##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File No. 001-11899
 
 THE HOUSTON EXPLORATION COMPANY
 (Exact name of registrant as specified in its charter)
 Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
    
    22-2674487
(IRS Employer Identification No.)1100 Louisiana, Suite 2000
Houston, Texas
(Address of Principal Executive Offices)
    
    77002-5215
(Zip Code)
 (713) 830-6800
(Registrants Telephone Number, including Area Code)
 
 þ o
  þ o o
 o þ




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TABLE OF CONTENTS
 Forward-Looking Statements
    
    
    2Available Information
    
    
    2Part I. Financial Information
    
    
    3Item 1. Condensed Consolidated Financial Statements
    
    
    3Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    34Item 4. Controls and Procedures
    
    
    36Part II. Other Information
    
    
    37Item 1. Legal Proceedings
    
    
    37Item 1A. Risk Factors
    
    
    37Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    38Item 4. Submission of Matters to a Vote of Security Holders
    
    
    38Item 6. Exhibits
    
    
    38SIGNATURES
    
    
    40First Amendment to Amended and Restated Credit AgreementForm of Indemnification AgreementForm of Non-Qualified Stock Option AgreementForm of Director Restricted Stock Award AgreementForm of Employee Restricted Stock Award AgreementComputation of ratio of earnings to fixed chargesCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  -1-




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




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##### Table of Contents



Part I. Financial Information
 
 Item 1. Condensed Consolidated Financial Statements
 THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED BALANCE SHEETS
 June 30,
    
    
    December 31,2006
    
    
    2005Assets:Cash and cash equivalents
    
    $
    3,488
    
    
    $
    7,979Accounts receivable
    
    
    83,390
    
    
    
    146,020Inventories
    
    
    4,215
    
    
    
    2,726Deferred tax asset
    
    
    67,439
    
    
    
    145,922Prepayments and other
    
    
    15,549
    
    
    
    19,709Total current assets
    
    
    174,081
    
    
    
    322,356Natural gas and oil properties, full cost methodUnevaluated properties
    
    
    39,381
    
    
    
    107,146Properties subject to amortization
    
    
    3,129,560
    
    
    
    3,556,755Other property and equipment
    
    
    13,880
    
    
    
    12,9713,182,821
    
    
    
    3,676,872Less: Accumulated depreciation, depletion and amortization
    
    
    1,799,997
    
    
    
    1,658,5321,382,824
    
    
    
    2,018,340Designated cash
    
    
    323,675
    
    
    
    Other non-current assets
    
    
    16,730
    
    
    
    20,928Total non-current assets
    
    
    340,405
    
    
    
    20,928Total Assets
    
    $
    1,897,310
    
    
    $
    2,361,624Liabilities:Accounts payable and accrued expenses
    
    $
    185,743
    
    
    $
    177,159Derivative financial instruments
    
    
    44,165
    
    
    
    352,457Asset retirement obligation
    
    
    
    
    
    
    7,265Total current liabilities
    
    
    229,908
    
    
    
    536,881Long-term debt and notes
    
    
    275,000
    
    
    
    597,000Derivative financial instruments
    
    
    36,928
    
    
    
    65,201Deferred income taxes
    
    
    410,511
    
    
    
    341,302Asset retirement obligation
    
    
    36,868
    
    
    
    112,406Other non-current liabilities
    
    
    10,648
    
    
    
    15,696Total Liabilities
    
    
    999,863
    
    
    
    1,668,486Commitments and Contingencies (see Note 4)Stockholders Equity:Preferred Stock, $0.01 par value, 5,000,000 shares authorized and no shares issued
    
    
    
    
    
    
    Common Stock, $0.01 par value, 100,000,000 shares authorized and 27,942,610 and
28,980,128 shares issued and outstanding at June 30, 2006 and December 31, 2005,
respectively
    
    
    279
    
    
    
    289Additional paid-in capital
    
    
    245,100
    
    
    
    297,218Retained earnings
    
    
    716,510
    
    
    
    663,367Accumulated other comprehensive (loss)
    
    
    (64,442
    )
    
    
    (267,736
    )Total Stockholders Equity
    
    
    897,447
    
    
    
    693,138Total Liabilities and Stockholders Equity
    
    $
    1,897,310
    
    
    $
    2,361,624
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THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenues:Natural gas and oil revenues
    
    $
    143,813
    
    
    $
    175,524
    
    
    $
    320,832
    
    
    $
    341,014Other
    
    
    2,101
    
    
    
    293
    
    
    
    2,686
    
    
    
    523Total revenues
    
    
    145,914
    
    
    
    175,817
    
    
    
    323,518
    
    
    
    341,537Operating expenses:Lease operating
    
    
    18,032
    
    
    
    19,124
    
    
    
    39,844
    
    
    
    34,492Severance tax
    
    
    4,830
    
    
    
    4,530
    
    
    
    10,989
    
    
    
    7,464Transportation expense
    
    
    2,859
    
    
    
    2,993
    
    
    
    5,630
    
    
    
    5,759Asset retirement accretion expense
    
    
    1,069
    
    
    
    1,326
    
    
    
    2,396
    
    
    
    2,651Depreciation, depletion and amortization
    
    
    57,858
    
    
    
    71,944
    
    
    
    141,619
    
    
    
    142,547General and administrative, net of
amounts capitalized
    
    
    8,705
    
    
    
    6,200
    
    
    
    17,311
    
    
    
    17,323Total operating expenses
    
    
    93,353
    
    
    
    106,117
    
    
    
    217,789
    
    
    
    210,236Income from operations
    
    
    52,561
    
    
    
    69,700
    
    
    
    105,729
    
    
    
    131,301Other (income) expense
    
    
    (791
    )
    
    
    (1,067
    )
    
    
    (2,198
    )
    
    
    387Interest expense, net of amounts capitalized
    
    
    6,451
    
    
    
    3,196
    
    
    
    15,172
    
    
    
    6,630Income before income taxes
    
    
    46,901
    
    
    
    67,571
    
    
    
    92,755
    
    
    
    124,284Provision for taxes
    
    
    23,530
    
    
    
    23,741
    
    
    
    39,612
    
    
    
    47,016Net income
    
    $
    23,371
    
    
    $
    43,830
    
    
    $
    53,143
    
    
    $
    77,268Earnings per share:Net income per share  basic
    
    $
    0.82
    
    
    $
    1.53
    
    
    $
    1.85
    
    
    $
    2.70Net income per share  diluted
    
    $
    0.81
    
    
    $
    1.51
    
    
    $
    1.84
    
    
    $
    2.67Weighted average shares outstanding  basic
    
    
    28,625
    
    
    
    28,679
    
    
    
    28,770
    
    
    
    28,589Weighted average shares outstanding  diluted
    
    
    28,678
    
    
    
    28,973
    
    
    
    28,824
    
    
    
    28,920
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THE HOUSTON EXPLORATION COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS
 Six Months Ended June 30,2006
    
    
    2005Operating Activities:Net income
    
    $
    53,143
    
    
    $
    77,268Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation, depletion and amortization
    
    
    141,619
    
    
    
    142,547Deferred income tax expense
    
    
    36,293
    
    
    
    30,988Asset retirement accretion expense
    
    
    2,396
    
    
    
    2,651Stock compensation expense
    
    
    4,872
    
    
    
    2,022Tax benefit from non-qualified stock options
    
    
    
    
    
    
    1,881Unrealized (gain) loss on derivative instruments
    
    
    (21,871
    )
    
    
    1,424Debt extinguishment
    
    
    572
    
    
    
    Changes in operating assets and liabilities:Accounts receivable
    
    
    62,630
    
    
    
    1,063Inventories
    
    
    (1,489
    )
    
    
    (663
    )Prepayments and other
    
    
    4,160
    
    
    
    6,397Other non-current assets
    
    
    3,825
    
    
    
    1,411Accounts payable and accrued expenses
    
    
    (27,795
    )
    
    
    (11,160
    )Other non-current liabilities
    
    
    (5,048
    )
    
    
    1,363Net cash provided by operating activities
    
    
    253,307
    
    
    
    257,192Investing Activities:Investment in property and equipment
    
    
    (278,572
    )
    
    
    (254,836
    )Designated cash
    
    
    (323,675
    )
    
    
    Dispositions and other
    
    
    723,648
    
    
    
    165Net cash provided by (used in) investing activities
    
    
    121,401
    
    
    
    (254,671
    )Financing Activities:Proceeds from long-term borrowings
    
    
    340,000
    
    
    
    207,000Repayments of long-term borrowings
    
    
    (662,000
    )
    
    
    (232,000
    )Proceeds from issuance of common stock from exercise of stock options
    
    
    4,426
    
    
    
    8,596Repurchase of common stock
    
    
    (61,638
    )
    
    
    Debt issue costs
    
    
    (199
    )
    
    
    Tax benefit from non-qualified stock options
    
    
    212
    
    
    
    Net cash used in financing activities
    
    
    (379,199
    )
    
    
    (16,404
    )Decrease in cash and cash equivalents
    
    
    (4,491
    )
    
    
    (13,883
    )Cash and cash equivalents, beginning of period
    
    
    7,979
    
    
    
    18,577Cash and cash equivalents, end of period
    
    $
    3,488
    
    
    $
    4,694Supplemental Information:Non-cash transactions:Investments in property and equipment accrued, not paid
    
    $
    (36,379
    )
    
    $
    (24,046
    )Cash paid during period for:Interest
    
    $
    16,470
    
    
    $
    10,494Federal and state income taxes
    
    
    
    
    
    
    10,860
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 NOTE 1  Summary of Organization and Significant Accounting Policies
 Our Business
  ).
  Principles of Consolidation
  Interim Financial Statements
   Use of Estimates
  -6-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS




Reclassifications




Business Segment Information






Revenue Recognition and Gas Imbalances






Cash and Cash Equivalents




Designated Cash




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Net Income Per Share
  Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands, except per share data)Numerator:Net income
    
    $
    23,371
    
    
    $
    43,830
    
    
    $
    53,143
    
    
    $
    77,268Denominator:Weighted average shares outstanding
    
    
    28,625
    
    
    
    28,679
    
    
    
    28,770
    
    
    
    28,589Add dilutive securities: options and restricted stock/units
    
    
    53
    
    
    
    294
    
    
    
    54
    
    
    
    331Total weighted average shares outstanding and dilutive
securities
    
    
    28,678
    
    
    
    28,973
    
    
    
    28,824
    
    
    
    28,920Net Income
per share  basic:
    
    $
    0.82
    
    
    $
    1.53
    
    
    $
    1.85
    
    
    $
    2.70Net Income
per share  diluted:
    
    $
    0.81
    
    
    $
    1.51
    
    
    $
    1.84
    
    
    $
    2.67
  Comprehensive Income (Loss)
  Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Net income
    
    $
    23,371
    
    
    $
    43,830
    
    
    $
    53,143
    
    
    $
    77,268Other comprehensive income (loss)Derivative contracts settled and reclassified, net of tax
    
    
    11,903
    
    
    
    15,720
    
    
    
    41,958
    
    
    
    24,877Change in fair value of open derivative contracts, net
of tax
    
    
    21,103
    
    
    
    11,860
    
    
    
    161,336
    
    
    
    (124,999
    )Change in accumulated other comprehensive income (loss)
    
    
    33,006
    
    
    
    27,580
    
    
    
    203,294
    
    
    
    (100,122
    )Comprehensive income (loss)
    
    $
    56,377
    
    
    $
    71,410
    
    
    $
    256,437
    
    
    $
    (22,854
    )
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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
 -9-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Asset Retirement Obligations
  Six Months Ended June 30,2006
    
    
    2005(in thousands)ARO liability at January 1,
    
    $
    119,671
    
    
    $
    91,746Accretion expense
    
    
    2,396
    
    
    
    2,651Liabilities
incurred  drilling
    
    
    3,252
    
    
    
    2,530Liabilities
incurred  assets acquired
    
    
    
    
    
    
    169Liabilities
settled  assets abandoned
    
    
    
    
    
    
    (870
    )Liabilities
settled  assets sold
    
    
    (88,375
    )
    
    
    (32
    )Changes in estimates
    
    
    (76
    )
    
    
    798ARO liability at June 30,
    
    $
    36,868
    
    
    $
    96,992
 Derivative Instruments and Hedging Activities
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 Sale
of Texas Gulf of Mexico Assets
 Liquidation of Derivative Contracts
  Accounting for Stock Options and Restricted Stock
   Three Months
    
    
    Six MonthsEnded
    
    
    EndedJune 30, 2005
    
    
    June 30, 2005Net income
 as reported
    
    $
    43,830
    
    
    $
    77,268Add: Stock-based compensation expense included in net income, net of tax.
    
    
    428
    
    
    
    874Less: Stock-based compensation expense determined using fair value
method,
net of tax
    
    
    (785
    )
    
    
    (1,586
    )Net income
 pro forma
    
    $
    43,473
    
    
    $
    76,556Net income
per share  basic  as reported
    
    $
    1.53
    
    
    $
    2.70Net income
per share  diluted  as reported
    
    
    1.51
    
    
    
    2.67Net income
per share  basic  pro forma
    
    $
    1.52
    
    
    $
    2.68Net income
per share  diluted  pro forma
    
    
    1.50
    
    
    
    2.65
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Six Months Ended June 30,2006
    
    2005Weighted average fair value of options granted
    
    $
    12.37
    
    
    $
    20.89Assumptions:Risk-free interest rate
    
    
    4.76
    %
    
    
    3.97
    %Expected years until exercise
    
    
    3
    
    
    
    5Expected stock volatility
    
    
    25.3
    %
    
    
    34.7
    %Expected dividends
    
    
    
    
    
    
    
   Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Options
    
    $
    1,562
    
    
    $
    766
    
    
    $
    3,249
    
    
    $
    1,583Restricted stock/units
    
    
    793
    
    
    
    244
    
    
    
    1,623
    
    
    
    439Stock compensation expense, gross
    
    
    2,355
    
    
    
    1,010
    
    
    
    4,872
    
    
    
    2,022Amounts capitalized
    
    
    (713
    )
    
    
    (347
    )
    
    
    (1,748
    )
    
    
    (669
    )Stock compensation expense, net of amounts
capitalized
    
    $
    1,642
    
    
    $
    663
    
    
    $
    3,124
    
    
    $
    1,353
  Stock Plans.
 Stock Options.
 -12-




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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
    WeightedAverageShares
    
    Weighted
    
    Remaining
    
    AggregateUnderlying
    
    Average
    
    Contractual
    
    IntrinsicOptions
    
    Exercise Price
    
    Term
    
    Value(1)(shares)
    
    ($/share)
    
    (Years)
    
    ($ in thousands)Options outstanding January 1, 2006
    
    
    1,696,610
    
    
    $
    39.85
    
    
    
    7.8
    
    
    $
    21,971Granted
    
    
    40,775
    
    
    
    52.85
    
    
    
    
    
    
    
    2,155Exercised
    
    
    (113,375
    )
    
    
    39.03
    
    
    
    
    
    
    
    2,346Forfeited
    
    
    (40,800
    )
    
    
    42.94
    
    
    
    
    
    
    
    Options outstanding June 30, 2006
    
    
    1,583,210
    
    
    $
    40.17
    
    
    
    5.9
    
    
    $
    33,279Options exercisable June 30, 2006
    
    
    626,563
    
    
    $
    31.80
    
    
    
    2.6
    
    
    $
    18,412
 
 (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 June 30, 2006 and December 31, 2005, the closing
price per share of our common stock on the NYSE was $61.19 and $52.80, respectively.  Restricted Stock
  Restricted
    
    WeightedStock and
    
    Average Grant
    
    AggregateUnits(1)
    
    Date Fair Value
    
    Intrinsic Value(2)(shares)
    
    ($/share)
    
    ($ in thousands)Unvested restricted stock January 1, 2006
    
    
    171,214
    
    
    $
    56.23
    
    
    $
    9,040Granted
    
    
    25,016
    
    
    
    54.16
    
    
    
    1,531Vested
    
    
    (803
    )
    
    
    58.88
    
    
    
    49Forfeited
    
    
    (5,798
    )
    
    
    58.88
    
    
    
    Unvested restricted stock June 30, 2006
    
    
    189,629
    
    
    $
    55.87
    
    
    $
    11,603
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 (1)
    
    Includes 52,501 units granted in July 2005 pursuant to a retention bonus plan for
certain employees at an average price of $58.76 per unit, of which 50% vest 18 months
following the grant date with the remaining 50% to vest 36 months following the grant date.
Restricted units will convert to shares of restricted stock at the end of the vesting period.
At June 30, 2006, 46,703 units under the retention bonus plan were unvested and outstanding.(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. For restricted shares that vested
during the period, the intrinsic value is calculated using the closing price of our common
stock on the vesting date. At June 30, 2006 and December 31, 2005, the closing price per
share of our common stock on the NYSE was $61.19 and $52.80, respectively. Recent Accounting Pronouncements
  NOTE 2  Long-Term Debt and Notes
 June 30, 2006
    
    
    December 31, 2005(in thousands)Senior Debt:Revolving credit facility, due November 30, 2010
    
    $
    100,000
    
    
    $
    422,000Subordinated Debt:7% senior subordinated notes, due June 15, 2013
    
    
    175,000
    
    
    
    175,000Total long-term debt and notes
    
    $
    275,000
    
    
    $
    597,000
  Revolving Credit Facility
 st st
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THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  §
    
    on base rate loans, at a fluctuating rate, or base rate, equal to the sum of (a)
the greater of the Federal funds rate plus 0.5% or Wachovias prime rate plus (b) a variable
margin between 0.00% and 0.50%, depending on the amount of borrowings outstanding under the
credit facility, or§
    
    on fixed rate loans, a fixed rate equal to the sum of (a) a quoted LIBOR rate
divided by one minus the average maximum rate during the interest period set for certain
reserves of member banks of the Federal Reserve System in Dallas, Texas, plus (b) a variable
margin between 1.00% 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 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 proceeds of assets sales;§
    
    transactions with affiliates;§
    
    creation, incurrence or assumption of liens;§
    
    merger or consolidation and sales or other dispositions of all or substantially all of our assets;§
    
    entering into agreements that restrict the ability of our subsidiaries to make
certain distributions or payments; and§
    
    guarantees by our subsidiaries of certain indebtedness.
 -15-




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
   NOTE 3  Stockholders Equity
 Stock Repurchase Authorization
  NOTE 4 Commitments and Contingencies
 Taxable Gain on Sale of Gulf of Mexico Assets
  Legal Proceedings
  -16-




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
  Operating Leases
 th
 Letters of Credit
  Drilling Contracts
  Supplemental Executive Retirement Plan
  NOTE 5  Related Party Transactions
 Employment Agreements with Executives
   -17-




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
     NOTE 6  Acquisitions and Dispositions
 Sale of Texas Gulf of Mexico Assets
  Sale of Louisiana Gulf of Mexico Assets
  -18-




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##### Table of Contents



THE HOUSTON EXPLORATION COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
    Payment of
Gulf of Mexico Net Profits Interest
 East Texas Acquisition
  NOTE 7  Subsequent Events
 Payment of Gulf of Mexico Net Profits Interest
 Sale of Louisiana Gulf of Mexico Assets
 Liquidation of Derivative Contracts
  -19-




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview of Our Business
    Derivative Instruments and Hedging Activities
  Strategic Restructuring Plan
   -20-




---



##### Table of Contents



Disposition of Gulf of Mexico Assets.
   Payment of Gulf of Mexico Net Profits Interest
  Redeployment of Net Sales Proceeds.
 -21-




---



##### Table of Contents



Hedging Strategy. Liquidation of Derivative Contracts
 Recent Acquisition
  Critical Accounting Estimates and Significant Accounting Policies
 -22-
    Table of Contents  Recent Accounting Pronouncements
  Overview of Results for the Second Quarter of 2006
   §
    
    We generated $23.4 million in net income, a decrease of 47% from $43.8 million
in the second quarter 2005;§
    
    We produced approximately 22 Bcfe, and our average daily production rate was 239
MMcfe per day compared to 312 MMcfe per day during the first quarter of 2006 and 328 MMcfe
per day during the second quarter of 2005, a 23% decrease from the previous quarter and a
27% decrease from a year ago;§
    
    We generated $133.0 million cash flows from operating activities compared to
$123.8 million generated during the second quarter of 2005, an increase of 7%;§
    
    We invested $193.1 million in natural gas and oil properties, which included
$21.3 million for the acquisition of producing properties and acreage with an estimated 16.2
Bcfe of proved reserves located in the Willow Springs Field of Gregg County, adjacent to our
existing East Texas operations (see Note 6  Acquisitions and Dispositions  East Texas
Acquisition) and an estimated $30 million accrued for the payment of a net profits interest
to the predecessor owner of certain Gulf of Mexico properties that was accelerated by the
sale (see Note 6  Acquisitions and Dispositions  Sale of Louisiana Gulf of Mexico Assets
and Note 7  Subsequent Events  Payment of Gulf of Mexico Net Profits Interest);§
    
    We deposited $323.7 million in proceeds from the sale of our Gulf of Mexico
assets with qualified intermediaries for potential reinvestment in like-kind exchange
transactions under Section 1031 of the Internal Revenue Code;§
    
    We decreased net borrowings under our revolving credit facility by $149 million
during the second quarter of 2006 and by $322 million during the first six months of 2006,
using a portion of the net proceeds from the sale of our Gulf of Mexico assets;§
    
    We paid $14.3 million to liquidate and settle derivative contracts covering
60,000 MMBtu per day for each of the months July through December 2006, reducing our volume
hedged from 250,000 MMBtu per day to 190,000
 -23-
    Table of Contents  MMBtu per day for each of the remaining six months of 2006 as required by our revolving
credit facility in connection with our Gulf of Mexico sale;§
    
    We commenced share repurchases under our previously announced $200 million stock
repurchase authorization in May 2006, and during May and June 2006, we repurchased 1,176,500
shares, or approximately 4% of our outstanding common stock, in the open market for
approximately $61.6 million, funded with cash on hand and borrowings under our revolving
credit facility;§
    
    We drilled 85 wells, of which 78, or 92%, were successful, with one offshore,
six in East Texas, 23 in South Texas, 16 in Arkoma and 32 in the Rockies;§
    
    In South Texas, we added an eighth drilling rig and began drilling on the
properties acquired in November 2005;§
    
    In the Rockies, we began to process seismic data and identify drilling locations
on leased acreage in the DJ Basin covered by the 150 square mile 3D seismic survey completed
during the first quarter of 2006 and continued to bring new wells on-line;§
    
    Effective June 1, 2006 and in connection with the completion of the sale of the
Louisiana portion of our Gulf of Mexico assets, the borrowing base on our revolving credit
facility was reduced by $50 million, from $550 million to $500 million, and as a result of
this reduction, we wrote-off unamortized loan costs of $0.6 million;§
    
    On June 12, 2006, we received an unsolicited proposal from JANA Partners LLC to
acquire our company for $62 per share; and§
    
    On June 26, 2006, we announced our Board of Directors determination that the
unsolicited proposal made by JANA Partners was not in the best interest of our shareholders
and that Lehman Brothers Inc. had been engaged to assist us in exploring a broad range of
strategic alternatives to further enhance shareholder value.
 -24-
    Table of Contents  Operating and Financial Results for the Three  Month and Six  Month Periods Ended June 30, 2006
Compared to the Three  Month and Six  Month Periods Ended June 30, 2005.
  Three Months Ended June 30,
    
    Six Months Ended June 30,2006
    
    2005
    
    $ change
    
    %
    
    2006
    
    2005
    
    $ change
    
    %(in thousands, except prices and percentages)Natural gas revenues
    
    $
    129,785
    
    
    $
    181,054
    
    
    $
    (51,269
    )
    
    
    -28
    %
    
    $
    328,290
    
    
    $
    345,023
    
    
    $
    (16,733
    )
    
    
    -5
    %Oil revenues
    
    
    15,167
    
    
    
    18,805
    
    
    
    (3,638
    )
    
    
    -19
    %
    
    
    35,620
    
    
    
    35,925
    
    
    
    (305
    )
    
    
    -1
    %Gain (loss) on settled derivatives
    
    
    (18,424
    )
    
    
    (24,335
    )
    
    
    5,911
    
    
    
    -24
    %
    
    
    (64,949
    )
    
    
    (38,510
    )
    
    
    (26,439
    )
    
    
    69
    %Unrealized gain (loss) derivatives
    
    
    17,285
    
    
    
    
    
    
    
    17,285
    
    
    
    100
    %
    
    
    21,871
    
    
    
    (1,424
    )
    
    
    23,295
    
    
    
    100
    %Operating revenues
    
    
    145,914
    
    
    
    175,817
    
    
    
    (29,903
    )
    
    
    -17
    %
    
    
    323,518
    
    
    
    341,537
    
    
    
    (18,019
    )
    
    
    -5
    %Operating expenses
    
    
    93,353
    
    
    
    106,117
    
    
    
    (12,764
    )
    
    
    -12
    %
    
    
    217,789
    
    
    
    210,236
    
    
    
    7,553
    
    
    
    4
    %Income from operations
    
    
    52,561
    
    
    
    69,700
    
    
    
    (17,139
    )
    
    
    -25
    %
    
    
    105,729
    
    
    
    131,301
    
    
    
    (25,572
    )
    
    
    -19
    %Net income
    
    
    23,371
    
    
    
    43,830
    
    
    
    (20,459
    )
    
    
    -47
    %
    
    
    53,143
    
    
    
    77,268
    
    
    
    (24,125
    )
    
    
    -31
    %Production:Natural gas (MMcf)
    
    
    20,244
    
    
    
    27,440
    
    
    
    (7,196
    )
    
    
    -26
    %
    
    
    46,267
    
    
    
    54,797
    
    
    
    (8,530
    )
    
    
    -16
    %Oil (MBbls)
    
    
    257
    
    
    
    406
    
    
    
    (149
    )
    
    
    -37
    %
    
    
    605
    
    
    
    812
    
    
    
    (207
    )
    
    
    -25
    %Total (MMcfe) (1)
    
    
    21,786
    
    
    
    29,876
    
    
    
    (8,090
    )
    
    
    -27
    %
    
    
    49,897
    
    
    
    59,669
    
    
    
    (9,772
    )
    
    
    -16
    %Average daily production (MMcfe/d)
    
    
    239
    
    
    
    328
    
    
    
    (89
    )
    
    
    -27
    %
    
    
    276
    
    
    
    330
    
    
    
    (54
    )
    
    
    -16
    %Average Sales Prices:Natural Gas (per Mcf) unhedged
    
    $
    6.41
    
    
    $
    6.60
    
    
    $
    (0.19
    )
    
    
    -3
    %
    
    $
    7.10
    
    
    $
    6.30
    
    
    $
    0.80
    
    
    
    13
    %Natural Gas (per Mcf) realized (2)
    
    
    5.50
    
    
    
    5.71
    
    
    
    (0.21
    )
    
    
    -4
    %
    
    
    5.69
    
    
    
    5.59
    
    
    
    0.10
    
    
    
    2
    %Natural Gas (per Mcf) all-in(3)
    
    
    6.35
    
    
    
    5.71
    
    
    
    0.64
    
    
    
    11
    %
    
    
    6.16
    
    
    
    5.57
    
    
    
    0.60
    
    
    
    11
    %Oil (per Bbl) realized
    
    
    59.02
    
    
    
    46.32
    
    
    
    12.70
    
    
    
    27
    %
    
    
    58.88
    
    
    
    44.24
    
    
    
    14.63
    
    
    
    33
    %
 
 (1)
    
    MMcfe is defined as one million cubic feet equivalent of natural gas,
determined using the ratio of six MMcf of natural gas to one MBbl of crude oil, condensate or
natural gas liquids.(2)
    
    Average prices include gains and losses realized on derivative contracts
settled during the period.(3)
    
    Average prices include both the effect of gains and losses realized on
derivative contracts settled during the period as well as unrealized gains and losses
recognized pursuant to accounting under SFAS 133. Income from Operations
   -25-
    Table of Contents  Production Volume
  Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    change
    
    
    %
    
    
    2006
    
    
    2005
    
    
    change
    
    
    %(MMcfe per day)
    
    
    (MMcfe per day)South Texas
    
    
    142
    
    
    
    139
    
    
    
    3
    
    
    
    2
    %
    
    
    143
    
    
    
    137
    
    
    
    6
    
    
    
    4
    %Arkoma
    
    
    39
    
    
    
    41
    
    
    
    (2
    )
    
    
    -5
    %
    
    
    40
    
    
    
    42
    
    
    
    (2
    )
    
    
    -5
    %East Texas
    
    
    10
    
    
    
    4
    
    
    
    6
    
    
    
    150
    %
    
    
    11
    
    
    
    3
    
    
    
    8
    
    
    
    267
    %Rockies
    
    
    6
    
    
    
    4
    
    
    
    2
    
    
    
    50
    %
    
    
    6
    
    
    
    5
    
    
    
    1
    
    
    
    20
    %Other
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    1
    
    
    
    
    
    
    
    Total onshore
    
    
    198
    
    
    
    189
    
    
    
    9
    
    
    
    5
    %
    
    
    201
    
    
    
    188
    
    
    
    13
    
    
    
    7
    %Offshore
    
    
    41
    
    
    
    139
    
    
    
    (98
    )
    
    
    -71
    %
    
    
    75
    
    
    
    142
    
    
    
    (67
    )
    
    
    -47
    %Total company
    
    
    239
    
    
    
    328
    
    
    
    (89
    )
    
    
    -27
    %
    
    
    276
    
    
    
    330
    
    
    
    (54
    )
    
    
    -16
    %
 Onshore.
  Offshore
 Commodity Prices and Effects of Hedging
  -26-
    Table of Contents  Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Cash (loss) realized on contracts settled (1)
    
    $
    (18,424
    )
    
    $
    (24,335
    )
    
    $
    (64,949
    )
    
    $
    (38,510
    )Non-cash unrealized gain (loss):Ineffectiveness gain (loss)
    
    
    16,110
    
    
    
    
    
    
    
    31,900
    
    
    
    (1,424
    )Mark-to-market change in fair value gain (loss)
    
    
    30,620
    
    
    
    
    
    
    
    68,786
    
    
    
    Deferred loss prior quarter production shortfalls
    
    
    
    
    
    
    
    
    
    
    (20,600
    )
    
    
    Recognition of all deferred losses relating to Gulf of
Mexico production sold during period
    
    
    (29,445
    )
    
    
    
    
    
    
    (58,215
    )
    
    
    Total non-cash unrealized gain (loss)
    
    
    17,285
    
    
    
    
    
    
    
    21,871
    
    
    
    (1,424
    )Total gain (loss) from hedging activities
    
    $
    (1,139
    )
    
    $
    (24,335
    )
    
    $
    (43,078
    )
    
    $
    (39,934
    )
 
 (1)
    
    Includes $14.3 million paid during the second quarter of 2006 to liquidate and
settle contracts covering 60,000 MMBtu per day for each of the months July through December
2006. This liquidation and settlement was made in connection with the completion of the sale
of our Gulf of Mexico assets on June 1, 2006 and was required under the terms of our revolving
credit facility.    -27-
    Table of Contents  Operating Expenses
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    $ change
    
    
    %
    
    
    2006
    
    
    2005
    
    
    $ change
    
    
    %($ per MMcfe)Lease operating expense
    
    $
    0.83
    
    
    $
    0.64
    
    
    $
    0.19
    
    
    
    30
    %
    
    $
    0.80
    
    
    $
    0.58
    
    
    $
    0.22
    
    
    
    38
    %Severance tax
    
    
    0.22
    
    
    
    0.15
    
    
    
    0.07
    
    
    
    47
    %
    
    
    0.22
    
    
    
    0.13
    
    
    
    0.09
    
    
    
    69
    %Transportation expense
    
    
    0.13
    
    
    
    0.10
    
    
    
    0.03
    
    
    
    30
    %
    
    
    0.11
    
    
    
    0.10
    
    
    
    0.01
    
    
    
    10
    %Asset retirement accretion expense
    
    
    0.05
    
    
    
    0.04
    
    
    
    0.01
    
    
    
    25
    %
    
    
    0.05
    
    
    
    0.04
    
    
    
    0.01
    
    
    
    25
    %Depreciation, depletion and
amortization
    
    
    2.66
    
    
    
    2.41
    
    
    
    0.25
    
    
    
    10
    %
    
    
    2.84
    
    
    
    2.39
    
    
    
    0.45
    
    
    
    19
    %General and administrative, net
    
    
    0.40
    
    
    
    0.21
    
    
    
    0.19
    
    
    
    90
    %
    
    
    0.35
    
    
    
    0.29
    
    
    
    0.06
    
    
    
    21
    %Total operating expenses per
unit of production
    
    $
    4.29
    
    
    $
    3.55
    
    
    $
    0.74
    
    
    
    21
    %
    
    $
    4.37
    
    
    $
    3.53
    
    
    $
    0.84
    
    
    
    24
    %
  Lease Operating Expense
 Severance Tax
 Depreciation, Depletion and Amortization
 -28-
    Table of Contents  General and Administrative Expenses, Net of Overhead Reimbursements and Capitalized General and
Administrative Expenses
 Absolute DollarsThree Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    $ change
    
    
    %
    
    
    2006
    
    
    2005
    
    
    $ change
    
    
    %(in thousands)Gross general and administrative expense
    
    $
    15,008
    
    
    $
    10,516
    
    
    $
    4,492
    
    
    
    43
    %
    
    $
    29,406
    
    
    $
    26,478
    
    
    $
    2,928
    
    
    
    11
    %Operating overhead reimbursements
    
    
    (583
    )
    
    
    (525
    )
    
    
    (58
    )
    
    
    11
    %
    
    
    (1,181
    )
    
    
    (1,075
    )
    
    
    (106
    )
    
    
    10
    %Capitalized general and administrative
    
    
    (5,720
    )
    
    
    (3,791
    )
    
    
    (1,929
    )
    
    
    51
    %
    
    
    (10,914
    )
    
    
    (8,080
    )
    
    
    (2,834
    )
    
    
    35
    %General and administrative expense, net
    
    $
    8,705
    
    
    $
    6,200
    
    
    $
    2,505
    
    
    
    40
    %
    
    $
    17,311
    
    
    $
    17,323
    
    
    $
    (12
    )
    
    
    
  Unit of Production - McfeThree Months Ended June 30,
    
    
    Six Months Ended June 30,General and Administrative Expense
    
    2006
    
    
    2005
    
    
    Variance
    
    
    2006
    
    
    2005
    
    
    Variance($ per MMcfe)Gross general and administrative expense
    
    $
    0.69
    
    
    $
    0.35
    
    
    $
    0.34
    
    
    
    97
    %
    
    $
    0.59
    
    
    $
    0.44
    
    
    $
    0.15
    
    
    
    34
    %Operating overhead reimbursements
    
    
    (0.03
    )
    
    
    (0.02
    )
    
    
    (0.01
    )
    
    
    50
    %
    
    
    (0.02
    )
    
    
    (0.02
    )
    
    
    
    
    
    
    Capitalized general and administrative
    
    
    (0.26
    )
    
    
    (0.12
    )
    
    
    (0.14
    )
    
    
    117
    %
    
    
    (0.22
    )
    
    
    (0.13
    )
    
    
    (0.09
    )
    
    
    69
    %General and administrative expense, net
    
    $
    0.40
    
    
    $
    0.21
    
    
    $
    0.19
    
    
    
    90
    %
    
    $
    0.35
    
    
    $
    0.29
    
    
    $
    0.06
    
    
    
    21
    %
  Other Income and Expense, Interest and Taxes
 Other Income and Expense
 -29-
    Table of Contents  Interest Expense, Net of Capitalized Interest
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,Interest and Average Borrowings
    
    2006
    
    
    2005
    
    
    Variance
    
    
    2006
    
    
    2005
    
    
    Variance(dollars in thousands)Gross interest
    
    $
    7,451
    
    
    $
    5,621
    
    
    $
    1,830
    
    
    
    33
    %
    
    $
    17,827
    
    
    $
    11,045
    
    
    $
    6,782
    
    
    
    61
    %Capitalized interest
    
    
    (1,000
    )
    
    
    (2,425
    )
    
    
    1,425
    
    
    
    59
    %
    
    
    (2,655
    )
    
    
    (4,415
    )
    
    
    1,760
    
    
    
    40
    %Interest expense, net of capitalized
interest
    
    $
    6,451
    
    
    $
    3,196
    
    
    $
    3,255
    
    
    
    102
    %
    
    $
    15,172
    
    
    $
    6,630
    
    
    $
    8,542
    
    
    
    129
    %Average total borrowings (1)
    
    $
    371,000
    
    
    $
    346,000
    
    
    $
    25,000
    
    
    
    7
    %
    
    $
    494,000
    
    
    $
    345,000
    
    
    $
    149,000
    
    
    
    43
    %Average total interest rate (1)
    
    
    6.97
    %
    
    
    6.04
    %
    
    
    0.93
    %
    
    
    15
    %
    
    
    6.66
    %
    
    
    5.94
    %
    
    
    0.72
    %
    
    
    12
    %Average bank borrowings
    
    $
    196,000
    
    
    $
    171,000
    
    
    $
    25,000
    
    
    
    15
    %
    
    $
    319,000
    
    
    $
    170,000
    
    
    $
    149,000
    
    
    
    88
    %Average bank interest rate
    
    
    7.02
    %
    
    
    5.13
    %
    
    
    1.89
    %
    
    
    37
    %
    
    
    6.50
    %
    
    
    4.88
    %
    
    
    1.62
    %
    
    
    33
    %
 
 (1)
    
    Average total borrowings and average total interest rate includes our $175
million senior subordinated notes at 7% due June 2013 and average borrowings under our
revolving credit facility.  Income Tax Provision.
 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;
 -30-
    Table of Contents  §
    
    Plugging and abandoning depleted or uneconomic natural gas and oil wells; and§
    
    Indirect costs related to our exploration activities, including payroll and
other expenses attributable to our exploration professional staff.
 Drilling Contracts
 Future Commitments
   Future CommitmentsPayments Due by PeriodReference
    
    
    Total
    
    
    1 year or less
    
    
    2  3 years
    
    
    4  5 years
    
    
    after 5 years(in thousands)Contractual Obligations:Revolving credit facility, due November 2010
    
    Note 2
    
    $
    100,000
    
    
    $
    
    
    
    $
    
    
    
    $
    100,000
    
    
    $
    7% senior subordinated notes, due June 2013
    
    Note 2
    
    
    175,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175,000Derivative instruments
    
    Note 1
    
    
    81,093
    
    
    
    44,165
    
    
    
    36,928
    
    
    
    
    
    
    
    Gulf of Mexico net profits payment
    
    Note 6
    
    
    30,000
    
    
    
    30,000
    
    
    
    
    
    
    
    
    
    
    
    Operating leases
    
    Note 4
    
    
    5,930
    
    
    
    949
    
    
    
    3,848
    
    
    
    1,133
    
    
    
    Letters of credit
    
    Note 4
    
    
    300
    
    
    
    300
    
    
    
    
    
    
    
    
    
    
    
    Drilling contracts
    
    Note 4
    
    
    17,613
    
    
    
    12,943
    
    
    
    4,670
    
    
    
    
    
    
    
    409,936
    
    
    
    88,357
    
    
    
    45,446
    
    
    
    101,133
    
    
    
    175,000Other Long-Term Obligations:Asset retirement obligations
    
    Note 1
    
    
    36,868
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    36,868Supplemental Executive Retirement Plan
    
    Note 4
    
    
    2,229
    
    
    
    100
    
    
    
    265
    
    
    
    261
    
    
    
    1,60339,097
    
    
    
    100
    
    
    
    265
    
    
    
    261
    
    
    
    38,471Total contractual obligations and
Commitments:
    
    
    
    
    
    $
    449,033
    
    
    $
    88,457
    
    
    $
    45,711
    
    
    $
    101,394
    
    
    $
    213,471
 Capital Resources
  -31-
    Table of Contents  Current Liquidity
  June 30,
    
    
    December 31,2006
    
    
    2005(in thousands)Revolving credit facility  borrowing base
    
    $
    500,000
    
    
    $
    600,000Outstanding borrowings
    
    
    (100,000
    )
    
    
    (422,000
    )Letters of credit
    
    
    (300
    )
    
    
    (300
    )Unused borrowing capacity
    
    
    399,700
    
    
    
    177,700Cash and cash equivalents
    
    
    3,488
    
    
    
    7,979Designated cash
    
    
    323,675
    
    
    
    Total available liquidity
    
    $
    726,863
    
    
    $
    185,679
  Six Months Ended June 30,2006
    
    
    2005
    
    
    variance(in thousands)Net cash provided by operating activities
    
    $
    253,307
    
    
    $
    257,192
    
    
    $
    (3,885
    )Net cash provided by (used in) investing activities
    
    
    121,401
    
    
    
    (254,671
    )
    
    
    376,072Net cash (used in) financing activities
    
    
    (379,199
    )
    
    
    (16,404
    )
    
    
    (362,795
    )Net (decrease) in cash
    
    $
    (4,491
    )
    
    $
    (13,883
    )
    
    $
    9,392
  Operating Activities
 -32-
    Table of Contents  Investing Activities.
 Natural Gas and Oil Expenditures and DispositionsThree Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(in thousands)Producing property acquisitions (1)
    
    $
    51,336
    
    
    $
    9,017
    
    
    $
    47,245
    
    
    $
    31,632Leasehold and lease acquisition costs (2)
    
    
    9,087
    
    
    
    10,338
    
    
    
    27,966
    
    
    
    35,574Development
    
    
    105,344
    
    
    
    74,981
    
    
    
    192,656
    
    
    
    147,403Exploration
    
    
    27,387
    
    
    
    37,739
    
    
    
    46,020
    
    
    
    63,778Total natural gas and oil capital expenditures
    
    
    193,154
    
    
    
    132,075
    
    
    
    313,887
    
    
    
    278,387Producing property dispositions (3)
    
    
    (534,278
    )
    
    
    
    
    
    
    (723,649
    )
    
    
    (150
    )Net natural gas and oil capital expenditures
    
    $
    (341,124
    )
    
    $
    132,075
    
    
    $
    (409,762
    )
    
    $
    278,237
 
 (1)
    
    For the three months ended June 30, 2006, includes the following: (i)
$21.3 million paid for producing properties in East Texas in April 2006; and (ii) $30 million
representing the accrual for an estimated net profits interest payment to the predecessor
owner of certain offshore properties acquired by us in October 2003, of which approximately
$21 million was paid on August 1, 2006, with the final settlement and payment, if any,
expected by the end of the third quarter of 2006. For the six months ended June 30, 2006,
includes the above mentioned transactions and a final purchase price adjustment and return of
capital of $4.1 million representing a reduction to the $159.0 net purchase price paid for the
South Texas properties acquired on November 30, 2005 from Kerr-McGee Oil & Gas Onshore LP and
Westport Oil and Gas Company, L.P.(2)
    
    For the three months ended June 30, 2006 and 2005, includes capitalized
interest and general and administrative expenses of $6.7 million and $6.2 million,
respectively. For the six months ended June 30, 2006 and 2005, includes capitalized interest
and general and administrative expenses of $13.6 million and $12.5 million, respectively.(3)
    
    For the three months ended June 30, 2006, includes net proceeds from the
sale of our Louisiana Gulf of Mexico assets of $530.8 million, net of $4.4 million in fees
associated with completion of the transaction, and $7.9 million in net proceeds for the sale
of other assets. For the six months ended June 30, 2006, includes proceeds from the above
mentioned transactions in addition to net proceeds from the sale of the Texas portion of our
Gulf of Mexico assets of $190.8 million, net of $1.5 million in transaction fees. Financing Activities
 -33-
    Table of Contents  Access to Capital Markets
   Stock Repurchase Authorization.
 Off-Balance Sheet Arrangements
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
 Market Risk
  Interest Rate Risk
  Commodity Risk
  -34-
    Table of Contents  Derivative Instruments and Hedging Activities)
  Changes in Fair Value of Derivative Instruments
  Six Months Ended June 30,2006
    
    
    2005Change in Fair Value of Derivative Instruments:
    
    Before Tax(in thousands)Fair value of contracts at January 1
    
    $
    (417,658
    )
    
    $
    (75,149
    )Realized loss on contracts settled during period (1)
    
    
    64,950
    
    
    
    38,510(Decrease) increase in fair value of all open contracts
    
    
    271,615
    
    
    
    (194,921
    )Net change during period
    
    
    336,565
    
    
    
    (156,411
    )Fair value of contracts outstanding at June 30
    
    $
    (81,093
    )
    
    $
    (231,560
    )
 
 (1)
    
    Includes $14.3 million paid during the second quarter of 2006 to
liquidate and settle contracts covering 60,000 MMBtu per day for each of the
months July through December 2006. This liquidation and settlement was made in
connection with the completion of the sale of our Gulf of Mexico assets on June 1,
2006 and was required under the terms of our revolving credit facility. -35-
    Table of Contents  Summary
of Derivative Contracts
  NYMEXPeriod
    
    
    
    Daily Volume
    
    Price
    
    Floor Price
    
    Ceiling PriceYear
    
    (Months)
    
    Transaction Type
    
    (MMBtu/day)
    
    ($/MMBtu)
    
    ($/MMBtu)
    
    ($/MMBtu)2006
    
    Jul  Dec
    
    Swap
    
    
    20,000
    
    
    $
    5.87
    
    
    
    
    
    
    
    2006
    
    Jul  Dec
    
    Swap
    
    
    10,000
    
    
    
    5.94
    
    
    
    
    
    
    
    2006
    
    Jul  Dec
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    $
    5.50
    
    
    $
    7.202006
    
    Jul  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    5.50
    
    
    
    7.262006
    
    Jul  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    5.75
    
    
    
    7.202006
    
    Jul  Dec
    
    Costless collar
    
    
    50,000
    
    
    
    
    
    
    
    5.82
    
    
    
    7.002006
    
    Jul  Aug
    
    Costless collar
    
    
    30,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.002006
    
    Sep Oct
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.002006
    
    Nov  Dec
    
    Costless collar
    
    
    30,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.002006
    
    Jul  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.022006
    
    Jul  Dec
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    6.00
    
    
    
    7.052007
    
    Jan  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    $
    5.00
    
    
    $
    6.502007
    
    Jan  Dec
    
    Costless collar
    
    
    10,000
    
    
    
    
    
    
    
    5.00
    
    
    
    6.792008
    
    Jan  Dec
    
    Costless collar
    
    
    20,000
    
    
    
    
    
    
    $
    5.00
    
    
    $
    5.72
   
 Item 4. Controls and Procedures
 Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
  Changes in Internal Control Over Financial Reporting
  -36-
    Table of Contents  Part II. Other Information
 
 Item 1. Legal Proceedings
 Legal Proceedings
 
 Item 1A. Risk Factors
  Our exploration of strategic alternatives is subject to a number of uncertainties and may or may
not result in any transactions.
  Our ability to replace revenues generated from the sale of our Gulf of Mexico properties depends
upon market conditions and numerous uncertainties.
  Our hedging activities have resulted in financial losses and reduced our income and may continue to
do so in the future.
  -37-
    Table of Contents  Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
  Our Purchases of Our Common StockTotal Number
    
    
    Maximumof Shares
    
    
    Approximate DollarPurchased as Part
    
    
    Value of Shares thatTotal Number
    
    
    Average Price
    
    
    of Publicly
    
    
    May Yet Beof Shares
    
    
    Paid per
    
    
    Announced Plans
    
    
    Purchased UnderPeriod
    
    Purchased
    
    
    Share
    
    
    or Programs(1)
    
    
    the Plans or Programs($ in thousands)April 1 to April 30, 2006
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    200,000May 1 to May 31, 2006
    
    
    766,800
    
    
    $
    51.95
    
    
    
    766,800
    
    
    
    160,166June 1 to June 30, 2006
    
    
    409,700
    
    
    $
    53.22
    
    
    
    409,700
    
    
    
    138,362Total
    
    
    1,176,500
    
    
    $
    52.39
    
    
    
    1,176,500
 
 (1)
    
    Repurchases during the second quarter of 2006 made pursuant to a $200 million
share repurchase authorization announced on November 8, 2005, and in connection with the
completion of the sale of our Gulf of Mexico assets. The $200 million share repurchase
authorization expires November 1, 2006. See Note 3  Shareholders Equity  Stock
Repurchase Authorization. 
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 6. Exhibits
 EXHIBITS
    
    
    
    DESCRIPTION10.1
    
    
    
    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 Agents10.2(1)
    
    
    
    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 Current Report on Form 8-K dated June 2, 2006 (File No.
001-11899) and incorporated by reference).10.3(1) (2)
    
    
    
    The Houston Exploration Company Supplemental Executive Retirement Plan (Amended and Restated
on July 25, 2006) (filed as Exhibit 10.1 to Current Report on Form 8-K dated July 31, 2006
(File No. 001-11899) and incorporated by reference).10.4(1) (2)
    
    
    
    Amendment No. 2 to The Houston Exploration Company Executive Deferred Compensation Plan
(filed as Exhibit 10.2 to Current Report on Form 8-K dated July 31, 2006 (File No.
001-11899) and incorporated by reference).10.5(1) (2)
    
    
    
    The Houston Exploration Company 2005 Executive Deferred Compensation Plan (filed as Exhibit
10.3 to Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and incorporated
by reference).10.6(1) (2)
    
    
    
    Amendment to The Houston Exploration Company Non-Employee Director Deferred Compensation
Plan (filed as Exhibit 10.4 to Current Report on Form 8-K dated July 31, 2006 (File No.
001-11899) and incorporated by reference).10.7(1) (2)
    
    
    
    The Houston Exploration Company Post-2004, AJCA Compliant Deferred Compensation Plan for
Non-Employee Directors effective April 26, 2005 (filed as Exhibit 10.5 to Current Report on
Form 8-K dated July 31, 2006 (File No. 001-11899) and incorporated by reference).10.8(2)
    
    
    
    Form of Indemnification Agreement for Directors and Executive Officers.10.9(2)
    
    
    
    Form of Non-Qualified Stock Option Agreement.10.10(2)
    
    
    
    Form of Director Restricted Stock Award Agreement.10.11(2)
    
    
    
    Form of Employee Restricted Stock Award Agreement.
 -38-
    Table of Contents  EXHIBITS
    
    
    
    DESCRIPTION12.1
    
    
    
    Computation of ratio of earnings to fixed charges.31.1
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certification of Robert T. Ray, Chief Financial Officer, as required pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    Certification of Robert T. Ray, Chief Financial Officer, as required pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
 
 (1)
 (2)
 -39-
    Table of Contents  SIGNATURES
  THE HOUSTON EXPLORATION COMPANYBy:
    /s/ William G. HargettWilliam G. HargettDate: August 8, 2006
    
    Chairman, President and Chief Executive OfficerBy:
    /s/ Robert T. RayRobert T. RayDate: August 8, 2006
    
    Senior Vice President and Chief Financial OfficerBy:
    /s/ James F. WestmorelandJames F. WestmorelandDate: August 8, 2006
    
    Vice President and Chief Accounting Officer -40-
    Table of Contents  Index to Exhibits
 EXHIBITS
    
    
    
    DESCRIPTION10.1
    
    
    
    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 Agents10.2(1)
    
    
    
    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 Current Report on Form 8-K dated June 2, 2006 (File No.
001-11899) and incorporated by reference).10.3(1) (2)
    
    
    
    The Houston Exploration Company Supplemental Executive Retirement Plan (Amended and Restated
on July 25, 2006) (filed as Exhibit 10.1 to Current Report on Form 8-K dated July 31, 2006
(File No. 001-11899) and incorporated by reference).10.4(1) (2)
    
    
    
    Amendment No. 2 to The Houston Exploration Company Executive Deferred Compensation Plan
(filed as Exhibit 10.2 to Current Report on Form 8-K dated July 31, 2006 (File No.
001-11899) and incorporated by reference).10.5(1) (2)
    
    
    
    The Houston Exploration Company 2005 Executive Deferred Compensation Plan (filed as Exhibit
10.3 to Current Report on Form 8-K dated July 31, 2006 (File No. 001-11899) and incorporated
by reference).10.6(1) (2)
    
    
    
    Amendment to The Houston Exploration Company Non-Employee Director Deferred Compensation
Plan (filed as Exhibit 10.4 to Current Report on Form 8-K dated July 31, 2006 (File No.
001-11899) and incorporated by reference).10.7(1) (2)
    
    
    
    The Houston Exploration Company Post-2004, AJCA Compliant Deferred Compensation Plan for
Non-Employee Directors effective April 26, 2005 (filed as Exhibit 10.5 to Current Report on
Form 8-K dated July 31, 2006 (File No. 001-11899) and incorporated by reference).10.8(2)
    
    
    
    Form of Indemnification Agreement for Directors and Executive Officers.10.9(2)
    
    
    
    Form of Non-Qualified Stock Option Agreement.10.10(2)
    
    
    
    Form of Director Restricted Stock Award Agreement.10.11(2)
    
    
    
    Form of Employee Restricted Stock Award Agreement.
 -41-
    Table of Contents  EXHIBITS
    
    
    
    DESCRIPTION12.1
    
    
    
    Computation of ratio of earnings to fixed charges.31.1
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certification of Robert T. Ray, Chief Financial Officer, as required pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certification of William G. Hargett, Chief Executive Officer, as required pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    Certification of Robert T. Ray, Chief Financial Officer, as required pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
 
 (1)
 (2)
 -42-