##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-K/A
 AMENDMENT NO. 1
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File No. 001-11899
 
 THE HOUSTON EXPLORATION COMPANY
 (Exact name of registrant as specified in its charter)
 Delaware
(State or Other Jurisdiction of 
Incorporation or Organization)
    
    22-2674487
(IRS Employer
Identification No.)1100 Louisiana, Suite 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, $0.01 par value
    
    New York Stock ExchangeSeries A Junior Participating Preferred Stock, $0.01 par value
    
    New York Stock Exchange
 Securities Registered Pursuant to Section 12(g) of the Act: None
 þ o
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  þ o o
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  DOCUMENTS INCORPORATED BY REFERENCE




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EXPLANATORY NOTE
  
    
    To amend paragraph five of the Report of Independent Registered Public Accounting Firm to correctly
reflect the date of the opinion related to Houston Explorations maintaining, in all material respects,
effective internal control over financial reporting as December 31, 2006.
   -1-




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TABLE OF CONTENTS
 Part IV.
    
    
    3Item 15. Exhibits, Financial Statement Schedules
    
    
    3Signatures
    
    
    9Index to Financial Statements
    
    
    F-1
 -2-




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Part IV.
 
 Item 15 . Exhibits, Financial Statement Schedules
  1. Financial Statements:
 PAGEIndex to Financial Statements
    
    F-1Managements Report on Internal Controls Over Financial Reporting
    
    F-2Report of Independent Registered Public Accounting Firm
    
    F-3Consolidated Balance Sheets as of December 31, 2006 and 2005
    
    F-4Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005 and 2004
    
    F-5Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) for the Period
January 1, 2004 to December 31, 2006
    
    F-6Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
    
    F-7Notes to Consolidated Financial Statements
    
    F-8Supplemental Information on Natural Gas and Oil Exploration, Development and
Production Activities (unaudited)
    
    F-39Quarterly Financial Information (Unaudited)
    
    F-42
   2. Exhibits:
 INDEX TO EXHIBITS
 EXHIBITS
    
    
    
    DESCRIPTION2.1
    
    
    
    Agreement and Plan of Merger dated as of January 7, 2007 by and among the Company, Forest
Oil Corporation and MJCO Corporation (filed as exhibit 2.1 to our Current Report on Form
8-K dated January 7, 2007 (file No. 001-11899) and incorporated by reference herein).3.1
    
    
    
    Restated Certificate of Incorporation, as amended, including the Certificate of Amendment
thereto dated April 26, 2005 (filed as exhibit 3.1 to our Quarterly Report on Form 10-Q
for the period ended March 31, 2005 (file No. 001-11899) and incorporated by reference
herein).3.2
    
    
    
    Restated Bylaws of The Houston Exploration Company (filed as Exhibit 3.2 to our Annual
Report on Form 10-K for the year ended December 31, 2005 (File No.001-11899) and
incorporated by reference).4.1
    
    
    
    Indenture, dated as of June 10, 2003, between The Houston Exploration Company and the
Bank of New York, as Trustee, with respect to the 7% Senior Subordinated Notes due 2013
(filed as Exhibit 4.2 to our Registration Statement on Form S-4 (Registration No.
333-106836) and incorporated by reference).4.2
    
    
    
    Rights Agreement, dated as of August 12, 2004, between The Houston Exploration Company
and The Bank of New York, as Rights Agent (filed as Exhibit 4.1 to our Current Report on
Form 8-K dated August 13, 2004 (File No. 001-11899) and incorporated by reference).4.3
    
    
    
    First Amendment dated as of May 2, 2005, to the Rights Agreement dated as of August 12,
2004 between The Houston Exploration Company and The Bank of New York, as Rights Agent
(filed as exhibit 4.1 to our Quarterly Report on Form 10-Q for the period ended March 31,
2005 (file No. 001-11899) and incorporated by reference herein).4.4
    
    
    
    Second Amendment to Rights Agreement dated as of January 7, 2007 between The Houston
Exploration Company and The Bank of New York, as Rights Agent (filed as exhibit 4.1 to
our Current Report on Form 8-K dated January 7, 2007 (file No. 001-11899) and
incorporated by reference herein).
 -3-




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EXHIBITS
    
    
    
    DESCRIPTION4.5
    
    
    
    Form of Certificate of Designation of Series A Junior Participating Preferred Stock of
The Houston Exploration Company (filed as Exhibit 4.2 to our Current Report on Form 8-K
dated August 13, 2004 (File No. 001-11899) and incorporated by reference).10.1
    
    
    
    Amended and Restated Credit Agreement dated November 30, 2005 among The Houston
Exploration Company and Wachovia Bank, National Association, as Issuing Bank and
Administrative Agent; The Bank of Nova Scotia and Bank of America as Co-Syndication
Agents; and BNP Paribas and Comerica Bank as Co-Documentation Agents (filed as exhibit
99.1 to our Current Report on Form 8-K dated November 30, 2005 (File No. 001-11899) and
incorporated by reference).10.2
    
    
    
    First Amendment to Amended and Restated Credit Agreement effective May 31, 2006 among The
Houston Exploration Company and Wachovia Bank, National Association, as Issuing Bank and
Administrative Agent; The Bank of Nova Scotia and Bank of America as Co-Syndication
Agents; and BNP Paribas and Comerica Bank as Co-Documentation Agents (filed as Exhibit
10.1 to our Quarterly Report on Form 10-Q for the period ended June 30, 2006 (File No.
001-11899) and incorporated by reference).10.3
    
    
    
    Purchase and Sale Agreement, dated September 3, 2003, by and among Transworld Exploration
and Production, Inc., as Seller, and The Houston Exploration Company, as Buyer (filed as
Exhibit 2.1 to our Current Report on Form 8-K dated October 15, 2003 (file No. 001-11899)
and incorporated by reference).10.4
    
    
    
    Asset Contribution Agreement dated June 2, 2004 between The Houston Exploration Company
and Seneca-Upshur Petroleum, Inc. (filed as Exhibit 99.3 to our Current Report on Form
8-K dated June 30, 2004 (File No. 001-11899) and incorporated by reference).10.5
    
    
    
    Tax Matters Agreement dated as of June 2, 2004 by and among The Houston Exploration
Company, Seneca-Upshur Petroleum, Inc., THEC Holdings Corp., and KeySpan Corporation
(filed as Exhibit 99.4 to our Current Report on Form 8-K dated June 30, 2004 (File No.
001-11899) and incorporated by reference).10.6
    
    
    
    Distribution Agreement dated as of June 2, 2004 by and among The Houston Exploration
Company, Seneca-Upshur Petroleum, Inc., THEC Holdings Corp. and KeySpan Corporation
(filed as Exhibit 99.2 to our Current Report on Form 8-K dated June 30, 2004 (File No.
001-11899) and incorporated by reference).10.7
    
    
    
    Purchase and Sale Agreement, dated September 17, 2004, between The Houston Exploration
Company and Orca Energy, L.P. (filed as Exhibit 2.1 to our Current Report on Form 8-K
dated November 1, 2004 (File No. 001-11899) and incorporated by reference).10.8
    
    
    
    Purchase and Sale Agreement dated October 21, 2005 by and between Kerr-McGee Oil & Gas
Onshore LP D/B/A KMOG Onshore LP and Westport Oil and Gas Company, L.P., as sellers, and
The Houston Exploration Company, as buyer, (filed as exhibit 99.2 to our Current Report
on Form 8-K dated November 30, 2005 (File No. 001-11899) and incorporated by reference).10.9
    
    
    
    Purchase and Sale Agreement dated February 28, 2006 between The Houston Exploration
Company, as seller, and Merit Management Partners I, L.P., Merit Management Partners II,
L.P., Merit Management Partners III, L.P., Merit Energy Partners III, L.P., Merit Energy
Partners D-III, L.P., Merit Energy Partners E-III, L.P. and Merit Energy Partners F-III,
L.P., collectively, as buyer (filed as Exhibit 10.1 to our Quarterly Report on Form 10-Q
for the period ended March 31, 2006 (File No. 001-11899) and incorporated by reference).10.10
    
    
    
    Purchase and Sale Agreement dated April 7, 2006 between The Houston Exploration Company,
as seller, and Merit Management Partners I, L.P., Merit Management Partners II, L.P.,
Merit Management Partners III, L.P., Merit Energy Partners III, L.P., Merit Energy
Partners D-III, L.P., Merit Energy Partners E-III, L.P. and Merit Energy Partners F-III,
L.P., collectively, as buyer (filed as Exhibit 99.1 to our Current Report on Form 8-K
dated June 2, 2006 (File No. 001-11899) and incorporated by reference).
 -4-




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EXHIBITS
    
    
    
    DESCRIPTION10.11(2)
    
    
    
    Deferred Compensation Plan for Non-Employee Directors (filed as Exhibit 10.24 to our
Annual Report on Form 10-K for the year ended December 31, 1997 (File No. 001-11899) and
incorporated by reference).10.12(2)
    
    
    
    Amendment dated April 26, 2005, but effective as of December 31, 2004, to The Houston
Exploration Company Non-Employee Director Deferred Compensation Plan (filed as Exhibit
10.4 to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and
incorporated by reference).10.13(2)
    
    
    
    The Houston Exploration Company Post-2004, AJCA Compliant Deferred Compensation Plan for
Non-Employee Directors dated April 26, 2005, effective as of January 1, 2005 (filed as
Exhibit 10.5 to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899)
and incorporated by reference).10.14(2)
    
    
    
    Compensation Table for Non-Employee Directors, effective January 1, 2006 (filed as
exhibit 99.2 to our Current Report on Form 8-K dated January 6, 2006.10.15(2)
    
    
    
    Amended and Restated 1996 Stock Option Plan (filed as Exhibit 10.1 to our Quarterly
Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 001-11899) and
incorporated by reference).10.16(2)
    
    
    
    1999 Non-Qualified Stock Option Plan dated October 26, 1999 (filed as Exhibit 10.24 to
our Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 001-11899)
and incorporated by reference).10.17(2)
    
    
    
    Amended and Restated 2002 Long-Term Incentive Plan effective May 17, 2002, adopted
October 26, 2003 (filed as Exhibit 10.31 to our Annual Report on Form 10-K for the year
ended December 31, 2003 (file No. 001-11899) and incorporated by reference).10.18(2)
    
    
    
    Amended and Restated 2004 Long Term Incentive Plan (filed as exhibit 99.1 to our Current
Report on Form 8-K dated January 31, 2006 (File No. 001-11899) and incorporated by
reference).10.19(2)
    
    
    
    Supplemental Executive Pension Plan dated May 1, 1996 (filed as exhibit 10.23 to our
Registration Statement on Form S-1/A (Amendment No. 2) (Registration No. 333-4437) and
incorporated by reference).10.20(2)
    
    
    
    The Houston Exploration Company Supplemental Executive Retirement Plan (Amended and
Restated on July 25, 2006) (filed as Exhibit 10.1 to our Current Report on Form 8-K dated
July 31, 2006 (File No. 001-11899) and incorporated by reference).10.21(2)
    
    
    
    First Amendment to The Houston Exploration Company Supplemental Executive Retirement Plan
(filed as exhibit 10.3 to our Current Report on Form 8-K dated January 7, 2007 (file No.
001-11899) and incorporated by reference herein).10.22(2)
    
    
    
    Executive Deferred Compensation Plan dated January 1, 2002 (filed as Exhibit 10.28 to our
Annual Report on Form 10-K for the year ended December 31, 2002 (File No. 001-11899) and
incorporated by reference).10.23(2)
    
    
    
    Amendment [No. 1] to The Houston Exploration Company Executive Deferred Compensation Plan
(filed as exhibit 99.2 to our Current Report on Form 8-K dated January 31, 2006 (File No.
001-11899) and incorporated by reference).10.24(2)
    
    
    
    Amendment No. 2 dated July 25, 2006, but effective as of December 31, 2004, to The
Houston Exploration Company Executive Deferred Compensation Plan (filed as Exhibit 10.2
to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and
incorporated by reference).10.25(2)
    
    
    
    The Houston Exploration Company 2005 Executive Deferred Compensation Plan (filed as
Exhibit 10.3 to our Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899)
and incorporated by reference).10.26(2)
    
    
    
    Amended and Restated Employment Agreement dated February 8, 2005 between The Houston
Exploration Company and William G. Hargett (filed as Exhibit 10.1 to our Current Report
on Form 8-K dated February 8, 2005 (File No. 001-11899) and incorporated by reference).
 -5-




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EXHIBITS
    
    
    
    DESCRIPTION10.27(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and William G. Hargett
(filed as Exhibit 10.1 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.38(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and
Steven L. Mueller dated February 8, 2005 (filed as Exhibit 10.19 to our Annual Report on
Form 10-K for the year ended December 31, 2004 (File No. 001-11899) and incorporated by
reference).10.29(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and Steven L. Mueller
(filed as Exhibit 10.2 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.30(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and
John H. Karnes dated February 8, 2005 (filed as Exhibit 10.20 to our Annual Report on
Form 10-K for the year ended December 31, 2004 (File No. 001-11899) and incorporated by
reference).10.31(2)
    
    
    
    Separation Agreement and General Release dated December 8, 2005 between The Houston
Exploration Company and John H. Karnes (filed as exhibit 99.1 to our Current Report on
Form 8-K dated December 12, 2005 (File No. 001-11899) and incorporated by reference).10.32(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and
James F. Westmoreland dated February 8, 2005 (filed as Exhibit 10.21 to our Annual Report
on Form 10-K for the year ended December 31, 2004 (File No. 001-11899) and incorporated
by reference).10.33(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and James F. Westmoreland
(filed as Exhibit 10.7 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.34(2)
    
    
    
    Amended and Restated Employment Agreement between The Houston Exploration Company and
Roger B. Rice dated February 8, 2005 (filed as Exhibit 10.22 to our Annual Report on Form
10-K for the year ended December 31, 2004 (File No. 001-11899) and incorporated by
reference).10.35(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Amended and Restated Employment Agreement
dated February 8, 2005 between The Houston Exploration Company and Roger B. Rice (filed
as Exhibit 10.5 to our Current Report on Form 8-K dated October 27, 2006 (File No.
001-11899) and incorporated by reference).10.36(2)
    
    
    
    Employment Agreement dated February 10, 2005 between The Houston Exploration Company and
Joanne C. Hresko (filed as Exhibit 10.3 to our Current Report on Form 8-K dated February
8, 2005 (File No. 001-11899) and incorporated by reference).10.37(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated February 10,
2005, between The Houston Exploration Company and Joanne C. Hresko (filed as Exhibit 10.8
to our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and
incorporated by reference).10.38(2)
    
    
    
    Employment Agreement effective March 10, 2005, between The Houston Exploration Company
and John E. Bergeron, Jr. (filed as exhibit 99.2 to our Current Report on Form 8-K dated
March 10, 2005 (File No. 001-11899) and incorporated by reference).10.39(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated March 10,
2005, between The Houston Exploration Company and John E. Bergeron, Jr. (filed as Exhibit
10.9 to our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and
incorporated by reference).
 -6-




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EXHIBITS
    
    
    
    DESCRIPTION10.40(2)
    
    
    
    Employment Agreement effective April 13, 2005, between The Houston Exploration Company
and Jeffrey B. Sherrick (filed as exhibit 99.2 to our Current Report on Form 8-K dated
April 13, 2005 (File No. 001-11899) and incorporated by reference).10.41(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated April 13,
2005, between The Houston Exploration Company and Jeffrey B. Sherrick (filed as Exhibit
10.6 to our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and
incorporated by reference).10.42(2)
    
    
    
    Employment Agreement dated January 18, 2006 between The Houston Exploration Company and
Robert T. Ray (filed as exhibit 99.1 to our Current Report on Form 8-K dated January 18,
2006 (File No. 001-11899) and incorporated by reference).10.43(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated January 18,
2006, between The Houston Exploration Company and Robert T. Ray (filed as Exhibit 10.3 to
our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and
incorporated by reference).10.44(2)
    
    
    
    Employment Agreement dated March 27, 2006 between The Houston Exploration Company and
Carolyn M. Campbell (filed as Exhibit 99.1 to our Current Report on Form 8-K dated March
27, 2006 (File No. 001-11899) and incorporated by reference).10.45(2)
    
    
    
    Amendment No. 1, dated October 24, 2006, to the Employment Agreement dated March 27,
2006, between The Houston Exploration Company and Carolyn M. Campbell (filed as Exhibit
10.4 to our Current Report on Form 8-K dated October 27, 2006 (File No. 001-11899) and
incorporated by reference).10.46
    
    
    
    Form of Amendment No. 2 to [Amended and Restated] Employment Agreement entered into by
and between The Houston Exploration Company and each of William G. Hargett, Steven L.
Mueller, James F. Westmoreland, Roger B. Rice, Joanne C. Hresko, John E. Bergeron Jr.,
Jeffrey B. Sherrick, Robert T. Ray and Carolyn M. Campbell (filed as Exhibit 10.1 to our
Current Report on Form 8-K dated January 7, 2007 (file No. 001-11899) and incorporated by
reference herein).10.47(2)
    
    
    
    Change of Control Plan dated October 26, 1999 (filed as Exhibit 10.25 to our Annual
Report on Form 10-K for the year ended December 31, 1999 (File No. 001-11899) and
incorporated by reference).10.48(2)
    
    
    
    First Amendment to The Houston Exploration Company Change of Control Plan dated May 17,
2002 (filed as Exhibit 10.48 to our Annual Report on Form 10-K for the year ended
December 31, 2006 (File No. 001-11899) and incorporated by reference).10.49(2)
    
    
    
    Second Amendment to The Houston Exploration Company Change of Control Plan (filed as
exhibit 10.4 to our Current Report on Form 8-K dated January 7, 2007 (file No. 001-11899)
and incorporated by reference herein).10.50(2)
    
    
    
    Form of Indemnification Agreement for Directors and Executive Officers (filed as Exhibit
10.8 to our Quarterly Report on Form 10-Q for the period ended June 30, 2006 (File No.
001-11899) and incorporated by reference).10.51(2)
    
    
    
    Form of Non-Qualified Stock Option Agreement (filed as Exhibit 10.9 to our Quarterly
Report on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and
incorporated by reference).10.52(2)
    
    
    
    Form of Director Restricted Stock Award Agreement (filed as Exhibit 10.10 to our
Quarterly Report on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and
incorporated by reference).10.53(2)
    
    
    
    Form of Employee Restricted Stock Award Agreement (filed as Exhibit 10.11 to our
Quarterly Report on Form 10-Q for the period ended June 30, 2006 (File No. 001-11899) and
incorporated by reference).12.1
    
    
    
    Computation of ratio of earnings to fixed charges (filed as Exhibit 10.48 to our Annual
Report on Form 10-K for the year ended December 31, 2006 (File No. 001-11899) and
incorporated by reference).21.1
    
    
    
    Subsidiaries of The Houston Exploration Company (filed as Exhibit 10.48 to our Annual
Report on Form 10-K for the year ended December 31, 2006 (File No. 001-11899) and
incorporated by reference).
 -7-




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EXHIBITS
    
    
    
    DESCRIPTION23.1
    
    
    
    Consent of Deloitte & Touche LLP (filed as Exhibit 23.1 to our Annual Report on Form 10-K
for the year ended December 31, 2006 (File No. 001-11899)
and incorporated by reference).23.2
    
    
    
    Consent of Netherland, Sewell & Associates (filed as Exhibit 23.2 to our Annual Report on
Form 10-K for the year ended December 31, 2006 (File No. 001-11899) and incorporated by
reference).23.3
    
    
    
    Consent of Miller and Lents (filed as Exhibit 23.3 to our Annual Report on Form 10-K for
the year ended December 31, 2006 (File No. 001-11899) and
incorporated by reference).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. -8-




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SIGNATURES
  THE HOUSTON EXPLORATION COMPANYBy:
    /s/ William G. HargettWilliam G. HargettDate: March 2, 2007
    
    President and Chief Executive Officer -9-




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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 2, 2007/s/ Robert T. Ray

Robert T. Ray
    
    Senior Vice President and Chief Financial
Officer
(Principal Financial Officer)
    
    March 2, 2007/s/ James F. Westmoreland

James F. Westmoreland
    
    Vice President and Chief Accounting Officer
(Principal Accounting Officer)
    
    March 2, 2007/s/ *

Robert B. Catell
    
    Director
    
    March 2, 2007/s/ *

John U. Clarke
    
    Director
    
    March 2, 2007/s/ *

David G. Elkins
    
    Director
    
    March 2, 2007/s/ *

Harold R. Logan, Jr.
    
    Director
    
    March 2, 2007/s/ *

Thomas A. McKeever
    
    Director
    
    March 2, 2007/s/ *

Stephen W. McKessy
    
    Director
    
    March 2, 2007/s/ *

Donald C. Vaughn
    
    Director
    
    March 2, 2007
 By:
    
    *James F. Westmoreland

James F. Westmoreland
    
    * Attorney-in-Fact
    
    March 2, 2007
 -10-




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Index to Financial Statements
 PAGEManagements Report on Internal Controls Over Financial Reporting.
    
    F-2Report of Independent Registered Public Accounting Firm.
    
    F-3Consolidated Balance Sheets as of December 31, 2006 and 2005.
    
    F-4Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005and 2004.
    
    F-5Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) for the
Period January 1, 2004 to December 31, 2006.
    
    F-6Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004
    
    F-7Notes to Consolidated Financial Statements.
    
    F-8Supplemental Information on Natural Gas and Oil Exploration, Development and Production
Activities (Unaudited).
    
    F-39Quarterly Financial Information (Unaudited).
    
    F-42
 F-1




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




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##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   
    
    on base rate loans, at a fluctuating rate, or base rate, equal to the sum of (a)
the greater of the Federal funds rate plus 0.5% or Wachovias prime rate plus (b) a variable
margin between 0.00% and 0.50%, depending on the amount of borrowings outstanding under the
credit facility, or
    
    on fixed rate loans, a fixed rate equal to the sum of (a) a quoted LIBOR rate
divided by one minus the average maximum rate during the interest period set for certain
reserves of member banks of the Federal Reserve System in
Dallas, Texas, plus (b) a variable margin between 1.00% and 1.75%, depending on the amount of
borrowings outstanding under the credit facility.
   
    
    maintain a ratio of earnings before interest, taxes, depreciation, depletion and
amortization (EBITDA) to cash interest payments of at least 3.00 to 1.00;
    
    maintain a ratio of total debt to EBITDA of not more than 3.50 to 1.00; and
    
    hedge no more than 85% of our projected production during any calendar year.
  Senior Subordinated Notes
   
    
    incurrence of additional indebtedness and issuance of preferred stock;
    
    repayment of certain other indebtedness;
    
    payment of dividends or certain other distributions;
    
    investments and repurchases of equity;
    
    use of the proceeds of assets sales;
    
    transactions with affiliates;
    
    creation, incurrence or assumption of liens;
    
    merger or consolidation and sales or other dispositions of all or substantially all of our assets;
    
    entering into agreements that restrict the ability of our subsidiary to make certain distributions or payments; or
    
    guarantees by our subsidiary of certain indebtedness.
 F-18




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




---



##### 



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




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##### 



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




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##### 



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




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##### 



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




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##### 



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




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##### 



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




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##### 



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




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##### 



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 31,2006
    
    
    2005
    
    
    2004(in thousands)Future cash inflows
    
    $
    3,547,732
    
    
    $
    7,065,492
    
    
    $
    4,558,560Future production costs
    
    
    (957,940
    )
    
    
    (1,403,934
    )
    
    
    (812,800
    )Future development costs
    
    
    (594,544
    )
    
    
    (874,327
    )
    
    
    (545,192
    )Future income taxes
    
    
    (555,522
    )
    
    
    (1,520,815
    )
    
    
    (976,611
    )Future net cash flows
    
    
    1,439,726
    
    
    
    3,266,416
    
    
    
    2,223,95710% annual discount for estimated timing of cash flows
    
    
    (702,500
    )
    
    
    (1,299,392
    )
    
    
    (783,902
    )Standardized measure of discounted future net cash flows
    
    $
    737,226
    
    
    $
    1,967,024
    
    
    $
    1,440,055
   F-40




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##### 



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




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##### 



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