##### 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, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For
the transition period
from
to
 Commission File No. 001-11899
 THE HOUSTON EXPLORATION COMPANY
 (Exact name of registrant as specified in its charter)
 Delaware
    
    22-2674487(State or Other Jurisdiction of
    
    (IRS EmployerIncorporation or Organization)
    
    Identification No.)1100 Louisiana, Suite 2000Houston, Texas
    
    77002-5215(Address of Principal Executive Offices)
    
    (Zip Code)
 (713) 830-6800
(Registrants Telephone Number, including Area Code)
 Securities Registered Pursuant to Section 12(b) of the Act:
 Name of EachTitle of Each Class
    
    Exchange on Which RegisteredCommon Stock, $.01 par value
    
    New York Stock Exchange7% Senior Subordinated Notes due 2013
 Securities Registered Pursuant to Section 12(g) of the Act: None
 þ o
 o þ
 þ o
 o þ
 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
    
    
    15Item 1B. Unresolved Staff Comments
    
    
    21Item 3. Legal Proceedings
    
    
    21Item 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
    
    
    23Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    25Item 7A. Quantitative and Qualitative Disclosures About Market Risk
    
    
    40Item 8. Financial Statements and Supplemental Data
    
    
    42Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
    
    
    42Item 9A. Controls and Procedures
    
    
    43Item 9B. Other Information
    
    
    43Part III.
    
    
    43Item 10. Directors and Executive Officers of the Registrant
    
    
    43Item 11. Executive Compensation
    
    
    43Item 12. Security Ownership of Beneficial Owners and Management
    
    
    43Item 13. Certain Relationships and Related Transactions
    
    
    43Item 14. Principal Accounting Fees and Services
    
    
    44Part IV.
    
    
    44Item 15. Exhibits, Financial Statement Schedules
    
    
    44Signatures
    
    
    45Glossary of Natural Gas and Oil Terms
    
    
    G-1Index to Financial Statements
    
    
    F-1Restated BylawsComputation of ratio of earnings to fixed chargesSubsidiariesConsent of Deloitte & Touche LLPConsent of Netherland, Sewell & AssociatesConsent of Miller and LentsCertification of William G. Hargett pursuant to Section 302Certification of Robert T. Ray pursuant to Section 302Certification of William G. Hargett pursuant to Section 906Certification of Robert T. Ray pursuant to Section 906
 -1-




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Forward-Looking Statements
  Available Information
 http://www.houstonexploration.com
 www.houstonexploration.com www.houstonexploration.com
 
     -2-




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




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##### Table of Contents



Business Strategy
  §
    
    Balanced Growth.We pursue a balanced strategy of exploiting our existing
reserves, exploring for new reserves and acquiring new properties. Typically, at least 70%
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.§
    
    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, 2005, approximately 92% of our proved reserves were natural gas and, for the
year ended December 31, 2005, approximately 93% 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 allowing a higher cash margin. While we
believe that the pricing fundamentals for natural gas will remain strong for the foreseeable
future, we have explored and may continue to explore opportunities to balance our asset
portfolio with additional oil properties. Such activities depend on the relative pricing
outlook for both natural gas and oil, acquisition opportunities, and operational
considerations, including our objectives of shifting operations onshore, lowering finding
and development costs, and lengthening reserve life.§
    
    Concentrate on Core Areas.We focus our drilling activities on properties in
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, 2005, approximately 89% of our reserves were located
in three core areas: South Texas, the Gulf of Mexico and the Arkoma Basin. Upon completion
of the pending sale of the Texas portion of our Gulf of Mexico assets, South Texas and
the Arkoma Basin will comprise approximately 47% and 19%, respectively, of our reserves. In
addition, through our current activities in both the Rocky Mountains and East Texas, either
one or both of these regions could develop into a core area in the future. Further, we plan
to seek opportunities in one or more new areas where we believe we can utilize the strengths
of our existing workforce to sustain future growth.§
    
    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, 2005, we operated approximately
80% of our wells and our average working interest was approximately 73%.§
    
    Focus on Low 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. Although we expect our costs will increase in 2006, we
believe that our operating structure provides us a significant competitive advantage because
it maximizes our margins and cash flows. For 2005, our lease operating expense was $0.59
per Mcfe.§
    
    Employ Conservative Financial Policies.We typically fund 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, and may increase from time to time in the future as we continue to make
acquisitions, we will seek to maintain conservative debt levels. Among other things, this
will provide us with flexibility to continually review and adjust our capital expenditure
program during the year based on operational developments, commodity prices, service costs,
acquisition opportunities and numerous other factors. In addition to bank borrowings and
public debt, we may also issue common stock in connection with future acquisitions, either
initially as an element of the transaction consideration or subsequently as part of a
financing plan.§
    
    Managing Commodity Price Risks.We have historically employed a hedging program
intended to reduce our exposure to adverse commodity price fluctuations and provide more
predictable cash flows that allow us to plan and fund our capital expenditure program.
While the use of derivative instruments has prevented us from realizing the full benefit of
upward price movements and may continue to do so in the future, we believe that price
volatility is likely to continue and that we can use this volatility to our benefit by
taking advantage of prices when they reach levels we believe lock in targeted rates of
return on our invested capital.
 -4-




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##### Table of Contents



Properties and Operating Areas
  Activity and Balances as of or for the Year Ended December 31, 2005Average
    
    
    
    
    
    Total
    
    PercentageDaily
    
    Total
    
    Proved
    
    Total ProvedProduction
    
    Production
    
    Reserves
    
    ReservesWells DrilledArea
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    Successful(MMcfe/d)
    
    (MMcfe)
    
    (MMcfe)
    
    
    
    
    
    (Gross)
    
    (Gross)South Texas
    
    
    134
    
    
    
    48,983
    
    
    
    374,163
    
    
    
    44
    %
    
    
    95
    
    
    
    82Arkoma Basin
    
    
    43
    
    
    
    15,789
    
    
    
    151,054
    
    
    
    18
    %
    
    
    61
    
    
    
    60East Texas
    
    
    5
    
    
    
    1,812
    
    
    
    61,308
    
    
    
    7
    %
    
    
    16
    
    
    
    16Rocky Mountains
    
    
    5
    
    
    
    1,665
    
    
    
    26,713
    
    
    
    3
    %
    
    
    149
    
    
    
    128Other
    
    
    1
    
    
    
    372
    
    
    
    2,986
    
    
    
    
    
    
    
    
    
    
    
    Total onshore
    
    
    188
    
    
    
    68,621
    
    
    
    616,224
    
    
    
    72
    %
    
    
    321
    
    
    
    286Gulf of Mexico
    
    
    125
    
    
    
    45,690
    
    
    
    244,596
    
    
    
    28
    %
    
    
    15
    
    
    
    12Total
    
    
    313
    
    
    
    114,311
    
    
    
    860,820
    
    
    
    100
    %
    
    
    336
    
    
    
    298
 South Texas.
  Gulf of Mexico.
   -5-




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##### Table of Contents



Arkoma Basin.
 East Texas
 Rocky Mountains.
   Other.
 -6-




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##### Table of Contents



Natural Gas and Oil Reserves
  As of December 31,Net Proved Reserves:
    
    2005(1)
    
    2004
    
    2003(in thousands)Natural gas (MMcf)
    
    
    793,074
    
    
    
    749,114
    
    
    
    709,883Oil and natural gas liquids (MBbls)
    
    
    11,291
    
    
    
    7,335
    
    
    
    7,481Total (MMcfe)
    
    
    860,820
    
    
    
    793,124
    
    
    
    754,769Standardized measure of discounted future net cash flows (2)
    
    $
    1,967,024
    
    
    $
    1,440,055
    
    
    $
    1,504,406
 
 (1)
    
    At December 31, 2005, net proved reserves attributable to our Gulf of Mexico
assets totaled 244,596 MMcfe and included 196,488 MMcf of natural gas and 8,018 MBbls of
oil and natural gas liquids. The pending sale of the Texas portion of our Gulf of Mexico
assets represents approximately 58,463 MMcfe and includes 54,728 MMcf of natural gas and
622.5 MBbls of oil and natural gas liquids.(2)
    
    The standardized measure of discounted future net cash flows has been calculated
in accordance with SFAS 69, Disclosures About Oil and Gas Producing Activities (see 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 hedging program. Year-end prices per Mcf
of natural gas used in making the standardized measure determinations as of December 31, 2005,
2004 and 2003 were $8.15, $5.68 and $5.79, respectively. Year-end prices per Bbl of oil
used in making the standardized measure determinations as of December 31, 2005, 2004 and
2003 were $53.27, $41.67 and $30.27, respectively.  Estimates of proved reserves and future net revenues
may change if the assumptions on which such estimates are based prove to be inaccurate.
 -7-




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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
    
    
    Net2005South 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 areas 2005
    
    
    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 areas 2004
    
    
    29
    
    
    
    26.8
    
    
    
    9
    
    
    
    6.0
    
    
    
    148
    
    
    
    116.7
    
    
    
    25
    
    
    
    21.0
    
    
    
    177
    
    
    
    143.5
    
    
    
    34
    
    
    
    27.0
    
    
    
    211
    
    
    
    170.52003South Texas
    
    
    3
    
    
    
    3.0
    
    
    
    3
    
    
    
    3.0
    
    
    
    53
    
    
    
    51.3
    
    
    
    18
    
    
    
    17.5
    
    
    
    56
    
    
    
    54.3
    
    
    
    21
    
    
    
    20.5
    
    
    
    77
    
    
    
    74.8Arkoma Basin
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    0.4
    
    
    
    46
    
    
    
    28.6
    
    
    
    4
    
    
    
    2.5
    
    
    
    46
    
    
    
    28.6
    
    
    
    5
    
    
    
    2.9
    
    
    
    51
    
    
    
    31.5Other onshore
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    2.0
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    2.0
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    2.0Gulf of Mexico
    
    
    6
    
    
    
    2.4
    
    
    
    8
    
    
    
    3.6
    
    
    
    3
    
    
    
    2.0
    
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    4.4
    
    
    
    8
    
    
    
    3.6
    
    
    
    17
    
    
    
    8.0Total areas 2003
    
    
    9
    
    
    
    5.4
    
    
    
    12
    
    
    
    7.0
    
    
    
    104
    
    
    
    83.9
    
    
    
    22
    
    
    
    20.0
    
    
    
    113
    
    
    
    89.3
    
    
    
    34
    
    
    
    27.0
    
    
    
    147
    
    
    
    116.3
  Productive Wells
  As of December 31, 2005Natural Gas Wells
    
    
    Oil Wells
    
    
    Total WellsOperated
    
    
    Non-Operated
    
    
    Operated
    
    
    Non-OperatedGross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    NetSouth Texas
    
    
    743
    
    
    
    707.8
    
    
    
    108
    
    
    
    14.9
    
    
    
    21
    
    
    
    12.4
    
    
    
    
    
    
    
    
    
    
    
    872
    
    
    
    735.1Arkoma Basin
    
    
    289
    
    
    
    197.1
    
    
    
    122
    
    
    
    26.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    411
    
    
    
    223.2East Texas
    
    
    48
    
    
    
    38.7
    
    
    
    1
    
    
    
    0.4
    
    
    
    3
    
    
    
    2.2
    
    
    
    
    
    
    
    
    
    
    
    52
    
    
    
    41.3Rocky Mountains
    
    
    117
    
    
    
    96.2
    
    
    
    42
    
    
    
    21.0
    
    
    
    2
    
    
    
    1.0
    
    
    
    
    
    
    
    
    
    
    
    161
    
    
    
    118.2Other
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    1.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2
    
    
    
    1.1Total onshore
    
    
    1,197
    
    
    
    1,039.8
    
    
    
    275
    
    
    
    63.5
    
    
    
    26
    
    
    
    15.6
    
    
    
    
    
    
    
    
    
    
    
    1,498
    
    
    
    1,118.9Gulf of Mexico
    
    
    91
    
    
    
    71.9
    
    
    
    54
    
    
    
    15.4
    
    
    
    18
    
    
    
    14.1
    
    
    
    6
    
    
    
    0.9
    
    
    
    169
    
    
    
    102.3Total
    
    
    1,288
    
    
    
    1,111.7
    
    
    
    329
    
    
    
    78.9
    
    
    
    44
    
    
    
    29.7
    
    
    
    6
    
    
    
    0.9
    
    
    
    1,667
    
    
    
    1,221.2
 -8-




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##### Table of Contents



Acreage Data
  As of December 31, 2005Undeveloped
    
    
    Developed
    
    
    Total AcreageGross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    NetSouth Texas
    
    
    14,606
    
    
    
    12,978
    
    
    
    107,299
    
    
    
    81,672
    
    
    
    121,905
    
    
    
    94,650Arkoma Basin
    
    
    25,624
    
    
    
    8,857
    
    
    
    59,707
    
    
    
    28,322
    
    
    
    85,331
    
    
    
    37,179East Texas
    
    
    5,547
    
    
    
    3,488
    
    
    
    10,746
    
    
    
    6,670
    
    
    
    16,293
    
    
    
    10,158Rocky Mountains
    
    
    703,196
    
    
    
    543,380
    
    
    
    41,943
    
    
    
    22,937
    
    
    
    745,139
    
    
    
    566,317Other onshore
    
    
    
    
    
    
    
    
    
    
    1,740
    
    
    
    620
    
    
    
    1,740
    
    
    
    620Total onshore
    
    
    748,973
    
    
    
    568,703
    
    
    
    221,435
    
    
    
    140,221
    
    
    
    970,408
    
    
    
    708,924Gulf of Mexico
    
    
    227,062
    
    
    
    159,521
    
    
    
    314,886
    
    
    
    200,926
    
    
    
    541,948
    
    
    
    360,447Total
    
    
    976,035
    
    
    
    728,224
    
    
    
    536,321
    
    
    
    341,147
    
    
    
    1,512,356
    
    
    
    1,069,371
 Undeveloped Acreage Expirations
  As of December 31, 20052006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    Net
    
    
    Gross
    
    
    NetSouth Texas
    
    
    3,686
    
    
    
    3,064
    
    
    
    5,399
    
    
    
    5,240
    
    
    
    1,111
    
    
    
    1,076
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Arkoma Basin
    
    
    
    
    
    
    
    
    
    
    2,816
    
    
    
    932
    
    
    
    
    
    
    
    
    
    
    
    614
    
    
    
    238
    
    
    
    4,088
    
    
    
    1,154East Texas
    
    
    
    
    
    
    
    
    
    
    3,592
    
    
    
    2,734
    
    
    
    60
    
    
    
    40
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Rocky Mountains
    
    
    193,559
    
    
    
    129,257
    
    
    
    110,287
    
    
    
    84,391
    
    
    
    150,362
    
    
    
    120,943
    
    
    
    35,399
    
    
    
    27,213
    
    
    
    16,171
    
    
    
    5,713Total onshore
    
    
    197,245
    
    
    
    132,321
    
    
    
    122,094
    
    
    
    93,297
    
    
    
    151,533
    
    
    
    122,059
    
    
    
    36,013
    
    
    
    27,451
    
    
    
    20,259
    
    
    
    6,867Gulf of Mexico
    
    
    32,257
    
    
    
    24,897
    
    
    
    46,181
    
    
    
    37,921
    
    
    
    62,824
    
    
    
    34,756
    
    
    
    42,280
    
    
    
    26,324
    
    
    
    15,000
    
    
    
    12,500Total
    
    
    229,502
    
    
    
    157,218
    
    
    
    168,275
    
    
    
    131,218
    
    
    
    214,357
    
    
    
    156,815
    
    
    
    78,293
    
    
    
    53,775
    
    
    
    35,259
    
    
    
    19,367
 Marketing and Customers
    -9-




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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
  Employees
  Offices
 th
 Regulation
  -10-




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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.
    Natural Gas Sales and Transportation.
  -11-




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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
 Federal Clean Air Act
 -13-




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-14-




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Item 1A Risk Factors
 The volatility of natural gas and oil prices may affect our financial results.
   §
    
    the domestic and foreign supply of natural gas and oil;§
    
    weather conditions;§
    
    the price of foreign imports;§
    
    overall domestic and global economic conditions;§
    
    terrorist attacks or military conflicts;§
    
    political and economic conditions in oil producing countries;§
    
    the ability of members of the Organization of Petroleum Exporting Countries to
agree to and maintain oil price and production controls;§
    
    the level of 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 sell assets and replace revenues generated from any sale of our Gulf of Mexico properties depends
upon market conditions and numerous uncertainties.
  Our level of indebtedness may limit our financial flexibility.
   §
    
    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
 -15-




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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 onshore assets because these
assets have been mortgaged to secure borrowings under our revolving bank credit facility;§
    
    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 writedowns if natural gas and oil prices decline.
   Lower natural gas and oil prices could negatively impact our ability to borrow.
  Our hedging activities have resulted in financial losses and reduced our income and may continue to
do so in the future.
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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.
  -17-




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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;
 -18-




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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.
  -19-




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Our acquisition and investment activities may be unsuccessful and costly.
  Our ability to maximize tax efficiencies with tax free asset exchange transactions following the
pending sale of our Gulf of Mexico assets is uncertain.
  Our investments in the Rocky Mountains may not be successful.
  We may incur substantial costs to comply with costly and stringent environmental and other
governmental laws and regulations.
   -20-




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We face strong competition.
  The inability of one or more of our customers to meet its obligations may adversely affect our
financial results.
  Provisions in our Charter, Agreements, Stockholder Rights Plan and Delaware Law May Inhibit a
Takeover of Houston Exploration.
  
 Item 1B. Unresolved Staff Comments
  Item 2. Properties (see Item 1. Business and Properties)
 
 Item 3. Legal Proceedings
  -21-




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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, 2005
    
    High
    
    LowFirst Quarter
    
    $
    62.29
    
    
    $
    51.14Second Quarter
    
    
    59.40
    
    
    
    45.60Third Quarter
    
    
    71.47
    
    
    
    53.30Fourth Quarter
    
    
    67.83
    
    
    
    49.86
 Year Ended December 31, 2004
    
    High
    
    LowFirst Quarter
    
    $
    45.85
    
    
    $
    35.79Second Quarter
    
    
    52.47
    
    
    
    41.40Third Quarter
    
    
    59.79
    
    
    
    48.30Fourth Quarter
    
    
    61.80
    
    
    
    53.65
  Dividends
  -22-




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##### Table of Contents



Item 6. Selected Financial Data
  Years Ended December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001(in thousands, except per share data)Income Statement Data:Revenues:Natural gas and oil revenues
    
    $
    620,271
    
    
    $
    649,087
    
    
    $
    491,440
    
    
    $
    344,295
    
    
    $
    387,156Other
    
    
    1,272
    
    
    
    1,352
    
    
    
    1,312
    
    
    
    1,086
    
    
    
    1,353Total revenues
    
    
    621,543
    
    
    
    650,439
    
    
    
    492,752
    
    
    
    345,381
    
    
    
    388,509Expenses:Lease operating expense
    
    
    67,796
    
    
    
    55,925
    
    
    
    47,072
    
    
    
    33,976
    
    
    
    25,291Severance tax
    
    
    18,121
    
    
    
    11,933
    
    
    
    15,958
    
    
    
    9,487
    
    
    
    11,035Transportation expense
    
    
    11,883
    
    
    
    11,819
    
    
    
    10,387
    
    
    
    9,317
    
    
    
    7,652Asset retirement accretion expense(1)
    
    
    5,278
    
    
    
    4,902
    
    
    
    3,668
    
    
    
    
    
    
    
    Depreciation, depletion and amortization
    
    
    295,351
    
    
    
    265,148
    
    
    
    197,530
    
    
    
    171,610
    
    
    
    128,736Writedown in carrying value
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,170General and administrative, net
    
    
    38,378
    
    
    
    32,899
    
    
    
    19,542
    
    
    
    13,077
    
    
    
    17,110Total operating expenses
    
    
    436,807
    
    
    
    382,626
    
    
    
    294,157
    
    
    
    237,467
    
    
    
    195,994Income from operations
    
    
    184,736
    
    
    
    267,813
    
    
    
    198,595
    
    
    
    107,914
    
    
    
    192,515Other (income) expense (2)
    
    
    142
    
    
    
    (1,058
    )
    
    
    (15,746
    )
    
    
    (9,070
    )
    
    
    119Interest expense, net
    
    
    16,535
    
    
    
    9,455
    
    
    
    8,342
    
    
    
    7,398
    
    
    
    2,992Income before income taxes
    
    
    168,059
    
    
    
    259,416
    
    
    
    205,999
    
    
    
    109,586
    
    
    
    189,404Income tax provision
    
    
    62,890
    
    
    
    96,592
    
    
    
    72,187
    
    
    
    39,092
    
    
    
    66,803Income before cumulative effect of change in
accounting principle
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    133,812
    
    
    $
    70,494
    
    
    $
    122,601Cumulative effect of change in accounting
principle (3)
    
    
    
    
    
    
    
    
    
    
    (2,772
    )
    
    
    
    
    
    
    Net income
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    131,040
    
    
    $
    70,494
    
    
    $
    122,601Earnings per share:Basic:Income per share before cumulative effect of
change in accounting principle change
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.30
    
    
    $
    2.31
    
    
    $
    4.06Cumulative effect of change in accounting
principle (3)
    
    
    
    
    
    
    
    
    
    
    (0.09
    )
    
    
    
    
    
    
    Net income per share  basic
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.21
    
    
    $
    2.31
    
    
    $
    4.06Diluted:Income per share before cumulative effect of
change in accounting principle
    
    $
    3.62
    
    
    $
    5.44
    
    
    $
    4.29
    
    
    $
    2.28
    
    
    $
    4.00Cumulative effect of change in accounting
principle (3)
    
    
    
    
    
    
    
    
    
    
    (0.09
    )
    
    
    
    
    
    
    Net income per share  diluted
    
    $
    3.62
    
    
    $
    5.44
    
    
    $
    4.20
    
    
    $
    2.28
    
    
    $
    4.00Weighted average shares  basic
    
    
    28,707
    
    
    
    29,616
    
    
    
    31,097
    
    
    
    30,569
    
    
    
    30,228Weighted average shares  diluted
    
    
    29,037
    
    
    
    29,932
    
    
    
    31,213
    
    
    
    30,878
    
    
    
    30,645Ratio of earnings to fixed charges(4)
    
    
    7.2
    x
    
    
    15.0
    x
    
    
    13.6
    x
    
    
    7.6
    x
    
    
    12.8
    x
 -23-




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##### Table of Contents



Years Ended December 31,2005
    
    2004
    
    2003
    
    2002
    
    2001(in thousands)Cash Flow Data:Net cash provided by operating activities
    
    $
    460,509
    
    
    $
    527,141
    
    
    $
    381,969
    
    
    $
    243,601
    
    
    $
    355,311Net cash used in investing activities
    
    
    727,003
    
    
    
    509,922
    
    
    
    452,959
    
    
    
    252,857
    
    
    
    365,556Net cash provided by (used in)financing
activities
    
    
    255,896
    
    
    
    (1,211
    )
    
    
    55,528
    
    
    
    17,668
    
    
    
    9,189
 At December 31,2005
    
    2004
    
    2003
    
    2002
    
    2001(in thousands)Balance Sheet Data:Working capital (deficit)(5)
    
    $
    (214,525
    )
    
    $
    (31,884
    )
    
    $
    (36
    )
    
    $
    10,550
    
    
    $
    34,314Property, plant and equipment, net
    
    
    2,018,340
    
    
    
    1,548,256
    
    
    
    1,371,129
    
    
    
    1,022,414
    
    
    
    938,761Total assets
    
    
    2,361,624
    
    
    
    1,722,577
    
    
    
    1,509,065
    
    
    
    1,151,068
    
    
    
    1,059,092Long-term debt and notes
    
    
    597,000
    
    
    
    355,000
    
    
    
    302,000
    
    
    
    252,000
    
    
    
    244,000Stockholders equity
    
    
    693,138
    
    
    
    782,920
    
    
    
    735,534
    
    
    
    592,789
    
    
    
    565,881
 
 (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 2005, 2004, 2003 and 2002, other income includes $2.7 million, $1.2
million, $21.6 million and $9.1 million, respectively, representing recoupments of prior
period 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. See
Note 9  Commitments and Contingencies. In addition, for 2005, other income and expense
includes 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 includes $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 includes $5.9 million in expenses incurred
pursuant to the early redemption of our $100 million
85/8% notes in June 2003. For 2001, other
expense of $0.2 million, represents nonrecurring expenses incurred in connection with a
strategic review of alternatives for KeySpans investment in our company, including the
possible sale of all or a portion of Houston Exploration.(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 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
for calculation.(5)
    
    The working capital deficit during at December 31, 2005, 2004 and 2003, was
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. -24-




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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
      Shift
in Operating Focus and Pending Sale of the Texas Portion of Our Gulf of Mexico Assets
   -25-




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Recent Acquisition
  Industry Outlook
    -26-




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##### Table of Contents



Critical Accounting Estimates
  Proved Reserves
 Unevaluated Properties
 -27-




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##### Table of Contents



Asset Retirement Obligations.
 Derivative Instruments.
 Taxes.
 Stock Compensation Expense.
  New Accounting Pronouncements
   -28-




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##### Table of Contents



Overview of 2005 Results
  §
    
    We incurred relatively minor structural damage from Hurricanes Katrina and Rita
and expect to spend a maximum of $35 million for hurricane related repairs. We anticipate
these losses in excess of our deductible will be covered by insurance. As we do not carry
business interruption insurance, the delay of revenues resulting from curtailed and delayed
production is not covered. We estimate the curtailment of production and drilling delays
resulting directly from the storms impacted operating revenues in 2005 by an estimated $132
million. Revenues are expected to be further impacted during the first quarter of 2006 as
we wait for repairs to third-party pipelines and processing facilities,
with restoration expected by the end of the first quarter of 2006;§
    
    We announced our intent to explore the sale of our Gulf of Mexico assets and
to shift our operating focus onshore. We plan to reinvest the net cash proceeds
from the pending sale of the Texas portion of our Gulf of Mexico assets primarily into longer-lived natural gas
assets onshore in North America and to retire debt. The pending sale of our offshore Texas
assets is expected to close on or about March 31, 2006, with an effective date of January 1,
2006 (see Consolidated Financial Statements, Note 11  Subsequent Events  Pending Sale of
Texas Gulf of Mexico Assets);§
    
    We generated $105.2 million in net income, a decrease of 35% from $162.8 million
in 2004, primarily as a result of lower revenues caused by production curtailments and
$264.5 million in net hedge losses combined with higher depreciation, depletion and
amortization expense, general and administrative expense and interest expense;§
    
    We produced 114 Bcfe and our average daily production rate was 313 MMcfe per day
compared to 339 Mcfe/day during 2004, a decrease of 8%. We estimate that approximately 10.6
Bcfe, or approximately 30 MMcfe per day on an annualized basis, was deferred by hurricane
related curtailments and delays;§
    
    We increased total net proved reserves by 9% to 861 Bcfe. We added a net 184
Bcfe, which includes 144 Bcfe added through the drill bit and 100 Bcfe added through
acquisitions after 60 Bcfe of downward revisions, due primarily to reservoir performance.
With the total net additions of 184 Bcfe, we replaced 161% of the 114 Bcfe produced in 2005;§
    
    We generated $460.5 million in net cash flows from operating activities compared
to $527.1 million during 2004, a decrease of 13%;§
    
    We spent $743.3 million for investments in natural gas and oil properties, an
increase of 44% over 2004. Our 2005 expenditures included $197.7 million for producing
property acquisitions that compares to $149.6 million spent towards acquisitions in 2004, an
increase of 32%;§
    
    We increased our outstanding borrowings under our revolving bank credit facility
by a net $242 million, in part to fund our acquisitions and in part to fund cash
requirements for the settlement of derivative contracts;§
    
    We drilled 336 wells, of which 298, or 89%, were successful with 12 offshore, 16
in East Texas, 82 in South Texas, 60 in Arkoma and 128 in the Rockies;
 -29-




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§
    
    We successfully integrated the Gulf of Mexico producing properties acquired in
September and October 2004 from BP Exploration & Production Inc. and Orca Energy, L.P.,
respectively and successfully completed key development projects at Main Pass 264 and Eugene
Island 331;§
    
    We drilled or participated in drilling of three offshore discoveries that were
considered deep shelf prospects. The successful wells were drilled at West Cameron 75,
West Cameron 77 and West Cameron 62. Additional exploratory successes included Galveston
210 and East Cameron 23;§
    
    We expanded our onshore exploration efforts in the DJ Basin with one rig
drilling throughout the year and brought on-line our first group of wells during the third
quarter of 2005;§
    
    We continued our exploration and exploitation efforts in the Uinta Basin with
one rig drilling throughout the year and partnered with two separate groups to spread our
risk and accelerate our efforts. At year-end, we had three rigs drilling on our acreage.
We had a discovery north of the Natural Buttes Field and the well is producing approximately
26 Bbls per day, net to our interests, as of the date of this Annual Report;§
    
    We extended our development efforts in the North Roleta Field, located in South
Texas, southwest of our operations in the Charco Field, where we began to assemble acreage
and drilled a discovery well in 2004. We successfully drilled and completed eight of ten
wells and added approximately 17.5 MMcfe per day in production, net to our interests;§
    
    We expanded our East Texas acreage through a series of three related
acquisitions totaling $38.7 million and added an estimated 38 Bcfe in proved reserves. We
successfully integrated these producing properties, added two drilling rigs, successfully
drilled 16 development wells which added 13 Bcfe in reserves and increased average daily
production in the area from 2 MMcfe per day in January 2005 to 8 MMcfe per day in December
2005 (see Note 10  Acquisitions and Dispositions);§
    
    We acquired producing properties and acreage in four South Texas fields along
the Frio and Vicksburg Trends from Kerr-McGee Oil & Gas and Westport at the end of November
2005 for a net $159.0 million and added estimated proved reserves of 62 Bcfe and future
exploitation opportunities. We took over operations December 1, 2005 and began to integrate
the properties and optimize production rates. Daily production is averaging 10 to 12 MMcfe
per day as of the date of this Annual Report. We expect to spud our first well in the
Rincon Field in April 2006; (see Note 10  Acquisitions and Dispositions);§
    
    Our depletion rate for natural gas and oil properties increased from $2.30 per
Mcfe during the fourth quarter of 2004 to $3.03 per MMcfe during the fourth quarter of 2005,
primarily as a result of an industry wide increase in costs. We spent more during 2005 on a
per Mcfe basis to find, develop or acquire new reserves and it is projected to cost more to
develop our proved reserves as our future development costs increased by $330 million or 60%
in 2005 from prior year end;§
    
    We incurred $13.7 million in additional general and administrative expenses as a
result of special charges, including $5.0 million incurred pursuant to the February 2005
renegotiation of employment agreements with five of our key executive officers, including
our Chief Executive Officer, Chief Operating Officer and our then Chief Financial Officer;
$4.7 million in outside professional fees attributable to the review of a corporate
transaction in the second quarter and an acquisition in the third quarter, both of which
were not consummated; and $4.0 million in the fourth quarter related to severance and other
separation related payments made to certain former employees, including our former Chief
Financial Officer;§
    
    As a result of higher market prices for natural gas at December 31, 2005, the
fair value of our open derivative contracts increased from a liability of $75.1 million
($48.5 million net of tax) at December 31, 2004, to a liability of $417.7 million ($269.8
million net of tax) at December 31, 2005. During 2005, we incurred a total net loss on our
hedging activities of $264.5 million which compares to a total net loss of $70.1 million
during 2004. Of our 2005 total net hedging loss, $116.5 million was incurred during the
fourth quarter;§
    
    Our Board of Directors approved a plan for discretionary stock repurchases from
time to time up to $200 million of our common stock in conjunction with the possible
divesture of all of our Gulf of Mexico assets and subject to market conditions, applicable
legal requirements and contractual restrictions, available cash, competing reinvestment
opportunities in the acquisition market for oil and gas assets and other factors; and§
    
    We renegotiated our revolving bank credit facility to increase our banks
lending commitments from $450 million to $750 million. Borrowings under the facility are
secured by our onshore natural gas and oil assets as well as certain other assets. Our
initial borrowing base has been set at $600 million, which is expected to decrease upon
completion of the pending sale of the Texas portion of our Gulf of Mexico assets and likely
would be reduced further upon any sale of the remaining portion of our Gulf of Mexico
assets.
 -30-




---



##### Table of Contents



Operating and Financial Results for 2005 Compared to 2004 and Operating and Financial Results for
2004 Compared to 2003
 Year Ended December 31,
    
    Year Ended December 31,Summary Operating Information:
    
    2005
    
    2004
    
    Variance
    
    2004
    
    2003
    
    Variance(in thousands, except for price data)Natural gas revenues
    
    $
    816,182
    
    
    $
    669,294
    
    
    $
    146,888
    
    
    
    22
    %
    
    $
    669,294
    
    
    $
    522,597
    
    
    $
    146,697
    
    
    
    28
    %Oil revenues
    
    
    68,631
    
    
    
    49,938
    
    
    
    18,693
    
    
    
    37
    %
    
    
    49,938
    
    
    
    37,201
    
    
    
    12,737
    
    
    
    34
    %Gain (loss) on settled derivatives
    
    
    (265,236
    )
    
    
    (68,195
    )
    
    
    (197,041
    )
    
    
    289
    %
    
    
    (68,195
    )
    
    
    (66,408
    )
    
    
    (1,787
    )
    
    
    3
    %Unrealized gain (loss) derivatives
    
    
    694
    
    
    
    (1,950
    )
    
    
    2,644
    
    
    
    -136
    %
    
    
    (1,950
    )
    
    
    (1,950
    )
    
    
    
    
    
    
    Operating revenues
    
    
    621,543
    
    
    
    650,439
    
    
    
    (28,896
    )
    
    
    -4
    %
    
    
    650,439
    
    
    
    492,752
    
    
    
    157,687
    
    
    
    32
    %Operating expenses
    
    
    436,807
    
    
    
    382,626
    
    
    
    54,181
    
    
    
    14
    %
    
    
    382,626
    
    
    
    294,157
    
    
    
    88,469
    
    
    
    30
    %Income from operations
    
    
    184,736
    
    
    
    267,813
    
    
    
    (83,077
    )
    
    
    -31
    %
    
    
    267,813
    
    
    
    198,595
    
    
    
    69,218
    
    
    
    35
    %Net income
    
    
    105,169
    
    
    
    162,824
    
    
    
    (57,655
    )
    
    
    -35
    %
    
    
    162,824
    
    
    
    131,040
    
    
    
    31,784
    
    
    
    24
    %Production:Natural gas (MMcf)
    
    
    105,809
    
    
    
    115,855
    
    
    
    (10,046
    )
    
    
    -9
    %
    
    
    115,855
    
    
    
    99,965
    
    
    
    15,890
    
    
    
    16
    %Oil (MBbls)
    
    
    1,417
    
    
    
    1,355
    
    
    
    62
    
    
    
    5
    %
    
    
    1,355
    
    
    
    1,307
    
    
    
    48
    
    
    
    4
    %Total (MMcfe) (1)
    
    
    114,311
    
    
    
    123,985
    
    
    
    (9,674
    )
    
    
    -8
    %
    
    
    123,985
    
    
    
    107,807
    
    
    
    16,178
    
    
    
    15
    %Average daily production (MMcfe/d)
    
    
    313
    
    
    
    339
    
    
    
    (26
    )
    
    
    -8
    %
    
    
    339
    
    
    
    295
    
    
    
    44
    
    
    
    15
    %Average Sales Prices:Natural Gas (per Mcf) unhedged
    
    $
    7.71
    
    
    $
    5.78
    
    
    $
    1.93
    
    
    
    33
    %
    
    $
    5.78
    
    
    $
    5.23
    
    
    $
    0.55
    
    
    
    11
    %Natural Gas (per Mcf) realized (2)
    
    
    5.21
    
    
    $
    5.19
    
    
    
    0.02
    
    
    
    
    
    
    
    5.19
    
    
    $
    4.57
    
    
    
    0.62
    
    
    
    14
    %Natural Gas (per Mcf) all-in (3)
    
    
    5.21
    
    
    
    5.17
    
    
    
    0.04
    
    
    
    1
    %
    
    
    5.17
    
    
    
    4.55
    
    
    
    0.62
    
    
    
    14
    %Oil (per Bbl) unhedged
    
    
    48.43
    
    
    
    36.85
    
    
    
    11.58
    
    
    
    31
    %
    
    
    36.85
    
    
    
    28.46
    
    
    
    8.39
    
    
    
    29
    %Oil (per Bbl) realized (2)
    
    
    48.43
    
    
    
    36.85
    
    
    
    11.58
    
    
    
    31
    %
    
    
    36.85
    
    
    
    28.15
    
    
    
    8.70
    
    
    
    31
    %
 
 (1)
    
    MMcfe is defined as one million cubic feet equivalent of natural gas,
determined using the ratio of six Mcf of natural gas to one Bbl of crude oil, condensate or
natural gas liquids.(2)
    
    Includes gains and losses realized on hedge contracts settled for natural
gas produced during the period.(3)
    
    Includes both the effect of gains and losses realized on contracts settled
for natural gas produced during the period as well as unrealized gains and losses. Income from Operations
 Income from Operations 2005
  Income from Operations 2004
  Production Volume 2005 vs. 2004
  Onshore.
 -31-




---



##### Table of Contents



Offshore
 Production Volume 2004 vs. 2003
  Onshore.
   Offshore
 -32-




---



##### Table of Contents



Commodity Prices and Effects of Hedging 2005 vs. 2004
   §
    
    Cash loss on contracts settled for natural gas produced during the period of $265.2
million ($171.3 million net of tax);§
    
    As a result of the offshore production shortfall during the fourth quarter caused by the
hurricanes, we deferred a $20.6 million loss ($13.3 million net) of tax related to the above cash
settlements made during the fourth quarter of 2005 to accumulated other comprehensive income.
We expect to recapture the production shortfall during the first quarter of 2006, at which
time the $20.6 million will be recognized as a reduction to earnings;§
    
    Unrealized loss of $46.0 million ($29.7 million net of tax) for the ineffective portion of
open contracts at the end of the period that were not eligible for
deferral under SFAS 133 due primarily to the basis differentials between the
contract price, which is NYMEX based, and the indexed price at the point of sale, 30% of which is allocated to the Houston Ship Channel index; and§
    
    Unrealized gain of $26.1 million ($16.9 million net of tax) due to the loss of correlation
during the fourth quarter of 2005 of the Houston Ship Channel index and the NYMEX price. Our
hedged production allocated to the Houston Ship Channel index failed to qualify for hedge
accounting and as a result, our Houston Ship Channel contracts were marked-to-market with the
change in the fair value during the fourth quarter creating an unrealized gain.
  Commodity Prices and Effects of Hedging 2004 vs. 2003
  -33-




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##### Table of Contents



Operating Expenses
 Year Ended December 31,
    
    
    Year Ended December 30,Operating Expenses per Mcfe
    
    2005
    
    
    2004
    
    
    Variance
    
    
    2004
    
    
    2003
    
    
    VarianceLease operating expense
    
    $
    0.59
    
    
    $
    0.45
    
    
    
    0.14
    
    
    
    31
    %
    
    $
    0.45
    
    
    $
    0.44
    
    
    $
    0.01
    
    
    
    2
    %Severance tax
    
    
    0.16
    
    
    
    0.10
    
    
    
    0.06
    
    
    
    60
    %
    
    
    0.10
    
    
    
    0.15
    
    
    
    (0.05
    )
    
    
    -33
    %Transportation expense
    
    
    0.10
    
    
    
    0.10
    
    
    
    
    
    
    
    
    %
    
    
    0.10
    
    
    
    0.10
    
    
    
    
    
    
    
    
    %Asset retirement accretion expense
    
    
    0.05
    
    
    
    0.04
    
    
    
    0.01
    
    
    
    25
    %
    
    
    0.04
    
    
    
    0.03
    
    
    
    0.01
    
    
    
    33
    %Depreciation, depletion and
amortization
    
    
    2.58
    
    
    
    2.14
    
    
    
    0.44
    
    
    
    21
    %
    
    
    2.14
    
    
    
    1.83
    
    
    
    0.31
    
    
    
    17
    %General and administrative, net
    
    
    0.34
    
    
    
    0.27
    
    
    
    0.07
    
    
    
    26
    %
    
    
    0.27
    
    
    
    0.18
    
    
    
    0.09
    
    
    
    50
    %Total operating expenses per
unit of production
    
    $
    3.82
    
    
    $
    3.10
    
    
    
    0.72
    
    
    
    23
    %
    
    $
    3.10
    
    
    $
    2.73
    
    
    $
    0.37
    
    
    
    14
    %
  Lease Operating Expense
  Severance Tax
  Depreciation, Depletion and Amortization
  -34-




---



##### Table of Contents



Asset Retirement Accretion Expense.
  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
    
    2005
    
    
    2004
    
    
    Variance
    
    
    2005
    
    
    2004
    
    
    Variance(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
    
    
    (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
    %
 2005 vs 2004. 
Employment Agreements
  KeySpan Exchange and Offering
  Absolute Dollars
    
    
    Unit of Production
 McfeYear Ended December 31,
    
    
    Year Ended December 31,General and Administrative Expense
    
    2004
    
    
    2003
    
    
    Variance
    
    
    2004
    
    
    2003
    
    
    Variance(in thousands)Gross general and administrative expense
    
    $
    49,924
    
    
    $
    33,980
    
    
    $
    15,944
    
    
    
    47
    %
    
    $
    0.40
    
    
    $
    0.32
    
    
    $
    0.08
    
    
    
    25
    %Operating overhead reimbursements
    
    
    (2,188
    )
    
    
    (1,559
    )
    
    
    (629
    )
    
    
    40
    %
    
    
    (0.01
    )
    
    
    (0.02
    )
    
    
    0.01
    
    
    
    -50
    %Capitalized general and administrative
    
    
    (14,837
    )
    
    
    (12,879
    )
    
    
    (1,958
    )
    
    
    40
    %
    
    
    (0.12
    )
    
    
    (0.12
    )
    
    
    
    
    
    
    General and administrative expense, net
    
    $
    32,899
    
    
    $
    19,542
    
    
    $
    13,357
    
    
    
    68
    %
    
    $
    0.27
    
    
    $
    0.18
    
    
    $
    0.09
    
    
    
    50
    %
 -35-




---



##### Table of Contents



2004 vs. 2003
 Other Income and Expense, Interest and Taxes
 Other Income and Expense
   Year Ended December 31,
    
    
    Year Ended December 31,Interest and Average Borrowings
    
    2005
    
    
    2004
    
    
    Variance
    
    
    2004
    
    
    2003
    
    
    Variance(in thousands)Gross interest
    
    $
    25,301
    
    
    $
    17,813
    
    
    
    7,488
    
    
    
    42
    %
    
    $
    17,813
    
    
    $
    15,642
    
    
    $
    2,171
    
    
    
    14
    %Capitalized interest
    
    
    (8,766
    )
    
    
    (8,358
    )
    
    
    (408
    )
    
    
    5
    %
    
    
    (8,358
    )
    
    
    (7,300
    )
    
    
    (1,058
    )
    
    
    14
    %Interest expense, net of capitalized
interest
    
    $
    16,535
    
    
    $
    9,455
    
    
    
    7,080
    
    
    
    75
    %
    
    $
    9,455
    
    
    $
    8,342
    
    
    $
    1,113
    
    
    
    13
    %Average total borrowings(1)
    
    $
    388,000
    
    
    $
    289,000
    
    
    $
    99,000
    
    
    
    34
    %
    
    $
    289,410
    
    
    $
    240,000
    
    
    $
    49,410
    
    
    
    -21
    %Average total interest rate(1)
    
    
    6.16
    %
    
    
    5.68
    %
    
    
    0.48
    %
    
    
    8
    %
    
    
    5.68
    %
    
    
    6.08
    %
    
    
    0.40
    %
    
    
    -7
    %Average bank borrowings
    
    $
    211,000
    
    
    $
    112,000
    
    
    $
    99,000
    
    
    
    88
    %
    
    $
    111,979
    
    
    $
    89,668
    
    
    
    22,311
    
    
    
    25
    %Average bank interest rate
    
    
    5.54
    %
    
    
    3.75
    %
    
    
    1.80
    %
    
    
    48
    %
    
    
    3.75
    %
    
    
    3.42
    %
    
    
    0.33
    %
    
    
    10
    %
 
 (1)
    
    Average total borrowings and average total interest rate includes our
$175 million senior notes at 7% due June 2013 and borrowings under our revolving bank
credit facility. Interest Expense, Net of Capitalized Interest
  -36-




---



##### Table of Contents



5 8
 Income Tax Provision.
  Employment Agreements
  Liquidity
 Capital Requirements
  §
    
    Drilling and completing new natural gas and oil wells;§
    
    Constructing and installing new production infrastructure;§
    
    Acquiring additional reserves and producing properties;§
    
    Acquiring and maintaining our lease acreage position and our seismic resources;§
    
    Maintaining, repairing, and enhancing existing natural gas and oil wells;§
    
    Plugging and abandoning depleted or uneconomic wells; and§
    
    Indirect costs related to our exploration activities, including payroll and
other expense attributable to our exploration professional staff.
  Future Commitments
  -37-




---



##### Table of Contents



As of December 31, 2005Payments Due by PeriodReference
    
    
    Total
    
    
    1 year or less
    
    
    2  3 years
    
    
    4  5 years
    
    
    after 5 years(in thousands)Contractual Obligations:Revolving bank credit facility, due November 2010
    
    Note 2
    
    $
    422,000
    
    
    $
    
    
    
    $
    
    
    
    $
    422,000
    
    
    $
    7% senior subordinated notes, due June 2013
    
    Note 2
    
    
    175,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175,000Derivative instruments
    
    Note 7
    
    
    417,657
    
    
    
    352,456
    
    
    
    65,201
    
    
    
    
    
    
    
    Seismic data purchase
    
    Note 9
    
    
    10,714
    
    
    
    10,714
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    Note 9
    
    
    6,599
    
    
    
    1,796
    
    
    
    3,718
    
    
    
    1,085
    
    
    
    Letters of credit
    
    Note 9
    
    
    300
    
    
    
    300
    
    
    
    
    
    
    
    
    
    
    
    1,032,270
    
    
    
    365,266
    
    
    
    69,919
    
    
    
    423,085
    
    
    
    175,000Other Long-Term Obligations:Asset retirement obligations
    
    Note 1
    
    
    119,671
    
    
    
    7,265
    
    
    
    30,301
    
    
    
    20,050
    
    
    
    62,055Total contractual obligations and commitments
    
    
    
    
    
    $
    1,151,941
    
    
    $
    372,531
    
    
    $
    99,220
    
    
    $
    443,135
    
    
    $
    237,055
 Capital Resources
   Years Ended December 31,2005
    
    
    2004
    
    
    variance
    
    
    % change(in thousands)Net cash provided by operating activities
    
    $
    460,509
    
    
    $
    527,141
    
    
    $
    (66,632
    )
    
    
    -13
    %Net cash used in investing activities
    
    
    (727,003
    )
    
    
    (509,922
    )
    
    
    ( 217,081
    )
    
    
    43
    %Net cash
provided by (used in) financing activities
    
    
    255,896
    
    
    
    (1,211
    )
    
    
    257,107
    
    
    
    +100
    %Net (decrease) increase in cash
    
    $
    (10,598
    )
    
    $
    16,008
    
    
    $
    (26,606
    )
    
    
    -100
    %
  -38-




---



##### Table of Contents



Operating Activities
 Investing Activities.
  Years Ended December 31,2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    2001(in thousands)Natural gas and oil capital expendituresProducing property acquisitions
    
    $
    197,680
    
    
    $
    149,599
    
    
    $
    175,420
    
    
    $
    73,351
    
    
    $
    69,010Leasehold and lease acquisition costs (1)
    
    
    66,113
    
    
    
    57,741
    
    
    
    56,076
    
    
    
    36,458
    
    
    
    48,068Development
    
    
    366,902
    
    
    
    245,971
    
    
    
    162,235
    
    
    
    122,036
    
    
    
    177,256Exploration
    
    
    112,634
    
    
    
    63,646
    
    
    
    66,259
    
    
    
    26,536
    
    
    
    72,056Total natural gas and oil capital expenditures
    
    
    743,329
    
    
    
    516,957
    
    
    
    459,990
    
    
    
    258,381
    
    
    
    366,390Producing property dispositions
    
    
    (1,864
    )
    
    
    (72,712
    )
    
    
    
    
    
    
    (5,309
    )
    
    
    Net natural gas and oil capital expenditures
    
    $
    741,465
    
    
    $
    444,245
    
    
    $
    459,990
    
    
    $
    253,072
    
    
    $
    366,390Proved reserve additions, net of revisions
(MMcfe)
    
    
    183,787
    
    
    
    225,633
    
    
    
    212,969
    
    
    
    144,291
    
    
    
    136,231
 
 (1)
    
    For 2005, 2004, 2003, 2002 and 2001, leasehold costs include capitalized
interest and general and administrative expenses of $25.7 million $23.2 million, $20.2
million, $21.1 million, and $24.9 million, respectively. -39-




---



##### Table of Contents



Financing Activities
 Access to Capital Markets
   Stock
Repurchase Program.
 Off-Balance Sheet Arrangements
  
 Item 7A. Quantitative and Qualitative Disclosures About Market Risk
 Market Risk
  Interest Rate Market Risk
  -40-




---



##### Table of Contents



Commodity Risk
   Changes in Fair Value of Derivative Instruments
  Year Ended December 31,2005
    
    
    2004Change in Fair Value of Derivatives Instruments:
    
    Before Tax(in thousands)Fair value of contracts at January 1
    
    $
    (75,149
    )
    
    $
    (36,862
    )Realized loss on contracts settled
    
    
    265,236
    
    
    
    68,195Fair value of new contracts when entered into
    
    
    
    
    
    
    (Decrease) in fair value of all open contracts
    
    
    (607,745
    )
    
    
    (106,482
    )Net (decrease)
increase during period
    
    
    (342,509
    )
    
    
    (38,287
    )Fair value of contracts outstanding at December 31
    
    $
    (417,658
    )
    
    $
    (75,149
    )
 -41-




---



##### Table of Contents



Derivatives in Place as of the Date of Our Report
   Daily Volume
    
    
    NYMEX Price
    
    
    Floor Price
    
    
    Ceiling PriceYear
    
    Transaction Type
    
    (MMBtu/day)
    
    
    ($/MMBtu)
    
    
    ($/MMBtu)
    
    
    ($/MMBtu)2006
    
    Swap
    
    
    20,000
    
    
    $
    5.87
    
    
    
    
    
    
    
    2006
    
    Swap
    
    
    10,000
    
    
    
    5.94
    
    
    
    
    
    
    
    Total swaps
    
    
    30,0002006
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    $
    5.50
    
    
    $
    7.202006
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    5.50
    
    
    
    7.252006
    
    Costless collar
    
    
    40,000
    
    
    
    
    
    
    
    5.50
    
    
    
    7.262006
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    5.75
    
    
    
    7.202006
    
    Costless collar
    
    
    30,000
    
    
    
    
    
    
    
    5.80
    
    
    
    7.002006
    
    Costless collar
    
    
    50,000
    
    
    
    
    
    
    
    5.82
    
    
    
    7.002006
    
    Costless collar
    
    
    30,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.002006
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.022006
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.05Total collars
    
    
    220,000Total daily volume 2006
    
    
    250,0002007
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    $
    5.00
    
    
    $
    6.502007
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    5.00
    
    
    
    6.79Total daily volume 2007
    
    
    30,0002008
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    $
    5.00
    
    
    $
    5.72Total daily volume 2008
    
    
    20,000
   
 Item 8 . Financial Statements and Supplemental Data
  
 Item 9 . Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
  -42-




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##### Table of Contents



Item 9A . Controls and Procedures
 Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
  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
  -43-




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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, 2005 and 2004
    
    
    F-4Consolidated Statements of Operations for the Years Ended December 31, 2005, 2004 and 2003
    
    
    F-5Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) for the Period
January 1, 2003 to December 31, 2005
    
    
    F-6Consolidated Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8Supplemental Information on Natural Gas and Oil Exploration, Development and
Production Activities (unaudited)
    
    
    F-30Quarterly Financial Information (Unaudited)
    
    
    F-34
  2. Exhibits:
  -44-




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##### Table of Contents



SIGNATURES
  THE HOUSTON EXPLORATION COMPANYBy:
    
    /s/ William G. HargettWilliam G. HargettDate:
March 3, 2006
    
    
    
    President and Chief Executive Officer
 -45-




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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)
    
    March 3, 2006/s/ Robert T. Ray

Robert T. Ray
    
    Senior Vice President and Chief Financial
Officer
(Principal Financial Officer)
    
    March 3, 2006/s/ James F. Westmoreland

James F. Westmoreland
    
    Vice President and Chief Accounting Officer
(Principal Accounting Officer)
    
    March 3, 2006/s/ Robert B. Catell

Robert B. Catell
    
    Director
    
    March 3, 2006/s/ John U. Clarke

John U. Clarke
    
    Director
    
    March 3, 2006/s/ David G. Elkins

David G. Elkins
    
    Director
    
    March 3, 2006/s/ Harold R. Logan, Jr.

Harold R. Logan, Jr.
    
    Director
    
    March 3, 2006/s/ Thomas A. McKeever

Thomas A. McKeever
    
    Director
    
    March 3, 2006/s/ Stephen W. McKessy

Stephen W. McKessy
    
    Director
    
    March 3, 2006/s/ Donald C. Vaughn

Donald C. Vaughn
    
    Director
    
    March 3, 2006
 -46-




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##### Table of Contents



Glossary of Oil and Gas Terms
  Bbl
 Bbl/d
 Bcf.
 Bcfe
 Btu
 Completion
 Deep Shelf.
 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
 G-1




---



##### Table of Contents



Mcf/d
 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
 G-2




---



##### Table of Contents



Royalty interest
 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, 2005 and 2004
    
    
    F-4Consolidated Statements of Operations for the Years Ended December 31, 2005, 2004 and 2003
    
    
    F-5Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) for the Period
January 1, 2003 to December 31, 2005
    
    
    F-6Consolidated Statements of Cash Flows for the Years Ended December 31, 2005, 2004 and 2003
    
    
    F-7Notes to Consolidated Financial Statements
    
    
    F-8Supplemental Information on Natural Gas and Oil Exploration, Development and Production Activities
(Unaudited)
    
    
    F-30Quarterly Financial Information (Unaudited)
    
    
    F-34
 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




---



##### 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 31,2005
    
    
    2004Assets:Cash and cash equivalents
    
    $
    7,979
    
    
    $
    18,577Accounts receivable
    
    
    146,020
    
    
    
    103,069Inventories
    
    
    2,726
    
    
    
    976Deferred tax asset
    
    
    145,922
    
    
    
    24,101Prepayments and other
    
    
    19,709
    
    
    
    9,107Total current assets
    
    
    322,356
    
    
    
    155,830Natural gas and oil properties, full cost methodUnevaluated properties
    
    
    107,146
    
    
    
    122,691Properties subject to amortization
    
    
    3,556,755
    
    
    
    2,777,097Other property and equipment
    
    
    12,971
    
    
    
    11,7403,676,872
    
    
    
    2,911,528Less: Accumulated depreciation, depletion and amortization
    
    
    1,658,532
    
    
    
    1,363,2722,018,340
    
    
    
    1,548,256Other non-current assets
    
    
    20,928
    
    
    
    18,491Total Assets
    
    $
    2,361,624
    
    
    $
    1,722,577Liabilities:Accounts payable and accrued expenses
    
    $
    177,159
    
    
    $
    118,971Derivative financial instruments
    
    
    352,457
    
    
    
    68,081Asset retirement obligation
    
    
    7,265
    
    
    
    662Total current liabilities
    
    
    536,881
    
    
    
    187,714Long-term debt and notes
    
    
    597,000
    
    
    
    355,000Derivative financial instruments
    
    
    65,201
    
    
    
    7,068Deferred federal income taxes
    
    
    341,302
    
    
    
    288,069Asset retirement obligation
    
    
    112,406
    
    
    
    91,084Other non-current liabilities
    
    
    15,696
    
    
    
    10,722Total Liabilities
    
    
    1,668,486
    
    
    
    939,657Commitments and Contingencies (see Note 9)Stockholders Equity:Preferred Stock, $0.01 par value, 5,000,000 shares authorized and no shares issued
    
    
    
    
    
    
    Common Stock, $.01 par value, 100,000,000 shares authorized and 28,980,128 issued
and outstanding at December 31, 2005 and 50,000,000 shares authorized and
28,380,207 shares issued and outstanding at December 31, 2004
    
    
    289
    
    
    
    284Additional paid-in capital
    
    
    305,077
    
    
    
    273,002Unearned compensation
    
    
    (7,859
    )
    
    
    (2,537
    )Retained earnings
    
    
    663,367
    
    
    
    558,198Accumulated other comprehensive income
    
    
    (267,736
    )
    
    
    (46,027
    )Total Stockholders Equity
    
    
    693,138
    
    
    
    782,920Total Liabilities and Stockholders Equity
    
    $
    2,361,624
    
    
    $
    1,722,577
  F-4




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 
 CONSOLIDATED STATEMENTS OF OPERATIONS
  For the Years Ended December 31,2005
    
    
    2004
    
    
    2003Revenues:Natural gas and oil revenues
    
    $
    620,271
    
    
    $
    649,087
    
    
    $
    491,440Other
    
    
    1,272
    
    
    
    1,352
    
    
    
    1,312Total revenues
    
    
    621,543
    
    
    
    650,439
    
    
    
    492,752Operating expenses:Lease operating
    
    
    67,796
    
    
    
    55,925
    
    
    
    47,072Severance tax
    
    
    18,121
    
    
    
    11,933
    
    
    
    15,958Transportation expense
    
    
    11,883
    
    
    
    11,819
    
    
    
    10,387Asset retirement accretion expense
    
    
    5,278
    
    
    
    4,902
    
    
    
    3,668Depreciation, depletion and amortization
    
    
    295,351
    
    
    
    265,148
    
    
    
    197,530General and administrative, net of amounts capitalized
    
    
    38,378
    
    
    
    32,899
    
    
    
    19,542Total operating expenses
    
    
    436,807
    
    
    
    382,626
    
    
    
    294,157Income from operations
    
    
    184,736
    
    
    
    267,813
    
    
    
    198,595Other (income) expense
    
    
    142
    
    
    
    (1,058
    )
    
    
    (15,746
    )Interest expense, net of amounts capitalized
    
    
    16,535
    
    
    
    9,455
    
    
    
    8,342Income before income taxes
    
    
    168,059
    
    
    
    259,416
    
    
    
    205,999Provision for taxes
    
    
    62,890
    
    
    
    96,592
    
    
    
    72,187Income before cumulative effect of change in accounting
principle
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    133,812Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (2,772
    )Net income
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    131,040Earnings per share:Net
income per share  basicIncome before cumulative effect of change in
accounting principle
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.30Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.09
    )Net income per share  basic
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.21Net income per share  dilutedIncome before cumulative effect of change in
accounting principle
    
    $
    3.62
    
    
    $
    5.44
    
    
    $
    4.29Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.09
    )Net income per share  diluted
    
    $
    3.62
    
    
    $
    5.44
    
    
    $
    4.20Weighted average shares outstanding  basic
    
    
    28,707
    
    
    
    29,616
    
    
    
    31,097Weighted average shares outstanding  diluted
    
    
    29,037
    
    
    
    29,932
    
    
    
    31,213
  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
    
    
    Unearned
    
    
    Retained
    
    
    Comprehensive
    
    
    ShareholdersShares
    
    
    $ Value
    
    
    Capital
    
    
    Compensation
    
    
    Earnings
    
    
    Income (Loss)
    
    
    EquityBalance January 1, 2003
    
    
    30,954,018
    
    
    $
    310
    
    
    $
    353,454
    
    
    $
    (107
    )
    
    
    264,334
    
    
    
    (25,202
    )
    
    $
    592,789Common
shares issued  stock options
    
    
    461,563
    
    
    
    5
    
    
    
    10,218
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,223Common
shares issued  restricted
stock
    
    
    22,000
    
    
    
    
    
    
    
    812
    
    
    
    (812
    )
    
    
    
    
    
    
    
    
    
    
    Common
shares issued  public
offering
    
    
    3,000,000
    
    
    
    30
    
    
    
    79,170
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    79,200Common shares repurchased from
KeySpan
    
    
    (3,000,000
    )
    
    
    (30
    )
    
    
    (79,170
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (79,200
    )Amortization restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    111
    
    
    
    
    
    
    
    
    
    
    
    111Stock
compensation expense  stock
options
    
    
    
    
    
    
    
    
    
    
    903
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    903Tax benefit exercise of
non-qualified stock options
    
    
    
    
    
    
    
    
    
    
    1,394
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,394Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    131,040
    
    
    
    
    
    
    
    131,040Other comprehensive income:Derivative settlements
reclassified to income, net of
tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    43,165
    
    
    
    43,165Unrealized loss change in fair
value of derivatives, net of
tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (44,091
    )
    
    
    (44,091
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    130,114Balance December 31, 2003
    
    
    31,437,581
    
    
    $
    315
    
    
    $
    366,781
    
    
    $
    (808
    )
    
    $
    395,374
    
    
    $
    (26,128
    )
    
    $
    735,534Common
shares issued  stock options
    
    
    873,626
    
    
    
    9
    
    
    
    25,586
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25,595Common
shares issued  restricted
stock
    
    
    49,000
    
    
    
    
    
    
    
    2,855
    
    
    
    (2,855
    )
    
    
    
    
    
    
    
    
    
    
    Common
shares issued  public
offering
    
    
    6,820,000
    
    
    
    68
    
    
    
    310,659
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    310,727Common shares repurchase from
KeySpan
    
    
    (10,800,000
    )
    
    
    (108
    )
    
    
    (441,471
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (441,579
    )Amortization restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,126
    
    
    
    
    
    
    
    
    
    
    
    1,126Stock
compensation expense  stock
options
    
    
    
    
    
    
    
    
    
    
    3,670
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,670Tax benefit exercise of
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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    44,054
    
    
    
    44,054Unrealized loss change in fair
value of derivatives, net of
tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (63,953
    )
    
    
    (63,953
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    142,925Balance December 31, 2004
    
    
    28,380,207
    
    
    $
    284
    
    
    $
    273,002
    
    
    $
    (2,537
    )
    
    $
    558,198
    
    
    $
    (46,027
    )
    
    $
    782,920Common
shares issued  stock options
    
    
    510,316
    
    
    
    5
    
    
    
    16,285
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,290Common
shares issued  restricted
stock
    
    
    89,605
    
    
    
    
    
    
    
    8,204
    
    
    
    (8,204
    )
    
    
    
    
    
    
    
    
    
    
    Amortization restricted stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,882
    
    
    
    
    
    
    
    
    
    
    
    2,882Stock
compensation expense  stock
options
    
    
    
    
    
    
    
    
    
    
    4,229
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,229Tax adjustment to 2004 benefit from
non-qualified stock options
    
    
    
    
    
    
    
    
    
    
    (180
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (180
    )Tax benefit exercise of
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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    171,342
    
    
    
    171,342Unrealized loss change in fair
value of derivatives, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (393,051
    )
    
    
    (393,051
    )Total comprehensive (loss)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (116,540
    )Balance December 31, 2005
    
    
    28,980,128
    
    
    $
    289
    
    
    $
    305,077
    
    
    $
    (7,859
    )
    
    $
    663,367
    
    
    $
    (267,736
    )
    
    $
    693,138
  F-6




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Years Ended December 31,2005
    
    
    2004
    
    
    2003Operating Activities:Net income
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    131,040Adjustments to reconcile net income to net cash provided by
operating activities:Deferred income tax expense
    
    
    57,555
    
    
    
    50,500
    
    
    
    58,274Depreciation, depletion and amortization
    
    
    295,351
    
    
    
    265,148
    
    
    
    197,530Asset retirement accretion expense
    
    
    5,278
    
    
    
    4,902
    
    
    
    3,668Stock compensation expense
    
    
    7,111
    
    
    
    4,796
    
    
    
    1,014Tax benefit (loss) non-qualified stock options
    
    
    (180
    )
    
    
    4,922
    
    
    
    1,394Unrealized (gain) loss on derivative instruments
    
    
    (694
    )
    
    
    1,950
    
    
    
    1,950Amortization of premiums paid on derivative contracts
    
    
    
    
    
    
    5,287
    
    
    
    Debt extinguishment expense
    
    
    
    
    
    
    211
    
    
    
    1,626Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    2,772Changes in operating assets and liabilities:Accounts receivable
    
    
    (42,951
    )
    
    
    (8,387
    )
    
    
    (4,863
    )Inventories
    
    
    (1,750
    )
    
    
    95
    
    
    
    361Prepayments and other
    
    
    (11,714
    )
    
    
    (3,289
    )
    
    
    (3,622
    )Other assets
    
    
    (43
    )
    
    
    (6,218
    )
    
    
    (8,449
    )Accounts payable and accrued expenses
    
    
    42,403
    
    
    
    39,693
    
    
    
    (3,055
    )Other non-current liabilities
    
    
    4,974
    
    
    
    7,276
    
    
    
    2,329ARO liability for assets abandoned
    
    
    
    
    
    
    (2,569
    )
    
    
    Net cash provided by operating activities
    
    
    460,509
    
    
    
    527,141
    
    
    
    381,969Investing Activities:Investment in property and equipment
    
    
    (728,882
    )
    
    
    (523,205
    )
    
    
    (452,959
    )Dispositions and other
    
    
    1,879
    
    
    
    13,283
    
    
    
    Net cash used in investing activities
    
    
    (727,003
    )
    
    
    (509,922
    )
    
    
    (452,959
    )Financing Activities:Proceeds from long-term borrowings
    
    
    831,000
    
    
    
    420,000
    
    
    
    414,000Repayments of long-term borrowings
    
    
    (589,000
    )
    
    
    (367,000
    )
    
    
    (364,000
    )Debt issuance costs
    
    
    (2,394
    )
    
    
    (1,555
    )
    
    
    (4,695
    )Proceeds from issuance of common stock from exercise of
stock options
    
    
    16,290
    
    
    
    25,596
    
    
    
    10,223Proceeds from issuance of common stock
    
    
    
    
    
    
    310,727
    
    
    
    79,200Repurchase of common stock
    
    
    
    
    
    
    (388,979
    )
    
    
    (79,200
    )Net cash (used in) provided by financing activities
    
    
    255,896
    
    
    
    (1,211
    )
    
    
    55,528Decrease in cash and cash equivalents
    
    
    (10,598
    )
    
    
    16,008
    
    
    
    (15,462
    )Cash and cash equivalents, beginning of year
    
    
    18,577
    
    
    
    2,569
    
    
    
    18,031Cash and cash equivalents, end of year
    
    $
    7,979
    
    
    $
    18,577
    
    
    $
    2,569Supplemental Information:Non-cash transactions:Investments in property and equipment accrued, not paid
    
    $
    (15,785
    )
    
    $
    4,705
    
    
    $
    (8,863
    )Divesture and exchange of Appalachian Basin assets
    
    
    
    
    
    
    60,000
    
    
    
    Deferred tax benefit exchange of Appalachian Basin assets
    
    
    
    
    
    
    7,400
    
    
    
    Cash paid during period for:Interest
    
    $
    23,858
    
    
    $
    16,385
    
    
    $
    18,403Federal and state income taxes
    
    
    19,297
    
    
    
    41,854
    
    
    
    14,800
  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
 KeySpan Exchange and Offering.
 Pending Sale of Texas Gulf of Mexico Assets
  Principles of Consolidation
   Use of Estimates
  Reclassifications
  Business Segment Information
  F-8




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
   Revenue Recognition and Gas Imbalances
   F-9




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
 Net Income Per Share
  Years Ended December 31,2005
    
    
    2004
    
    
    2003(in thousand, except per share data)Numerator:Income before cumulative effect of change in accounting principle
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    133,812Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (2,772
    )Net income
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    131,040Denominator:Weighted average shares outstanding
    
    
    28,707
    
    
    
    29,616
    
    
    
    31,097Add dilutive securities: Stock options and restricted stock
    
    
    330
    
    
    
    316
    
    
    
    116Total weighted average shares outstanding and dilutive securities
    
    
    29,037
    
    
    
    29,932
    
    
    
    31,213Earnings
per share  basic:Income before cumulative effect of change in accounting principle
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.30Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.09
    )Net income
per share  basic
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.21Earnings
per share  diluted:Income before cumulative effect of change in accounting principle
    
    $
    3.62
    
    
    $
    5.44
    
    
    $
    4.29Cumulative effect of change in accounting principle
    
    
    
    
    
    
    
    
    
    
    (0.09
    )Net income
per share  diluted
    
    $
    3.62
    
    
    $
    5.44
    
    
    $
    4.20
  Comprehensive Income
  For the Year Ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Net income
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    131,040Other comprehensive income (loss)Derivative instruments settled and reclassified, net of tax
    
    
    171,342
    
    
    
    44,054
    
    
    
    43,165Change in unrealized (loss) fair value of open contracts, net of tax
    
    
    (393,051
    )
    
    
    (63,953
    )
    
    
    (44,091
    )Total other comprehensive (loss)
    
    
    (221,709
    )
    
    
    (19,899
    )
    
    
    (926
    )Comprehensive income (loss)
    
    $
    (116,540
    )
    
    $
    142,925
    
    
    $
    130,114
 F-10




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
 Natural Gas and Oil Properties
 Full Cost Accounting
 §
    
    full cost pool (including assets associated with retirement obligations); plus,§
    
    estimates for future development costs (excluding asset retirement obligations); less,§
    
    unevaluated properties and their related costs; less,§
    
    estimates for salvage.
     Unevaluated Properties
 F-11




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
  Asset Retirement Obligations
  st
 Years Ended December 31,2005
    
    
    2004(in thousands)ARO liability at January 1,
    
    $
    91,746
    
    
    $
    92,357Accretion expense
    
    
    5,278
    
    
    
    4,902Liabilities incurred from drilling
    
    
    7,520
    
    
    
    4,487Liabilities
incurred  assets acquired
    
    
    5,783
    
    
    
    19,638Liabilities settled   assets sold
    
    
    (32
    )
    
    
    (12,714
    )Liabilities settled  assets abandoned
    
    
    (971
    )
    
    
    (4,915
    )Changes in estimates
    
    
    10,347
    
    
    
    (12,009
    )ARO liability at December 31,
    
    $
    119,671
    
    
    $
    91,746
 Other Property and Equipment
  Cash and Cash Equivalents
  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.
 F-12




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
 
 Inventories
  General and Administrative Costs and Expenses
   Capitalization of Interest
  Financial Instruments
  Concentration of Credit Risk
   Derivative Instruments and Hedging Activities
  F-13




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
      Accounting for Stock Options
  F-14




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
   Years Ended December 31,2005
    
    
    2004
    
    
    2003(in thousands, except per share data)Net income
 as reported
    
    $
    105,169
    
    
    $
    162,824
    
    
    $
    131,040Add: Stock-based compensation expense included in
net income, net of tax
    
    
    3,292
    
    
    
    2,581
    
    
    
    551Less: Stock-based compensation expense determined
using fair value method, net of tax
    
    
    4,679
    
    
    
    4,694
    
    
    
    4,427Net income   pro forma
    
    $
    103,782
    
    
    $
    160,711
    
    
    $
    127,164Net income
per share  basic  as reported
    
    $
    3.66
    
    
    $
    5.50
    
    
    $
    4.21Net income
per share  diluted  as reported
    
    
    3.62
    
    
    
    5.44
    
    
    
    4.20Net income
per share  basic  pro forma
    
    $
    3.62
    
    
    $
    5.43
    
    
    $
    4.09Net income
per share  diluted  pro forma
    
    
    3.57
    
    
    
    5.37
    
    
    
    4.07
   Years Ended December 31,2005
    
    2004
    
    2003Risk-free interest rate
    
    
    4.1
    %
    
    
    3.7
    %
    
    
    4.0
    %Expected life in years
    
    
    5
    
    
    
    5
    
    
    
    5Expected stock volatility
    
    
    42.7
    %
    
    
    37.2
    %
    
    
    42.7
    %Expected dividends
    
    
    0.0
    %
    
    
    0.0
    %
    
    
    0.0
    %
  New Accounting Pronouncements
   F-15




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
   NOTE 2  Long-Term Debt and Notes
 Years Ended December 31,2005
    
    
    2004(in thousands)Senior Debt:Revolving bank credit facility, due November 30, 2010
    
    $
    422,000
    
    
    $
    180,000Subordinated Debt:7% senior subordinated notes, due June 15, 2013
    
    
    175,000
    
    
    
    175,000Total long-term debt and notes
    
    $
    597,000
    
    
    $
    355,000
  After2006
    
    
    2007
    
    
    2008
    
    
    2009
    
    
    2010
    
    
    2011(in thousands)Revolving bank credit facility
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    422,000
    
    
    $
    7% senior Subordinated Notes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175,000Total maturities
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    422,000
    
    
    $
    175,000
 Revolving Bank Credit Facility
 Pending Sale of Texas Gulf of Mexico
Assets
  §
    
    on base rate loans, at a fluctuating rate, or base rate, equal to the sum of (a)
the greater of the Federal funds rate plus 0.5% or Wachovias prime rate plus (b) a variable
margin between 0.00% and 0.50%, depending on the amount of borrowings outstanding under the
credit facility, or
 F-16




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
 §
    
    on fixed rate loans, a fixed rate equal to the sum of (a) a quoted LIBOR rate
divided by one minus the average maximum rate during the interest period set for certain
reserves of member banks of the Federal Reserve System in Dallas, Texas, plus (b) a variable
margin between 1.00% and 1.75%, depending on the amount of borrowings outstanding under the
credit facility.
   §
    
    maintain a ratio of earnings before interest, taxes, depreciation, depletion and
amortization (EBITDA) to cash interest payments of at least 3.00 to 1.00;§
    
    maintain a ratio of total debt to EBITDA of not more than 3.50 to 1.00; and§
    
    not hedge more than 85% of our production during any calendar year.
  Senior Subordinated Notes
   §
    
    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-17




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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
  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-18




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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 and Option Plans
 4 01(k) Plan
  Deferred Compensation Plan
  F-19




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
 Supplemental Executive Retirement Plans
  Employee Annual Incentive Compensation Plan
  Retention Bonus Plan
  Deferred Compensation Plan for Non-Employee Directors
  Stock and Option Plans
  F-20




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
 NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
      December 31,2005
    
    
    2004
    
    
    2003(in thousands)Options
    
    $
    4,229
    
    
    $
    3,670
    
    
    $
    903Restricted stock and units(1)
    
    
    2,882
    
    
    
    1,126
    
    
    
    111Stock compensation expense, gross
    
    
    7,111
    
    
    
    4,796
    
    
    
    1,014Amounts capitalized
    
    
    (2,015
    )
    
    
    (800
    )
    
    
    (166
    )Stock compensation expense, net of amounts capitalized
    
    $
    5,096
    
    
    $
    3,996
    
    
    $
    848
 
 (1)
    
    Includes $21,000 and $85,000, respectively, during 2004 and 2003 for the
amortization of 10,000 shares of restricted stock granted to our Chief Executive Officer
upon his employment with our company in April 2001. These shares fully vested in April
2004 and were not made pursuant to one of our Plans.  F-21




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 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
    
    
    646,680
    
    
    
    1,194,000
    
    
    
    806,606
    
    
    
    2,132,758
    
    
    
    4,780,044Forfeitures
    
    
    (33,772
    )
    
    
    (85,720
    )
    
    
    (43,665
    )
    
    
    (26,600
    )
    
    
    (189,757
    )Cancellations
    
    
    
    
    
    
    322,045
    
    
    
    37,059
    
    
    
    18,300
    
    
    
    377,404Total options
    
    
    612,908
    
    
    
    1,478,000
    
    
    
    800,000
    
    
    
    3,033,912
    
    
    
    5,924,820Restricted stock and units:(1)Grants
    
    
    195,423
    
    
    
    22,000
    
    
    
    
    
    
    
    
    
    
    
    217,423Forfeitures
    
    
    (4,317
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,317
    )Total restricted stock and units (2)
    
    
    191,106
    
    
    
    22,000
    
    
    
    
    
    
    
    
    
    
    
    213,106Options and restricted stock available for grant
    
    
    695,986
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    695,986Total exercised and issued
    
    
    163,558
    
    
    
    540,370
    
    
    
    547,329
    
    
    
    2,755,632
    
    
    
    4,006,889
 
 (1)
    
    Average grant price for restricted stock was $57.47, $58.28 and $36.94,
respectively, during years ended December 31, 2005, 2004 and 2003.(2)
    
    Includes 52,501 units granted in 2005 pursuant to the July 2005 Retention Bonus
Plan at an average of $58.76 per share.  Years Ended December 31,2005
    
    2004
    
    2003Shares
    
    Price(1)
    
    Shares
    
    Price(1)
    
    Shares
    
    Price(1)Options outstanding January 1
    
    
    1,957,598
    
    
    $
    35.05
    
    
    
    2,535,159
    
    
    $
    30.23
    
    
    
    2,421,166
    
    
    $
    27.50Granted
    
    
    345,230
    
    
    
    55.37
    
    
    
    342,950
    
    
    
    55.98
    
    
    
    606,725
    
    
    
    34.86Exercised
    
    
    (510,316
    )
    
    
    31.92
    
    
    
    (873,626
    )
    
    
    29.30
    
    
    
    (461,563
    )
    
    
    22.15Forfeited
    
    
    (95,902
    )
    
    
    40.14
    
    
    
    (46,885
    )
    
    
    34.49
    
    
    
    (31,169
    )
    
    
    27.73Options outstanding December 31
    
    
    1,696,610
    
    
    $
    39.85
    
    
    
    1,957,598
    
    
    $
    35.05
    
    
    
    2,535,159
    
    
    $
    30.23Options exercisable December 31
    
    
    615,523
    
    
    $
    32.83
    
    
    
    555,546
    
    
    $
    29.80
    
    
    
    838,568
    
    
    $
    28.28Options available for grant
December 31
    
    
    695,986
    
    
    
    
    
    
    
    1,152,975
    
    
    
    
    
    
    
    309,889
 
 (1)
    
    Weighted average price. For all grants, the grant price equal to closing
market price on the NYSE on date of grant.  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$
    15.50
    
    
    
    
    
    
    $
    17.25
    
    
    
    14,400
    
    
    
    1996
    
    
    1 years
    
    $
    15.60
    
    
    
    14,400
    
    
    $
    15.50
    
    
    
    $
    13.13
    
    
    
    
    
    
    $
    25.00
    
    
    
    15,900
    
    
    
    1997
    
    
    2 years
    
    
    20.73
    
    
    
    15,900
    
    
    
    20.73
    
    
    
    $
    15.75
    
    
    
    
    
    
    $
    23.38
    
    
    
    6,920
    
    
    
    1998
    
    
    3 years
    
    
    18.86
    
    
    
    6,920
    
    
    
    18.86
    
    
    
    $
    16.94
    
    
    
    
    
    
    $
    21.00
    
    
    
    27,430
    
    
    
    1999
    
    
    4 years
    
    
    19.62
    
    
    
    27,430
    
    
    
    19.62
    
    
    
    $
    18.00
    
    
    
    
    
    
    $
    26.19
    
    
    
    29,500
    
    
    
    2000
    
    
    5 years
    
    
    23.72
    
    
    
    29,500
    
    
    
    23.72
    
    
    
    $
    22.50
    
    
    
    
    
    
    $
    37.38
    
    
    
    315,482
    
    
    
    2001
    
    
    6 years
    
    
    29.38
    
    
    
    205,247
    
    
    
    29.56
    
    
    
    110,235$
    27.49
    
    
    
    
    
    
    $
    33.75
    
    
    
    318,760
    
    
    
    2002
    
    
    7 years
    
    
    30.15
    
    
    
    120,800
    
    
    
    30.14
    
    
    
    197,960$
    26.18
    
    
    
    
    
    
    $
    37.42
    
    
    
    339,785
    
    
    
    2003
    
    
    8 years
    
    
    34.75
    
    
    
    96,320
    
    
    
    35.07
    
    
    
    243,465$
    36.56
    
    
    
    
    
    
    $
    60.45
    
    
    
    294,678
    
    
    
    2004
    
    
    9 years
    
    
    56.08
    
    
    
    74,006
    
    
    
    57.93
    
    
    
    220,672$
    46.25
    
    
    
    
    
    
    $
    67.08
    
    
    
    333,755
    
    
    
    2005
    
    
    10 years
    
    
    55.37
    
    
    
    25,000
    
    
    
    36.55
    
    
    
    308,7551,696,610
    
    
    
    
    
    
    
    
    
    
    $
    39.85
    
    
    
    615,523
    
    
    $
    32.83
    
    
    
    1,081,087
 F-22




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 5  Income Taxes
  Years Ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Current
    
    $
    5,335
    
    
    $
    46,092
    
    
    $
    13,913Deferred
    
    
    57,555
    
    
    
    50,500
    
    
    
    58,274Total
    
    $
    62,890
    
    
    $
    96,592
    
    
    $
    72,187
   Years Ended December 31,2005
    
    
    2004
    
    
    2003(in thousands)Income before income taxes
    
    $
    168,059
    
    
    $
    259,416
    
    
    $
    205,999Statutory rate
    
    
    35
    %
    
    
    35
    %
    
    
    35
    %Income tax expense computed at statutory rate
    
    
    58,821
    
    
    
    90,796
    
    
    
    72,100Reconciling items:State income taxes and other, net of federal
tax benefit
    
    
    672
    
    
    
    4,358
    
    
    
    Permanent differences
    
    
    40
    
    
    
    45
    
    
    
    29Other adjustments (1)
    
    
    1,852
    
    
    
    
    
    
    
    58Non-deductible compensation expense
    
    
    1,505
    
    
    
    1,393
    
    
    
    Tax provision
    
    $
    62,890
    
    
    $
    96,592
    
    
    $
    72,187
 
 (1)
    
    For 2005, includes an adjustment relating to 2004 estimates for federal and
state taxes. For 2003, comprised of excess deductions for Section 29 tax credits taken
in 2002. Deferred Income Taxes
    F-23




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Years Ended December 31,2005
    
    
    2004(in thousands)Deferred tax assets:Derivative instruments
    
    $
    146,716
    
    
    $
    25,222Ineffectiveness derivative instruments
    
    
    1,135
    
    
    
    1,381Net operating loss
    
    
    11,101
    
    
    
    Alternative minimum tax credit carryforwards
    
    
    8,728
    
    
    
    Deferred compensation
    
    
    5,728
    
    
    
    4,327Total deferred tax assets
    
    
    173,408
    
    
    
    30,930Deferred tax liabilities:Oil and gas property and equipment
    
    
    368,788
    
    
    
    294,898Total deferred tax liability
    
    $
    195,380
    
    
    $
    263,968Reflected in the accompanying Balance Sheet as:Current  deferred income tax asset
    
    $
    (145,922
    )
    
    $
    (24,101
    )Non-current deferred income tax liability
    
    
    341,302
    
    
    
    288,069$
    195,380
    
    
    $
    263,968
 NOTE 6  Related Party Transactions
 Transactions With Our Executive Officers and Directors
 Employment Agreements
    Employment Agreement with Robert T. Ray, Chief Financial Officer
  F-24




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Amendments to Employment Agreements
   Lump-Sum Payments to Executives Under Employment Contracts
   Transactions Involving Companies with Common Directors
  F-25




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Transactions with KeySpan
 KeySpan Exchange and Offering
 NOTE 7  Derivative Instruments
   Natural Gas
    
    Fixed Price Swaps
    
    CollarsDaily
    
    NYMEX
    
    Daily
    
    NYMEXVolume
    
    Contract
    
    Volume
    
    Contract PricePeriod
    
    (MMBtu)
    
    Price
    
    (MMBtu)
    
    Floor
    
    Ceiling
    
    Fair Value(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
    )
   Natural Gas
    
    Fixed Price Swaps
    
    CollarsDaily
    
    NYMEX
    
    Daily
    
    NYMEXVolume
    
    Contract
    
    Volume
    
    Contract PricePeriod
    
    (MMBtu)
    
    Price
    
    (MMBtu)
    
    Floor
    
    Ceiling
    
    Fair Value(thousands)January  December 2005
    
    
    80,000
    
    
    $
    5.304
    
    
    
    180,000
    
    
    $
    4.833
    
    
    $
    6.434
    
    
    $
    (68,081
    )January  December 2006
    
    
    30,000
    
    
    
    5.893
    
    
    
    60,000
    
    
    
    5.500
    
    
    
    7.248
    
    
    
    (3,889
    )January  December 2007
    
    
    
    
    
    
    
    
    
    
    30,000
    
    
    
    5.000
    
    
    
    6.597
    
    
    
    (1,662
    )January  December 2008
    
    
    
    
    
    
    
    
    
    
    20,000
    
    
    
    5.000
    
    
    
    5.720
    
    
    
    (1,517
    )$
    (75,149
    )
 F-26




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 st
  NOTE 8  Sales to Major Customers
  For the Year Ended December 31,Major Purchaser
    
    2005
    
    
    2004
    
    
    2003ConocoPhillips
    
    
    11.9
    %
    
    
    11.9
    %
    
    
    18.4
    %Anadarko Petroleum Corporation
    
    
    10.1
    %
    
    
    9.08
    %
    
    
    11.7
    %KinderMorgan
    
    
    2.7
    %
    
    
    10.1
    %
    
    
    11.4
    %
 NOTE 9  Commitments and Contingencies
 Legal Proceedings
  Severance Tax Refund
  Leases
 th
 F-27




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 MinimumYears Ended December 31,
    
    Payments2006
    
    $
    1,7962007
    
    
    1,8552008
    
    
    1,8632009
    
    
    1,0832010
    
    
    2Thereafter
    
    
    Total
    
    $
    6,599
 Purchase Obligations
  Letters of Credit
  NOTE 10  Acquisitions and Dispositions
 Acquisition of South Texas Properties
   East Texas Acquisitions
   F-28




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Orca Acquisition
  BP Acquisition
  Disposition and Exchange of Appalachian Basin Assets
 KeySpan Exchange and
Offering
  Sale of Onshore South Louisiana Properties
  EnerVest Acquisition
  F-29




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Transworld Exploration and Production Inc. Acquisition
  NOTE 11  Subsequent Events
 Pending
Sale of Texas Gulf of Mexico Assets
  F-30




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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 31,2005
    
    
    2004
    
    
    2003(in thousands)Unevaluated properties, not subject to amortization
    
    $
    107,146
    
    
    $
    122,691
    
    
    $
    134,491Properties subject to amortization
    
    
    3,462,907
    
    
    
    2,705,897
    
    
    
    2,252,852Asset retirement obligations (1)
    
    
    93,848
    
    
    
    71,200
    
    
    
    71,159Capitalized costs
    
    
    3,663,901
    
    
    
    2,899,788
    
    
    
    2,458,502Accumulated depreciation, depletion and amortization
    
    
    (1,649,674
    )
    
    
    (1,355,857
    )
    
    
    (1,092,073
    )Net capitalized costs
    
    $
    2,014,277
    
    
    $
    1,543,931
    
    
    $
    1,366,429
 Additions to Unevaluated Properties
  Costs incurred by Year as of December 31, 2005Total
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    2002 and Prior(in thousands)Property acquisition costs
    
    $
    82,457
    
    
    $
    28,120
    
    
    $
    13,104
    
    
    $
    28,723
    
    
    $
    12,510Exploration and development
    
    
    13,599
    
    
    
    4,429
    
    
    
    1,168
    
    
    
    119
    
    
    
    7,883Capitalized interest
    
    
    11,090
    
    
    
    5,366
    
    
    
    4,052
    
    
    
    1,672
    
    
    
    Total
    
    $
    107,146
    
    
    $
    37,915
    
    
    $
    18,324
    
    
    $
    30,514
    
    
    $
    20,393
 Capitalized Costs Incurred
  As of December 31,2005
    
    
    2004
    
    
    2003(in thousands)Property acquisition and leasehold costsUnevaluated
    
    $
    31,009
    
    
    $
    28,059
    
    
    $
    61,224Proved
    
    
    232,784
    
    
    
    179,281
    
    
    
    170,272Exploration costs
    
    
    112,634
    
    
    
    63,646
    
    
    
    66,259Development costs
    
    
    366,902
    
    
    
    245,971
    
    
    
    162,235743,329
    
    
    
    516,957
    
    
    
    459,990Asset
retirement obligations costs  assumed (1)
    
    
    23,651
    
    
    
    12,116
    
    
    
    31,652Asset
retirement obligations costs  properties sold (1)
    
    
    (32
    )
    
    
    (12,714
    )
    
    
    Asset retirement expenditures
    
    
    (971
    )
    
    
    (2,362
    )
    
    
    Total costs incurred
    
    $
    765,977
    
    
    $
    513,997
    
    
    $
    491,642
 
 (1)
    
    Asset retirement obligation costs reflect abandonment obligations assumed
during the year and revisions to prior estimates. As a result of the disposition of our
South Louisiana and Appalachian Basin assets during 2004, asset retirement obligations were
reduced by $12.7 million. Actual retirement expenditures reflect plugging and abandonment
costs during the year. For 2003, our presentation of asset retirement obligation costs
incurred does not include the cumulative effect of adopting SFAS 143 Asset Retirement
Obligations on January 1, 2003 of $42.5 million.. F-31




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 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 31,2005
    
    
    2004
    
    
    2003(in thousands)Future cash inflows
    
    $
    7,065,492
    
    
    $
    4,558,560
    
    
    $
    4,335,669Future production costs
    
    
    (1,403,934
    )
    
    
    (812,800
    )
    
    
    (764,373
    )Future development costs
    
    
    (874,327
    )
    
    
    (545,192
    )
    
    
    (369,121
    )Future income taxes
    
    
    (1,520,815
    )
    
    
    (976,611
    )
    
    
    (850,264
    )Future net cash flows
    
    
    3,266,416
    
    
    
    2,223,957
    
    
    
    2,351,91110% annual discount for estimated timing of cash flows
    
    
    (1,299,392
    )
    
    
    (783,902
    )
    
    
    (847,505
    )Standardized measure of discounted future net cash flows
    
    $
    1,967,024
    
    
    $
    1,440,055
    
    
    $
    1,504,406
  Present Value of Future Net Cash Flows Relating to Proved Natural Gas and Oil Reserves
  F-32




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  As of December 31,2005
    
    
    2004
    
    
    2003(in thousands)Net present value of future cash flows, before income taxes
    
    $
    2,877,420
    
    
    $
    2,071,976
    
    
    $
    2,056,414Future income taxes, discounted at 10%
    
    
    (910,396
    )
    
    
    (631,921
    )
    
    
    (552,008
    )Standardized measure of discounted future net cash flows
    
    $
    1,967,024
    
    
    $
    1,440,055
    
    
    $
    1,504,406
  As of December 31,2005
    
    
    2004
    
    
    2003(in thousands)Beginning of the year
    
    $
    1,440,055
    
    
    $
    1,504,406
    
    
    $
    1,058,064Revisions in quantities
    
    
    (251,007
    )
    
    
    (59,549
    )
    
    
    (123,954
    )Changes in prices
    
    
    943,487
    
    
    
    (34,170
    )
    
    
    459,373Changes in future development costs
    
    
    (198,013
    )
    
    
    (35,056
    )
    
    
    (13,029
    )Development costs incurred during the period
    
    
    209,322
    
    
    
    85,439
    
    
    
    72,717Extensions and discoveries, net of related costs
    
    
    620,243
    
    
    
    445,908
    
    
    
    434,311Sales of natural gas and oil, net of production costs
    
    
    (787,013
    )
    
    
    (639,555
    )
    
    
    (486,382
    )Accretion of discount
    
    
    207,197
    
    
    
    205,641
    
    
    
    136,492Net change in income taxes
    
    
    (278,475
    )
    
    
    (79,913
    )
    
    
    (245,151
    )Purchase of reserves in place
    
    
    250,520
    
    
    
    247,671
    
    
    
    254,030Sale of reserves in place
    
    
    (4,904
    )
    
    
    (110,877
    )
    
    
    Production timing and other
    
    
    (184,388
    )
    
    
    (89,890
    )
    
    
    (42,065
    )End of year
    
    $
    1,967,024
    
    
    $
    1,440,055
    
    
    $
    1,504,406
 F-33




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Estimated Net Quantities of Natural Gas and Oil Reserves
  Natural Gas  (MMcf)
    
    
    Crude Oil, Liquids and Condensate (MBbls)2005
    
    
    2004
    
    
    2003
    
    
    2005
    
    
    2004
    
    
    2003Beginning of the year reserves
    
    
    749,114
    
    
    
    709,883
    
    
    
    610,409
    
    
    
    7,335
    
    
    
    7,481
    
    
    
    6,533Revisions of previous estimates
    
    
    (66,205
    )
    
    
    (13,232
    )
    
    
    (30,573
    )
    
    
    1,097
    
    
    
    (1,110
    )
    
    
    (1,615
    )Extensions and discoveries
    
    
    135,336
    
    
    
    162,719
    
    
    
    140,632
    
    
    
    1,395
    
    
    
    255
    
    
    
    117Production
    
    
    (105,809
    )
    
    
    (115,855
    )
    
    
    (99,965
    )
    
    
    (1,417
    )
    
    
    (1,355
    )
    
    
    (1,307
    )Purchase of reserves in place
    
    
    81,704
    
    
    
    67,806
    
    
    
    89,380
    
    
    
    3,000
    
    
    
    2,245
    
    
    
    3,753Sales of reserves in place
    
    
    (1,066
    )
    
    
    (62,207
    )
    
    
    
    
    
    
    (119
    )
    
    
    (181
    )
    
    
    End of year reserves
    
    
    793,074
    
    
    
    749,114
    
    
    
    709,883
    
    
    
    11,291
    
    
    
    7,335
    
    
    
    7,481Proved developed reserves:Beginning of year
    
    
    475,080
    
    
    
    487,867
    
    
    
    435,629
    
    
    
    3,535
    
    
    
    4,073
    
    
    
    2,413End of year
    
    
    506,212
    
    
    
    475,080
    
    
    
    487,867
    
    
    
    6,933
    
    
    
    3,535
    
    
    
    4,073Natural Gas Equivalents (MMcfe)2005
    
    
    2004
    
    
    2003Beginning of year reserves
    
    
    793,124
    
    
    
    754,769
    
    
    
    649,607Revisions of previous estimates
    
    
    (59,623
    )
    
    
    (19,892
    )
    
    
    (40,263
    )Extensions and discoveries
    
    
    143,706
    
    
    
    164,249
    
    
    
    141,334Production
    
    
    (114,311
    )
    
    
    (123,985
    )
    
    
    (107,807
    )Purchase of reserves in place
    
    
    99,704
    
    
    
    81,276
    
    
    
    111,898Sales of reserves in place
    
    
    (1,780
    )
    
    
    (63,293
    )
    
    
    End of year reserves
    
    
    860,820
    
    
    
    793,124
    
    
    
    754,769Proved developed reserves:Beginning of year
    
    
    496,290
    
    
    
    512,305
    
    
    
    450,107End of year
    
    
    547,810
    
    
    
    496,290
    
    
    
    512,305
 F-34




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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 Quarter2005Total revenues(1)
    
    $
    165,720
    
    
    $
    175,817
    
    
    $
    125,413
    
    
    $
    154,593Total operating expenses (2)
    
    
    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 (4)
    
    $
    1.17
    
    
    $
    1.53
    
    
    $
    0.28
    
    
    $
    0.69Net income
per share  diluted (4)
    
    $
    1.16
    
    
    $
    1.51
    
    
    $
    0.28
    
    
    $
    0.692004Total revenues
    
    $
    151,882
    
    
    $
    172,776
    
    
    $
    162,760
    
    
    $
    163,021Total operating expenses (3)
    
    
    86,839
    
    
    
    97,702
    
    
    
    94,366
    
    
    
    103,719Income from operations
    
    
    65,043
    
    
    
    75,074
    
    
    
    68,394
    
    
    
    59,302Net income
    
    
    39,690
    
    
    
    45,350
    
    
    
    42,998
    
    
    
    34,786Net income
per share  basic (4)
    
    $
    1.26
    
    
    $
    1.49
    
    
    $
    1.53
    
    
    $
    1.23Net income
per share  diluted (4)
    
    $
    1.25
    
    
    $
    1.47
    
    
    $
    1.51
    
    
    $
    1.21
 
 (1)
    
    For the fourth quarter of 2005, total revenues includes a net loss of $116.5 million
from hedging activities which includes the following items: a $164.5 million loss realized on
contracts settled during fourth quarter; 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; 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.(2)
    
    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.(3)
    
    During the fourth quarter of 2004, as a result of management organizational changes
made within our company in November 2004, we recognized additional general and administrative
expense of $5.1 million. The additional compensation expenses were a result of lump-sum
severance payments and entitlements under executive employment agreements, including expenses
related to the accelerated vesting of stock options and restricted stock. See Note 6 
Subsequent Events  Lump Sum Payments to Executives Under Employment Contracts.(4)
    
    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-35




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##### Table of Contents



INDEX TO EXHIBITS
 EXHIBITS
    
    
    
    DESCRIPTION3.1
    
    
    
    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(1)
    
    
    
    Restated Bylaws of The Houston Exploration Company.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 on April 26, 2005
(file No. 001-11899) and incorporated by reference herein).4.4
    
    
    
    Form of Certificate of Designation of Series A Junior Participation 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(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).10.3(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, 2006.10.4(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).10.5(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).10.6(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).10.7(2)
    
    
    
    Amendment to The Houston Exploration Company Executive Deferred Compensation
Plan (filed as exhibit 99.2 to our Current Report on Form 8-K file dated January 31, 2006
(File No. 001-11899) and incorporated by reference).10.8(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).10.9(2)
    
    
    
    Amended and Restated 2004 Long Term Incentive Plan (filed as exhibit 99.1 to our Current Report on
Form 8-K file dated January 31, 2006 (File No. 001-11899) and incorporated by reference).
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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION10.10(2)
    
    
    
    Supplemental Executive Retirement Plan dated January 1, 2006 (filed as exhibit 99.1 to our Current
Report on Form 8-K dated January 6, 2006 (File No. 001-11899) and incorporated by reference).10.11(2)
    
    
    
    Employment Agreement dated July 16, 2001 between The Houston Exploration Company and Tracy Price
(filed as Exhibit 10.1 to our Quarterly Report on Form 10-Q for the quarter ended September 30,
2001 (File No. 001-11899) and incorporated by reference).10.12(2)
    
    
    
    Employment Agreement dated September 29, 2003 between The Houston Exploration Company and Timothy
R. Lindsey (filed as Exhibit 10.3 to our Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003 (File No. 001-11899) and incorporated by reference).10.13(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).10.14(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).10.15(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and John H.
Karnes 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).10.16(2)
    
    
    
    Separation Agreement and General Release dated December 8, 2005 between the 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) .10.17(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).10.18(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).10.19(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).10.20(2)
    
    
    
    Employment Agreement effective March 10, 2005, between John E. Bergeron, Jr. and The Houston
Exploration Company (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).10.21(2)
    
    
    
    Employment Agreement effective April 13, 2005, between Jeffrey B. Sherrick and The Houston
Exploration Company (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).10.22(2)
    
    
    
    Employment Agreement dated January 18, 2006 between Robert T. Ray and The Houston Exploration
Company (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).10.23(2)
    
    
    
    Compensation Table for Executive Officers (filed as Exhibit 10.2 to our Quarterly Report on Form
10-Q for the period ended September 30, 2005 (File No. 001-11899) and incorporated by reference).10.24(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).10.25
    
    
    
    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 (Exhibit 2.1 to Current
Report on Form 8-K dated October 15, 2003 (file No. 001-11899) and incorporated by reference).
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##### Table of Contents



EXHIBITS
    
    
    
    DESCRIPTION10.26
    
    
    
    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).10.27
    
    
    
    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).10.28
    
    
    
    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).10.29
    
    
    
    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).10.30
    
    
    
    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).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. F-38