Stock
  Issuance of 3,000,000 Shares to the Public and Concurrent Repurchase of 3,000,000 Shares from
KeySpan.
 KeySpan Exchange and Offering.
 F-19




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
    KeySpan Secondary Offering.
 NOTE 4 Employee Benefit and Stock Compensation Plans
 401(k) Plan
 Pending Merger with Forest Oil Corporation
 Deferred Compensation Plan
   F-20




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Pending Merger with Forest Oil Corporation
 Deferred Compensation Plan for Non-Employee Directors
   Employee Annual Incentive Compensation Plan
  Retention Bonus Plan
  F-21




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   Supplemental Executive Retirement Plans
   st
 2006(in thousands)Change in Benefit Obligation:Benefit obligation at January 1, 2006
    
    $
    4,013Service cost
    
    
    572Interest cost
    
    
    249Actuarial (gain) loss
    
    
    382Benefits paid
    
    
    (100
    )Benefit obligation at December 31, 2006
    
    $
    5,116Change in Plan Assets:Fair value of plan assets at January 1, 2006
    
    $
    Actual return on plan assets
    
    
    Employer contributions
    
    
    100Benefits paid
    
    
    (100
    )Fair value of plan assets at December 31, 2006
    
    $
    
 F-22




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Reconciliation of Funded Status:Funded (unfunded) status of plan at December 31, 2006
    
    $
    (5,116
    )Unrecognized actuarial (gain) loss
    
    
    Unrecognized prior service cost
    
    
    Unrecognized transition cost
    
    
    Accrued asset (liability) recognized at December 31, 2006
    
    $
    (5,116
    )Accumulated Benefit Obligation at December 31, 2006:
    
    $
    3,709
  2006(in thousands)Projected benefit obligation
    
    $
    5,116Accumulated benefit obligation
    
    
    3,709Fair value of plan assets
    
    
    
  2006(in thousands)Net Periodic Benefit Cost:Service cost
    
    $
    572Interest cost
    
    
    250Amortization of prior service cost
    
    
    316Recognized net actuarial (gain) loss
    
    
    8Net periodic benefit cost
    
    
    1,146Curtailment and settlement expense
    
    
    Special termination benefit expense
    
    
    Total expense
    
    $
    1,146
  2006(in thousands)Net actuarial losses
    
    $
    599Prior service costs
    
    
    2,9203,520Tax expense (benefit)
    
    
    (1,271
    )Benefit obligation, net of tax
    
    $
    2,249
  2007
    
    $
    1002008
    
    
    982009
    
    
    1422010
    
    
    1622011
    
    
    1592012 through 2016
    
    $
    2,455
 F-23




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Stock Compensation Plans
 Stock Plans.
  2004 Plan
    
    2002 Plan
    
    1999 Plan
    
    1996 Plan
    
    Total PlansOptions and restricted stock authorized
    
    
    1,500,000
    
    
    
    1,500,000
    
    
    
    800,000
    
    
    
    3,033,912
    
    
    
    6,833,912Options:Incentive stock grants
    
    
    
    
    
    
    47,675
    
    
    
    
    
    
    
    909,454
    
    
    
    957,129Non-qualified stock grants
    
    
    943,050
    
    
    
    1,194,000
    
    
    
    806,606
    
    
    
    2,132,758
    
    
    
    5,076,414Forfeitures
    
    
    (66,090
    )
    
    
    (115,440
    )
    
    
    (47,905
    )
    
    
    (40,000
    )
    
    
    (269,435
    )Cancellations
    
    
    
    
    
    
    351,765
    
    
    
    41,299
    
    
    
    31,700
    
    
    
    424,764Total options
    
    
    876,960
    
    
    
    1,478,000
    
    
    
    800,000
    
    
    
    3,033,912
    
    
    
    6,188,872Restricted stock and units:Grants
    
    
    274,039
    
    
    
    22,000
    
    
    
    
    
    
    
    
    
    
    
    296,039Forfeitures
    
    
    (13,496
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (13,496
    )Cancellations
    
    
    (380
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (380
    )Total restricted stock and units
    
    
    260,163
    
    
    
    22,000
    
    
    
    
    
    
    
    
    
    
    
    282,163Options and restricted stock available for grant
    
    
    362,877
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    362,877Total exercised and issued
    
    
    84,666
    
    
    
    607,105
    
    
    
    597,143
    
    
    
    2,820,092
    
    
    
    4,109,006
 Pending Merger with Forest Oil Corporation
 Stock Options.
  F-24




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   Options Outstanding
    
    
    Options Exercisable
    
    
    UnvestedWeighted
    
    
    
    
    
    
    WeightedShares
    
    
    
    
    
    
    Remaining
    
    
    Average
    
    
    Shares
    
    
    Average
    
    
    SharesRange of
    
    
    Underlying
    
    
    Year
    
    
    Contractual
    
    
    Exercise
    
    
    Underlying
    
    
    Exercise
    
    
    UnderlyingExercise Prices
    
    
    Options
    
    
    Granted
    
    
    Life
    
    
    Price
    
    
    Options
    
    
    Price
    
    
    Options$13.13
    
    
    
    
    
    $
    25.00
    
    
    
    15,500
    
    
    
    1997
    
    
    1 years
    
    
    20.72
    
    
    
    15,500
    
    
    
    20.72
    
    
    
    $15.75
    
    
    
    
    
    $
    23.38
    
    
    
    4,980
    
    
    
    1998
    
    
    2 years
    
    
    18.97
    
    
    
    4,980
    
    
    
    18.97
    
    
    
    $16.94
    
    
    
    
    
    $
    21.00
    
    
    
    24,230
    
    
    
    1999
    
    
    3 years
    
    
    19.53
    
    
    
    24,230
    
    
    
    19.53
    
    
    
    $18.00
    
    
    
    
    
    $
    26.19
    
    
    
    26,500
    
    
    
    2000
    
    
    4 years
    
    
    23.69
    
    
    
    26,500
    
    
    
    23.69
    
    
    
    $22.50
    
    
    
    
    
    $
    37.38
    
    
    
    219,369
    
    
    
    2001
    
    
    5 years
    
    
    29.13
    
    
    
    219,368
    
    
    
    29.13
    
    
    
    $27.49
    
    
    
    
    
    $
    33.75
    
    
    
    273,970
    
    
    
    2002
    
    
    6 years
    
    
    30.13
    
    
    
    183,670
    
    
    
    30.12
    
    
    
    90,300$26.18
    
    
    
    
    
    $
    37.42
    
    
    
    287,540
    
    
    
    2003
    
    
    7 years
    
    
    34.76
    
    
    
    146,070
    
    
    
    35.07
    
    
    
    141,470$36.56
    
    
    
    
    
    $
    60.45
    
    
    
    247,195
    
    
    
    2004
    
    
    8 years
    
    
    56.63
    
    
    
    106,924
    
    
    
    57.82
    
    
    
    140,271$46.25
    
    
    
    
    
    $
    66.86
    
    
    
    305,206
    
    
    
    2005
    
    
    9 years
    
    
    55.49
    
    
    
    98,127
    
    
    
    54.17
    
    
    
    207,079$50.41
    
    
    
    
    
    $
    64.61
    
    
    
    293,945
    
    
    
    2006
    
    
    10 years
    
    
    55.15
    
    
    
    
    
    
    
    
    
    
    
    293,9451,698,434
    
    
    
    
    
    
    
    
    
    
    $
    43.16
    
    
    
    825,369
    
    
    $
    36.42
    
    
    
    873,065
  WeightedWeighted
    
    AverageAverage
    
    Remaining
    
    AggregateExercise
    
    Contractual
    
    IntrinsicOptions
    
    Price
    
    Term
    
    Value(1)(Shares)
    
    ($/Share)
    
    (Years)
    
    ($ in thousands)Options outstanding January 1, 2004
    
    
    2,535,159
    
    
    $
    30.23
    
    
    
    
    
    
    $
    15,946Granted
    
    
    342,950
    
    
    
    55.98Exercised
    
    
    (873,626
    )
    
    
    29.30Forfeited
    
    
    (46,885
    )
    
    
    34.49Options outstanding December 31, 2004
    
    
    1,957,598
    
    
    
    35.05
    
    
    
    
    
    
    
    41,619Granted
    
    
    345,230
    
    
    
    55.37Exercised
    
    
    (510,316
    )
    
    
    31.92Forfeited
    
    
    (95,902
    )
    
    
    40.14Options outstanding December 31, 2005
    
    
    1,696,610
    
    
    $
    39.85
    
    
    
    
    
    
    
    21,971Granted
    
    
    296,370
    
    
    
    55.37Exercised
    
    
    (214,868
    )
    
    
    31.92Forfeited
    
    
    (79,678
    )
    
    
    40.14Options outstanding December 31, 2006
    
    
    1,698,434
    
    
    $
    39.85
    
    
    
    4.1
    
    
    $
    14,640Options exercisable December 31, 2006
    
    
    825,369
    
    
    $
    36.42
    
    
    
    2.7
    
    
    $
    12,676Options available for grant December 31, 2006
    
    
    362,877
 
 (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, or the market price at the end
of the period less the exercise price. At December 31, 2006, 2005, 2004 and 2003, the closing
price per share of our common stock on the NYSE was $51.78, $52.80 and $56.31 and $36.52,
respectively.  F-25




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Restricted Stock
  Weighted
    
    AggregateRestricted Stock
    
    Average Grant
    
    Intrinsicand Units(1)
    
    Date Fair Value
    
    Value(2)(Shares)
    
    ($/Share)
    
    ($ in thousands)Unvested restricted stock January 1, 2004
    
    
    25,333
    
    
    $
    35.44
    
    
    $
    925Granted
    
    
    49,000
    
    
    
    58.28Vested
    
    
    (22,333
    )
    
    
    44.29Forfeited
    
    
    
    
    
    
    Unvested restricted stock December 31, 2004
    
    
    52,000
    
    
    
    53.16
    
    
    
    2,928Granted
    
    
    146,423
    
    
    
    57.47Vested
    
    
    (22,892
    )
    
    
    56.64Forfeited
    
    
    (4,317
    )
    
    
    59.07Unvested restricted stock December 31, 2005
    
    
    171,214
    
    
    $
    56.23
    
    
    
    9,040Granted
    
    
    78,616
    
    
    
    55.07Vested
    
    
    (1,440
    )
    
    
    58.88Forfeited
    
    
    (9,179
    )
    
    
    58.88Unvested restricted stock December 31,2006
    
    
    239,211
    
    
    $
    55.73
    
    
    $
    12,386
 
 (1)
    
    At December 31, 2006 and 2005, includes 41,882 and 52,501 restricted units unvested
and outstanding, respectively, granted in July 2005 pursuant to a retention bonus plan for
certain employees at an average price of $58.76 per unit. See above discussion of the terms
of our retention bonus plan.(2)
    
    For unvested shares of restricted stock, the intrinsic value is calculated using the
closing price of our common stock at the end of the period. At December 31, 2006, 2005, 2004
and 2003, the closing price per share of our common stock on the NYSE was $51.78, $52.80 and
$56.31 and $36.52, respectively. Stock Compensation Expense
  F-26




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Years Ended December 31,2005
    
    
    2004(in thousands, except per share data)Net income  as reported
    
    $
    105,169
    
    
    $
    162,824Add: Stock-based compensation expense included in
net income, net of tax
    
    
    3,292
    
    
    
    2,581Less: Stock-based compensation expense determined
using fair value method, net of tax
    
    
    4,679
    
    
    
    4,694Net income   pro forma
    
    $
    103,782
    
    
    $
    160,711Net income per share  basic  as reported
    
    $
    3.66
    
    
    $
    5.50Net income per share  diluted  as reported
    
    
    3.62
    
    
    
    5.44Net income per share  basic  pro forma
    
    $
    3.62
    
    
    $
    5.43Net income per share  diluted  pro forma
    
    
    3.57
    
    
    
    5.37
   Years Ended December 31,2006
    
    2005
    
    2004Weighted average fair value of options granted
    
    $
    15.02
    
    
    $
    16.62
    
    
    $
    21.36Valuation assumptions:Risk-free interest rate
    
    
    4.8
    %
    
    
    4.1
    %
    
    
    3.7
    %Expected life or years until exercise
    
    
    4
    
    
    
    4
    
    
    
    5Expected stock volatility
    
    
    23.6
    %
    
    
    42.7
    %
    
    
    37.2
    %Expected dividends
    
    
    
    
    
    
    
    
    
    
    
   December 31,2006
    
    
    2005
    
    
    2004(in thousands)Options
    
    $
    6,287
    
    
    $
    4,229
    
    
    $
    3,670Restricted stock/units
    
    
    3,435
    
    
    
    2,882
    
    
    
    1,126Stock compensation expense, gross
    
    
    9,722
    
    
    
    7,111
    
    
    
    4,796Amounts capitalized
    
    
    (3,265
    )
    
    
    (2,015
    )
    
    
    (800
    )Stock compensation expense, net of amounts capitalized
    
    $
    6,457
    
    
    $
    5,096
    
    
    $
    3,996
 F-27




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  NOTE 5  Income Taxes
  Years Ended December 31,2006
    
    
    2005
    
    
    2004(in thousands)Current:State
    
    $
    (16
    )
    
    $
    (258
    )
    
    $
    3,411Federal
    
    
    24,668
    
    
    
    5,593
    
    
    
    42,681Total current.
    
    
    24,652
    
    
    
    5,335
    
    
    
    46,092Deferred :State
    
    
    6,544
    
    
    
    1,149
    
    
    
    3,236Federal
    
    
    16,158
    
    
    
    56,406
    
    
    
    47,264Total deferred
    
    
    22,702
    
    
    
    57,555
    
    
    
    50,500Total income tax provision
    
    $
    47,354
    
    
    $
    62,890
    
    
    $
    96,592
 Sale of Texas and Louisiana Gulf of Mexico Assets
   Years Ended December 31,2006
    
    
    2005
    
    
    2004(in thousands, except rates)Income before income taxes
    
    $
    115,137
    
    
    $
    168,059
    
    
    $
    259,416Statutory rate
    
    
    35
    %
    
    
    35
    %
    
    
    35
    %Income tax expense computed at statutory rate
    
    
    40,298
    
    
    
    58,821
    
    
    
    90,796Reconciling items:State income taxes and other, net of federal
tax benefit(1)
    
    
    7,033
    
    
    
    672
    
    
    
    4,358Permanent differences
    
    
    23
    
    
    
    40
    
    
    
    45Other adjustments(2)
    
    
    
    
    
    
    1,852
    
    
    
    Non-deductible compensation expense
    
    
    
    
    
    
    1,505
    
    
    
    1,393Tax provision
    
    $
    47,354
    
    
    $
    62,890
    
    
    $
    96,592
 
 (1)
    
    For 2006, includes approximately $5.4 million for Texas state margin tax
implemented during 2006.(2)
    
    For 2005, includes an adjustment relating to 2004 estimates for federal and
state taxes. F-28




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Deferred Income Taxes
    Years Ended December 31,2006
    
    
    2005(in thousands)Deferred tax assets:Derivative instruments
    
    $
    10,446
    
    
    $
    146,716Future post retirement benefit obligation
    
    
    1,271
    
    
    
    Ineffectiveness derivative instruments
    
    
    
    
    
    
    1,135Net operating loss
    
    
    979
    
    
    
    11,101Alternative minimum tax credit carryforwards
    
    
    2,961
    
    
    
    8,728Deferred compensation
    
    
    9,192
    
    
    
    5,728Total gross deferred tax assets
    
    
    24,849
    
    
    
    173,408Deferred tax liabilities:Oil and gas property and equipment
    
    
    377,367
    
    
    
    368,788Ineffectiveness of derivative instruments
    
    
    560
    
    
    
    Total gross deferred tax liabilities
    
    
    377,927
    
    
    
    368,788Net deferred tax liability
    
    $
    353,078
    
    
    $
    195,380Reflected in the accompanying Balance Sheet as:Current  deferred income tax asset
    
    $
    (10,244
    )
    
    $
    (145,922
    )Non-current deferred income tax liability
    
    
    363,322
    
    
    
    341,302$
    353,078
    
    
    $
    195,380
 NOTE 6  Related Party Transactions
 Transactions with our Executive Officers and Directors
 Employment Agreements
  Pending Merger With Forest Oil Corporation
 F-29




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
    Pending
Merger With Forest Oil Corporation
  Employment Agreements with Robert T. Ray, Chief Financial Officer, and Carolyn M. Campbell, Senior
Vice President and General Counsel.
  Amendments to Employment Agreements  2005
  F-30




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   Lump-Sum Payments to Executives Under Employment Contracts  2005 and 2004
   Transactions Involving Companies with Common Directors
  Transactions with KeySpan
 KeySpan Exchange and Offering
 F-31




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 7  Derivative Instruments
   December 31,Natural Gas Derivatives at December 31, 2006
    
    Fixed Price Swaps
    
    
    Collars
    
    
    2006Daily
    
    
    NYMEX
    
    
    Daily
    
    
    NYMEXVolume
    
    
    Contract
    
    
    Volume
    
    
    Contract Price
    
    
    Fair ValuePeriod
    
    (MMBtu)
    
    
    Price
    
    
    (MMBtu)
    
    
    Floor
    
    
    Ceiling
    
    
    (thousands)January  December 2007
    
    
    
    
    
    
    
    
    
    
    30,000
    
    
    $
    5.000
    
    
    $
    6.597
    
    
    $
    (10,151
    )January  December 2008
    
    
    
    
    
    
    
    
    
    
    20,000
    
    
    
    5.000
    
    
    
    5.720
    
    
    
    (17,247
    )$
    (27,398
    )
   F-32




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 December 31,Natural Gas Derivatives at December 31, 2005
    
    Fixed Price Swaps
    
    
    Collars
    
    
    2005Daily
    
    
    NYMEX
    
    
    Daily
    
    
    NYMEXVolume
    
    
    Contract
    
    
    Volume
    
    
    Contract Price
    
    
    Fair ValuePeriod
    
    (MMBtu)
    
    
    Price
    
    
    (MMBtu)
    
    
    Floor
    
    
    Ceiling
    
    
    (thousands)January  December 2006
    
    
    30,000
    
    
    $
    5.893
    
    
    
    220,000
    
    
    $
    5.774
    
    
    $
    7.090
    
    
    $
    (352,456
    )January  December 2007
    
    
    
    
    
    
    
    
    
    
    30,000
    
    
    
    5.000
    
    
    
    6.597
    
    
    
    (40,255
    )January  December 2008
    
    
    
    
    
    
    
    
    
    
    20,000
    
    
    
    5.000
    
    
    
    5.720
    
    
    
    (24,947
    )$
    (417,658
    )
  st
  NOTE 8  Sales to Major Customers
  For the Year Ended December 31,Major Purchaser
    
    2006
    
    
    2005
    
    
    2004Oneok
    
    
    11.9
    %
    
    
    8.8
    %
    
    
    8.0
    %ConocoPhillips
    
    
    11.7
    %
    
    
    11.9
    %
    
    
    11.9
    %Kinder Morgan
    
    
    11.3
    %
    
    
    8.5
    %
    
    
    10.1
    %Anadarko Petroleum Corporation
    
    
    6.1
    %
    
    
    10.1
    %
    
    
    9.1
    %
 NOTE 9  Commitments and Contingencies
 Legal Proceedings
  F-33




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   Severance Tax Refund
  Operating Leases
 th
 MinimumYears Ended December 31,
    
    Payments(in thousands)2007
    
    $
    1,9132008
    
    
    1,9242009
    
    
    1,1372010
    
    
    23Thereafter
    
    
    Total
    
    $
    4,997
 Letters of Credit
  North Dakota Lease Acquisition
  F-34




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Drilling Contracts
  Seismic Contracts
  NOTE 10  Acquisitions and Dispositions
 2006 Acquisitions and Dispositions
 East Texas Acquisition.
 South Texas Acquisition.
 DJ Basin Acquisition.
 Sale of Texas Gulf of Mexico Assets.
 F-35




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Sale of Louisiana Gulf of Mexico Assets.
    2005 Acquisitions
 Kerr-McGee South Texas Acquisition.
  Dale East Texas Acquisitions.
  F-36




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  2004 Acquisitions and Dispositions
 Orca Acquisition.
 BP Acquisition.
 Disposition and Exchange of Appalachian Basin Assets.
  Sale of Onshore South Louisiana Properties.
 NOTE 11  Subsequent Events
 Pending Merger Agreement with Forest Oil Corporation
  F-37




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
     F-38




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 12  Supplemental Information on Natural Gas and Oil Exploration, Development and Production
Activities (Unaudited)
  Capitalized Costs of Natural Gas and Oil Properties
 As of December 31,2006
    
    
    2005
    
    
    2004(in thousands)Unevaluated properties, not subject to amortization
    
    $
    28,317
    
    
    $
    107,146
    
    
    $
    122,691Properties subject to amortization (1)
    
    
    3,478,878
    
    
    
    3,556,755
    
    
    
    2,777,097Capitalized costs
    
    
    3,507,195
    
    
    
    3,663,901
    
    
    
    2,899,788Accumulated depreciation, depletion and amortization
    
    
    (1,920,494
    )
    
    
    (1,649,674
    )
    
    
    (1,355,857
    )Net capitalized costs
    
    $
    1,586,701
    
    
    $
    2,014,227
    
    
    $
    1,543,931
 
 (1)
    
    Includes asset retirement obligations of $43.6 million, $93.8 million and
$71.2 million, respectively, for the years ended December 31, 2006, 2005 and 2004. Additions to Unevaluated Properties
  Costs incurred by Year as of December 31, 2006Total
    
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003 and Prior(in thousands)Property acquisition costs
    
    $
    17,393
    
    
    $
    1,008
    
    
    $
    11,426
    
    
    $
    4,495
    
    
    $
    464Exploration and development
    
    
    10,924
    
    
    
    10,078
    
    
    
    603
    
    
    
    224
    
    
    
    19Total
    
    $
    28,317
    
    
    $
    11,086
    
    
    $
    12,029
    
    
    $
    4,719
    
    
    $
    483
 Capitalized Costs Incurred
  As of December 31,2006
    
    
    2005
    
    
    2004(in thousands)Property acquisition and leasehold costsUnevaluated
    
    $
    2,334
    
    
    $
    31,009
    
    
    $
    28,059Proved
    
    
    112,646
    
    
    
    232,784
    
    
    
    179,281Exploration costs
    
    
    71,195
    
    
    
    112,634
    
    
    
    63,646Development costsDevelopment drilling
    
    
    426,615
    
    
    
    366,902
    
    
    
    245,971Asset retirement obligations costs  assumed (1)
    
    
    38,113
    
    
    
    23,651
    
    
    
    12,116Asset retirement obligations costs  properties sold (1)
    
    
    (88,375
    )
    
    
    (32
    )
    
    
    (12,714
    )Asset retirement expenditures (1)
    
    
    
    
    
    
    (971
    )
    
    
    (2,362
    )Total development costs
    
    
    376,353
    
    
    
    389,550
    
    
    
    243,011Total costs incurred
    
    $
    562,528
    
    
    $
    765,977
    
    
    $
    513,997
 
 (1)
    
    Asset retirement obligation costs reflect abandonment obligations assumed
during the year and revisions to prior estimates. As a result of the dispositions of
substantially all of our Gulf of Mexico assets during 2006 and our South Louisiana and F-39




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 Appalachian Basin assets during 2004, asset retirement obligations were reduced by $88.7
million during 2006 and by $12.7 million in 2004. Actual retirement expenditures reflect
plugging and abandonment costs during the year. Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Natural Gas and
Oil Reserves
    1.
    
    Estimates are made of quantities of proved reserves and future periods during which
they are expected to be produced based on year-end economic conditions.2.
    
    The estimated future cash flows are compiled by applying year-end prices of natural gas
and oil relating to our proved reserves to the year-end quantities of those reserves.3.
    
    The future cash flows are reduced by estimated production costs, costs to develop and
produce the proved reserves and abandonment costs, all based on year-end economic
conditions.4.
    
    Future income tax expenses are based on year-end statutory tax rates giving effect to
the remaining tax basis in the natural gas and oil properties, other deductions, credits
and allowances relating to our proved natural gas and oil reserves.5.
    
    Future net cash flows are discounted to present value by applying a discount rate of
10%.
   As of December 31,2006
    
    
    2005
    
    
    2004(in thousands)Future cash inflows
    
    $
    3,547,732
    
    
    $
    7,065,492
    
    
    $
    4,558,560Future production costs
    
    
    (957,940
    )
    
    
    (1,403,934
    )
    
    
    (812,800
    )Future development costs
    
    
    (594,544
    )
    
    
    (874,327
    )
    
    
    (545,192
    )Future income taxes
    
    
    (555,522
    )
    
    
    (1,520,815
    )
    
    
    (976,611
    )Future net cash flows
    
    
    1,439,726
    
    
    
    3,266,416
    
    
    
    2,223,95710% annual discount for estimated timing of cash flows
    
    
    (702,500
    )
    
    
    (1,299,392
    )
    
    
    (783,902
    )Standardized measure of discounted future net cash flows
    
    $
    737,226
    
    
    $
    1,967,024
    
    
    $
    1,440,055
   F-40




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  As of December 31,2006
    
    
    2005
    
    
    2004(in thousands)Beginning of the year
    
    $
    1,967,024
    
    
    $
    1,440,055
    
    
    $
    1,504,406Revisions in quantities
    
    
    (66,056
    )
    
    
    (251,007
    )
    
    
    (59,549
    )Changes in prices
    
    
    (859,166
    )
    
    
    943,487
    
    
    
    (34,170
    )Changes in future development costs
    
    
    (44,270
    )
    
    
    (198,013
    )
    
    
    (35,056
    )Development costs incurred during the period
    
    
    195,723
    
    
    
    209,322
    
    
    
    85,439Extensions and discoveries, net of related costs
    
    
    237,296
    
    
    
    620,243
    
    
    
    445,908Sales of natural gas and oil, net of production costs
    
    
    (499,057
    )
    
    
    (787,013
    )
    
    
    (639,555
    )Accretion of discount
    
    
    287,742
    
    
    
    207,197
    
    
    
    205,641Net change in income taxes
    
    
    644,930
    
    
    
    (278,475
    )
    
    
    (79,913
    )Purchase of reserves in place
    
    
    55,115
    
    
    
    250,520
    
    
    
    247,671Sale of reserves in place
    
    
    (1,137,244
    )
    
    
    (4,904
    )
    
    
    (110,877
    )Production timing and other
    
    
    (44,811
    )
    
    
    (184,388
    )
    
    
    (89,890
    )End of year
    
    $
    737,226
    
    
    $
    1,967,024
    
    
    $
    1,440,055
 Estimated Net Quantities of Natural Gas and Oil Reserves
  Natural Gas (MMcf)
    
    
    Crude Oil, Liquids and Condensate (MBbls)2006
    
    
    2005
    
    
    2004
    
    
    2006
    
    
    2005
    
    
    2004Beginning of the year reserves
    
    
    793,074
    
    
    
    749,114
    
    
    
    709,883
    
    
    
    11,291
    
    
    
    7,335
    
    
    
    7,481Revisions of previous estimates
    
    
    (33,797
    )
    
    
    (66,205
    )
    
    
    (13,232
    )
    
    
    471
    
    
    
    1,097
    
    
    
    (1,110
    )Extensions and discoveries
    
    
    153,020
    
    
    
    135,336
    
    
    
    162,719
    
    
    
    1,140
    
    
    
    1,395
    
    
    
    255Production
    
    
    (82,528
    )
    
    
    (105,809
    )
    
    
    (115,855
    )
    
    
    (938
    )
    
    
    (1,417
    )
    
    
    (1,355
    )Purchase of reserves in place
    
    
    30,779
    
    
    
    81,704
    
    
    
    67,806
    
    
    
    237
    
    
    
    3,000
    
    
    
    2,245Sales of reserves in place
    
    
    (188,912
    )
    
    
    (1,066
    )
    
    
    (62,207
    )
    
    
    (7,586
    )
    
    
    (119
    )
    
    
    (181
    )End of year reserves
    
    
    671,636
    
    
    
    793,074
    
    
    
    749,114
    
    
    
    4,615
    
    
    
    11,291
    
    
    
    7,335Proved developed reserves:Beginning of year
    
    
    506,212
    
    
    
    475,080
    
    
    
    487,867
    
    
    
    6,933
    
    
    
    3,535
    
    
    
    4,073End of year
    
    
    446,109
    
    
    
    506,212
    
    
    
    475,080
    
    
    
    3,589
    
    
    
    6,933
    
    
    
    3,535
 Natural Gas Equivalents (MMcfe)2006
    
    
    2005
    
    
    2004Beginning of year reserves
    
    
    860,820
    
    
    
    793,124
    
    
    
    754,769Revisions of previous estimates
    
    
    (30,971
    )
    
    
    (59,623
    )
    
    
    (19,892
    )Extensions and discoveries
    
    
    159,860
    
    
    
    143,706
    
    
    
    164,249Production
    
    
    (88,156
    )
    
    
    (114,311
    )
    
    
    (123,985
    )Purchase of reserves in place
    
    
    32,201
    
    
    
    99,704
    
    
    
    81,276Sales of reserves in place
    
    
    (234,428
    )
    
    
    (1,780
    )
    
    
    (63,293
    )End of year reserves
    
    
    699,328
    
    
    
    860,820
    
    
    
    793,124Proved developed reserves:Beginning of year
    
    
    547,810
    
    
    
    496,290
    
    
    
    512,305End of year
    
    
    467,643
    
    
    
    547,810
    
    
    
    496,290
 F-41




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 NOTE 13 Quarterly Financial Information (Unaudited)
  1st Quarter
    
    
    2nd Quarter
    
    
    3rd Quarter
    
    
    4th Quarter2006(1)Total revenues(2)
    
    $
    177,604
    
    
    $
    145,914
    
    
    $
    131,337
    
    
    $
    76,742Total operating expenses(3)
    
    
    124,436
    
    
    
    93,353
    
    
    
    81,809
    
    
    
    105,151Income (loss) from operations
    
    
    53,168
    
    
    
    52,561
    
    
    
    49,528
    
    
    
    (28,409
    )Net income (loss)(4)
    
    
    29,772
    
    
    
    23,371
    
    
    
    34,003
    
    
    
    (19,363
    )Net income (loss)per share  basic(7)
    
    $
    1.03
    
    
    $
    0.82
    
    
    $
    1.22
    
    
    $
    (0.69
    )Net income (loss) per share  diluted(7)
    
    $
    1.02
    
    
    $
    0.81
    
    
    $
    1.22
    
    
    $
    (0.69
    )2005Total revenues(5)
    
    $
    165,720
    
    
    $
    175,817
    
    
    $
    125,413
    
    
    $
    154,593Total operating expenses(6)
    
    
    104,119
    
    
    
    106,117
    
    
    
    109,180
    
    
    
    117,391Income from operations
    
    
    61,601
    
    
    
    69,700
    
    
    
    16,233
    
    
    
    37,202Net income
    
    
    33,438
    
    
    
    43,830
    
    
    
    8,081
    
    
    
    19,820Net income per share  basic(7)
    
    $
    1.17
    
    
    $
    1.53
    
    
    $
    0.28
    
    
    $
    0.69Net income per share  diluted(7)
    
    $
    1.16
    
    
    $
    1.51
    
    
    $
    0.28
    
    
    $
    0.69
 
 (1)
    
    Operating results for 2006 reflect the sale of substantially all of our Gulf
of Mexico assets with completion of the sale of the Texas offshore assets on March 31, 2006
and the completion of the sale of the Louisiana offshore assets on June 1, 2006. In addition,
the fluctuations in total revenues each quarter reflect the loss of hedge accounting during
the first quarter of 2006 and the subsequent application of mark-to-market accounting for open
derivative contracts. The loss of hedge accounting was a result of market factors subsequent
to Hurricanes Katrina and Rita and the sale of the Gulf of Mexico assets.(2)
    
    For the fourth quarter of 2006, total revenues includes a net loss of $41.2 million
from hedging activities which includes the following items: (i) a $1.5 million loss realized
on contracts settled during the fourth quarter; (ii) an unrealized loss of $46.6 million for
the mark-to-market change in the fair value of open derivative contracts; and (iii) a $6.9
million unrealized gain for ineffective contracts.(3)
    
    For the fourth quarter of 2006, total operating expenses includes a writedown in the
carrying value of our natural gas and oil properties of $19.0 million ($12.3 million net of
tax) incurred due to the cumulative effect of higher finding and development costs during
recent years, combined with higher estimated future operating and development costs at
year-end 2006.(4)
    
    For the fourth quarter of 2006, the loss from operations and the net loss were
primarily due to realized natural gas prices that averaged $5.80 per Mcf; higher depreciation,
depletion and amortization expense caused by higher rates due to higher finding and
development costs and higher estimated future development costs; and a writedown in the
carrying value of our natural gas and oil properties of $19.0 million ($12.3 million net of
tax).(5)
    
    For the fourth quarter of 2005, total revenues includes a net loss of $116.5 million
from hedging activities which includes the following items: (i) a $164.5 million loss
realized on contracts settled during fourth quarter; (ii) a $20.6 million unrealized gain for
the deferral of losses on settled contracts that were deferred to accumulated other
comprehensive income due to an offshore production shortfall; and (iii) a $27.6 million
unrealized gain for ineffective contracts which includes $26.4 million due to loss of
correlation between the NYMEX price and the Houston Ship Channel index during the fourth
quarter of 2005.(6)
    
    For the fourth quarter of 2005, total operating expenses includes $4.0 million in
additional general and administrative expenses related to severance and other separation
related payments made to certain former employees, including our former Chief Financial
Officer.(7)
    
    Quarterly earnings per share is based on the weighted average number of shares outstanding during
the quarter. Because of changes in the number of shares outstanding during the quarters due to
the exercise of stock options and/or the issuance or repurchase of common stock, the sum of
quarterly earnings per share may not equal earnings per share for the year F-42




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##### Table of Contents



INDEX TO EXHIBITS
 2.1
    
    
    
    Agreement and Plan of Merger dated as of January 7, 2007 by
and among the Company, Forest Oil Corporation and MJCO
Corporation (filed as exhibit 2.1 to our Current Report on
Form 8-K dated January 7, 2007 (file No. 001-11899) and
incorporated by reference herein).3.1
    
    
    
    Restated Certificate of Incorporation, as amended, including
the Certificate of Amendment thereto dated April 26, 2005
(filed as exhibit 3.1 to our Quarterly Report on Form 10-Q
for the period ended March 31, 2005 (file No. 001-11899) and
incorporated by reference herein).3.2
    
    
    
    Restated Bylaws of The Houston Exploration Company (filed as
Exhibit 3.2 to our Annual Report on Form 10-K for the year
ended December 31, 2005 (File No.001-11899) and incorporated
by reference).4.1
    
    
    
    Indenture, dated as of June 10, 2003, between The Houston
Exploration Company and the Bank of New York, as Trustee,
with respect to the 7% Senior Subordinated Notes due 2013
(filed as Exhibit 4.2 to our Registration Statement on Form
S-4 (Registration No. 333-106836) and incorporated by
reference).4.2
    
    
    
    Rights Agreement, dated as of August 12, 2004, between The
Houston Exploration Company and The Bank of New York, as
Rights Agent (filed as Exhibit 4.1 to our Current Report on
Form 8-K dated August 13, 2004 (File No. 001-11899) and
incorporated by reference).4.3
    
    
    
    First Amendment dated as of May 2, 2005, to the Rights
Agreement dated as of August 12, 2004 between The Houston
Exploration Company and The Bank of New York, as Rights
Agent (filed as exhibit 4.1 to our Quarterly Report on Form
10-Q for the period ended March 31, 2005 (file No.
001-11899) and incorporated by reference herein).4.4
    
    
    
    Second Amendment to Rights Agreement dated as of January 7,
2007 between The Houston Exploration Company and The Bank of
New York, as Rights Agent (filed as exhibit 4.1 to our
Current Report on Form 8-K dated January 7, 2007 (file No.
001-11899) and incorporated by reference herein).4.5
    
    
    
    Form of Certificate of Designation of Series A Junior
Participating Preferred Stock of The Houston Exploration
Company (filed as Exhibit 4.2 to our Current Report on Form
8-K dated August 13, 2004 (File No. 001-11899) and
incorporated by reference).10.1
    
    
    
    Amended and Restated Credit Agreement dated November 30,
2005 among The Houston Exploration Company and Wachovia
Bank, National Association, as Issuing Bank and
Administrative Agent; The Bank of Nova Scotia and Bank of
America as Co-Syndication Agents; and BNP Paribas and
Comerica Bank as Co-Documentation Agents (filed as exhibit
99.1 to our Current Report on Form 8-K dated November 30,
2005 (File No. 001-11899) and incorporated by reference).10.2
    
    
    
    First Amendment to Amended and Restated Credit Agreement
effective May 31, 2006 among The Houston Exploration Company
and Wachovia Bank, National Association, as Issuing Bank and
Administrative Agent; The Bank of Nova Scotia and Bank of
America as Co-Syndication Agents; and BNP Paribas and
Comerica Bank as Co-Documentation Agents (filed as Exhibit
10.1 to our Quarterly Report on Form 10-Q for the period
ended June 30, 2006 (File No. 001-11899) and incorporated by
reference).




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##### Table of Contents



10.3
    
    
    
    Purchase and Sale Agreement, dated September 3, 2003, by and
among Transworld Exploration and Production, Inc., as
Seller, and The Houston Exploration Company, as Buyer (filed
as Exhibit 2.1 to our Current Report on Form 8-K dated
October 15, 2003 (file No. 001-11899) and incorporated by
reference).10.4
    
    
    
    Asset Contribution Agreement dated June 2, 2004 between The
Houston Exploration Company and Seneca-Upshur Petroleum,
Inc. (filed as Exhibit 99.3 to our Current Report on Form
8-K dated June 30, 2004 (File No. 001-11899) and
incorporated by reference).10.5
    
    
    
    Tax Matters Agreement dated as of June 2, 2004 by and among
The Houston Exploration Company, Seneca-Upshur Petroleum,
Inc., THEC Holdings Corp., and KeySpan Corporation (filed as
Exhibit 99.4 to our Current Report on Form 8-K dated June 30, 2004 (File No. 001-11899) and
incorporated by reference).10.6
    
    
    
    Distribution Agreement dated as of June 2, 2004 by and among The Houston Exploration
Company, Seneca-Upshur Petroleum, Inc., THEC Holdings Corp. and KeySpan Corporation (filed
as Exhibit 99.2 to our Current Report on Form 8-K dated June 30, 2004 (File No. 001-11899)
and incorporated by reference).10.7
    
    
    
    Purchase and Sale Agreement, dated September 17, 2004, between The Houston Exploration
Company and Orca Energy, L.P. (filed as Exhibit 2.1 to our Current Report on Form 8-K dated
November 1, 2004 (File No. 001-11899) and incorporated by reference).10.8
    
    
    
    Purchase and Sale Agreement dated October 21, 2005 by and between Kerr-McGee Oil & Gas
Onshore LP D/B/A KMOG Onshore LP and Westport Oil and Gas Company, L.P., as sellers, and The
Houston Exploration Company, as buyer, (filed as exhibit 99.2 to our Current Report on Form
8-K dated November 30, 2005 (File No. 001-11899) and incorporated by reference).10.9
    
    
    
    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 (filed as Exhibit 10.1 to our Quarterly Report on Form 10-Q for the period ended
March 31, 2006 (File No. 001-11899) and incorporated by reference).10.10
    
    
    
    Purchase and Sale Agreement dated April 7, 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 (filed as Exhibit 99.1 to our Current Report on Form 8-K dated June 2, 2006 (File
No. 001-11899) and incorporated by reference).
 10.11(2)
    
    
    
    Deferred Compensation Plan for Non-Employee Directors (filed as Exhibit 10.24 to our Annual
Report on Form 10-K for the year ended December 31, 1997 (File No. 001-11899) and
incorporated by reference).10.12(2)
    
    
    
    Amendment dated April 26, 2005, but effective as of December 31, 2004, to The Houston
Exploration Company Non-Employee Director Deferred Compensation Plan (filed as Exhibit 10.4
to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and incorporated
by reference).




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##### Table of Contents



10.13(2)
    
    
    
    The Houston Exploration Company Post-2004, AJCA Compliant Deferred Compensation Plan for
Non-Employee Directors dated April 26, 2005, effective as of January 1, 2005 (filed as
Exhibit 10.5 to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and
incorporated by reference).10.14(2)
    
    
    
    Compensation Table for Non-Employee Directors, effective January 1, 2006 (filed as exhibit 99.2 to our Current Report on Form 8-K dated January 6, 2006.10.15(2)
    
    
    
    Amended and Restated 1996 Stock Option Plan (filed as Exhibit 10.1 to our Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998 (File No. 001-11899) and incorporated by
reference).10.16(2)
    
    
    
    1999 Non-Qualified Stock Option Plan dated October 26, 1999 (filed as Exhibit 10.24 to our
Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 001-11899) and
incorporated by reference).10.17(2)
    
    
    
    Amended and Restated 2002 Long-Term Incentive Plan effective May 17, 2002, adopted October
26, 2003 (filed as Exhibit 10.31 to our Annual Report on Form 10-K for the year ended
December 31, 2003 (file No. 001-11899) and incorporated by reference).10.18(2)
    
    
    
    Amended and Restated 2004 Long Term Incentive Plan (filed as exhibit 99.1 to our Current
Report on Form 8-K dated January 31, 2006 (File No. 001-11899) and incorporated by
reference).10.19(2)
    
    
    
    Supplemental Executive Pension Plan dated May 1, 1996 (filed as exhibit 10.23 to our
Registration Statement on Form S-1/A (Amendment No. 2) (Registration No. 333-4437) and
incorporated by reference).10.20(2)
    
    
    
    The Houston Exploration Company Supplemental Executive Retirement Plan (Amended and Restated
on July 25, 2006) (filed as Exhibit 10.1 to our Current Report on Form 8-K dated July 31,
2006 (File No. 001-11899) and incorporated by reference).10.21(2)
    
    
    
    First Amendment to The Houston Exploration Company Supplemental Executive Retirement Plan
(filed as exhibit 10.3 to our Current Report on Form 8-K dated January 7, 2007 (file No.
001-11899) and incorporated by reference herein).10.22(2)
    
    
    
    Executive Deferred Compensation Plan dated January 1, 2002 (filed as Exhibit 10.28 to our
Annual Report on Form 10-K for the year ended December 31, 2002 (File No. 001-11899) and
incorporated by reference).10.23(2)
    
    
    
    Amendment [No. 1] to The Houston Exploration Company Executive Deferred Compensation Plan
(filed as exhibit 99.2 to our Current Report on Form 8-K dated January 31, 2006 (File No.
001-11899) and incorporated by reference).10.24(2)
    
    
    
    Amendment No. 2 dated July 25, 2006, but effective as of December 31, 2004, to The Houston
Exploration Company Executive Deferred Compensation Plan (filed as Exhibit 10.2 to our
Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and incorporated by
reference).10.25(2)
    
    
    
    The Houston Exploration Company 2005 Executive Deferred Compensation Plan (filed as Exhibit
10.3 to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and
incorporated by reference).10.26(2)
    
    
    
    Amended and Restated Employment Agreement dated February 8, 2005 between The Houston
Exploration Company and William G. Hargett (filed as Exhibit 10.1 to our




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##### Table of Contents



Current Report on
Form 8-K dated February 8, 2005 (File No. 001-11899) and incorporated by reference).10.27(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and William G. Hargett (filed
as Exhibit 10.1 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.38(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and Steven
L. Mueller dated February 8, 2005 (filed as Exhibit 10.19 to our Annual Report on Form 10-K
for the year ended December 31, 2004 (File No. 001-11899) and incorporated by reference).10.29(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and Steven L. Mueller (filed
as Exhibit 10.2 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.30(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and John
H. Karnes dated February 8, 2005 (filed as Exhibit 10.20 to our Annual Report on Form 10-K
for the year ended December 31, 2004 (File No. 001-11899) and incorporated by reference).10.31(2)
    
    
    
    Separation Agreement and General Release dated December 8, 2005 between The Houston
Exploration Company and John H. Karnes (filed as exhibit 99.1 to our Current Report on Form
8-K dated December 12, 2005 (File No. 001-11899) and incorporated by reference).10.32(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and James
F. Westmoreland dated February 8, 2005 (filed as Exhibit 10.21 to our Annual Report on Form
10-K for the year ended December 31, 2004 (File No. 001-11899) and incorporated by
reference).10.33(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and James F. Westmoreland
(filed as Exhibit 10.7 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.34(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and Roger
B. Rice dated February 8, 2005 (filed as Exhibit 10.22 to our Annual Report on Form 10-K for
the year ended December 31, 2004 (File No. 001-11899) and incorporated by reference).10.35(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and Roger B. Rice (filed as
Exhibit 10.5 to our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899)
and incorporated by reference).10.36(2)
    
    
    
    Employment Agreement dated February 10, 2005 between The Houston Exploration Company and
Joanne C. Hresko (filed as Exhibit 10.3 to our Current Report on Form 8-K dated February 8,
2005 (File No. 001-11899) and incorporated by reference).10.37(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated February 10,
2005, between The Houston Exploration Company and Joanne C. Hresko (filed as Exhibit 10.8 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated
by reference).




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##### Table of Contents



10.38(2)
    
    
    
    Employment Agreement effective March 10, 2005, between The Houston Exploration Company and
John E. Bergeron, Jr. (filed as exhibit 99.2 to our Current Report on Form 8-K dated March
10, 2005 (File No. 001-11899) and incorporated by reference).10.39(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated March 10, 2005,
between The Houston Exploration Company and John E. Bergeron, Jr. (filed as Exhibit 10.9 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated
by reference).10.40(2)
    
    
    
    Employment Agreement effective April 13, 2005, between The Houston Exploration Company and
Jeffrey B. Sherrick (filed as exhibit 99.2 to our Current Report on Form 8-K dated April 13,
2005 (File No. 001-11899) and incorporated by reference).10.41(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated April 13, 2005,
between The Houston Exploration Company and Jeffrey B. Sherrick (filed as Exhibit 10.6 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated
by reference).10.42(2)
    
    
    
    Employment Agreement dated January 18, 2006 between The Houston Exploration Company and
Robert T. Ray (filed as exhibit 99.1 to our Current Report on Form 8-K dated January 18,
2006 (File No. 001-11899) and incorporated by reference).10.43(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated January 18, 2006,
between The Houston Exploration Company and Robert T. Ray (filed as Exhibit 10.3 to our
Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated by
reference).10.44(2)
    
    
    
    Employment Agreement dated March 27, 2006 between The Houston Exploration Company and
Carolyn M. Campbell (filed as Exhibit 99.1 to our Current Report on Form 8-K dated March 27,
2006 (File No. 001-11899) and incorporated by reference).10.45(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated March 27, 2006,
between The Houston Exploration Company and Carolyn M. Campbell (filed as Exhibit 10.4 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and incorporated
by reference).10.46
    
    
    
    Form of Amendment No. 2 to [Amended and Restated] Employment Agreement entered into by and
between The Houston Exploration Company and each of William G. Hargett, Steven L. Mueller,
James F. Westmoreland, Roger B. Rice, Joanne C. Hresko, John E. Bergeron Jr., Jeffrey B.
Sherrick, Robert T. Ray and Carolyn M. Campbell (filed as Exhibit 10.1 to our Current Report
on Form 8-K dated January 7, 2007 (file No. 001-11899) and incorporated by reference
herein).10.47(2)
    
    
    
    Change of Control Plan dated October 26, 1999 (filed as Exhibit 10.25 to our Annual Report
on Form 10-K for the year ended December 31, 1999 (File No. 001-11899) and incorporated by
reference).10.48(1)(2)
    
    
    
    First Amendment to The Houston Exploration Company Change of Control Plan dated May 17, 2002.10.49(2)
    
    
    
    Second Amendment to The Houston Exploration Company Change of Control Plan (filed as exhibit
10.4 to our Current Report on Form 8-K dated January 7, 2007 (file No. 001-11899) and
incorporated by reference herein).




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##### Table of Contents



10.50(2)
    
    
    
    Form of Indemnification Agreement for Directors and Executive Officers (filed as Exhibit
10.8 to our Quarterly Report on Form 10-Q for the period ended June 30, 2006 (File No.
001-11899) and incorporated by reference).10.51(2)
    
    
    
    Form of Non-Qualified Stock Option Agreement (filed as Exhibit 10.9 to our Quarterly Report
on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and incorporated by
reference).10.52(2)
    
    
    
    Form of Director Restricted Stock Award Agreement (filed as Exhibit 10.10 to our Quarterly
Report on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and incorporated
by reference).10.53(2)
    
    
    
    Form of Employee Restricted Stock Award Agreement (filed as Exhibit 10.11 to our Quarterly
Report on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and incorporated
by reference).12.1(1)
    
    
    
    Computation of ratio of earnings to fixed charges.21.1(1)
    
    
    
    Subsidiaries of The Houston Exploration Company.23.1(1)
    
    
    
    Consent of Deloitte & Touche LLP.23.2(1)
    
    
    
    Consent of Netherland, Sewell & Associates.23.3(1)
    
    
    
    Consent of Miller and Lents.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)
    
    Management contract or compensation plan.