-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IbCqClRCjmgpcLdevDcgx4V8aKIC2KnXB/P4JWotU7byDmZD4gUGtMJ4olXz8ozy /Jrh6pYGtXBQzTCppYOixQ== 0000899243-99-000638.txt : 19990402 0000899243-99-000638.hdr.sgml : 19990402 ACCESSION NUMBER: 0000899243-99-000638 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ZYDECO ENERGY INC CENTRAL INDEX KEY: 0000908246 STANDARD INDUSTRIAL CLASSIFICATION: CRUDE PETROLEUM & NATURAL GAS [1311] IRS NUMBER: 760404904 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22076 FILM NUMBER: 99583030 BUSINESS ADDRESS: STREET 1: 1710 TWO ALLEN CENTER STREET 2: 1200 SMITH STREET CITY: HOUSTON STATE: TX ZIP: 77002-4312 BUSINESS PHONE: 7136592222 MAIL ADDRESS: STREET 1: 1710 TWO ALLEN CENTER STREET 2: 1200 SMITH STREET CITY: HOUSTON STATE: TX ZIP: 77002-4312 FORMER COMPANY: FORMER CONFORMED NAME: TN ENERGY SERVICES ACQUISITION CORP DATE OF NAME CHANGE: 19930701 10-K 1 FORM 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from __________ to __________ Commission file number: 0-22076 Zydeco Energy, Inc. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 76-0404904 (I.R.S. Employer Identification No.) 1710 Two Allen Center, 1200 Smith Street Houston, Texas (Address of principal executive offices) 77002 (Zip Code) (713) 659-2222 (Registrant's telephone number, including area code) SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $.001 par value Warrants to Purchase One Share of Common Stock Units Consisting of One Share of Common Stock and Two Warrants (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------ ------ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ((S) 229.405 under the Securities Exchange Act of 1934) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ____ As of March 22, 1999, there were 10,357,096 shares of Zydeco Energy, Inc. Common Stock, $.001 par value, issued and outstanding, of which 6,775,643 shares, having an aggregate market value of approximately $2,329,466 were held by non-affiliates of the registrant (affiliates being, for these purposes only, directors, executive officers, and holders of more than 5% of the registrant's Common Stock). DOCUMENTS INCORPORATED BY REFERENCE Part III, Items 10 through 13 are incorporated from the registrant's definitive Proxy Statement to be filed in connection with its Annual Meeting of Stockholders. - -------------------------------------------------------------------------------- TABLE OF CONTENTS Item 1. Business........................................................ 1 The Company................................................... 1 Seismic Technology............................................ 2 Geologic and Geophysical Expertise............................ 3 Louisiana Transition Zone..................................... 3 West Cameron Seismic Project.................................. 3 Proprietary Rights and Licenses............................... 5 Competition and Markets....................................... 5 Governmental Regulation....................................... 6 Risk Factors.................................................. 9 Facilities.................................................... 11 Employees..................................................... 12 Item 2. Properties...................................................... 12 Prospects and Leases.......................................... 12 Oil and Gas Reserves.......................................... 13 Statistical Information - Oil and Gas Properties.............. 13 Item 3. Legal Proceedings............................................... 15 Item 4. Submission of Matters to a Vote of Security Holders............. 16 Part II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters........................................... 17 Dividend Policy............................................... 18 Sales of Unregistered Securities.............................. 18 Item 6. Selected Financial Data......................................... 18 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..................................... 20 Overview...................................................... 20 Results of Operations......................................... 22 Year Ended December 31, 1998 Compared to Year Ended December 31, 1997...................... 22 Year Ended December 31, 1997 Compared to Year Ended December 31, 1996...................... 23 Liquidity and Capital Resources............................... 23 Year 2000 Compliance.......................................... 25 Item 7A. Quantitative & Qualitative Disclosures About Market Risk........ 26 Item 8. Financial Statements and Supplementary Data..................... 26 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................... 26 Part III Item 10. Directors and Executive Officers of the Registrant.............. 26 Item 11. Executive Compensation.......................................... 26 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................... 26 Item 13. Certain Relationships and Related Transactions.................. 26 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................................................ 26 Signatures...................................................... 28 Exhibit Index................................................... E-1 Index to Consolidated Financial Statements...................... F-1 i PART I When used in this document, the words "anticipate," "believe," "expect," "estimate," "project," and similar expressions are intended to identify forward- looking statements. Such statements are subject to certain risks, uncertainties, and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, believed, expected, estimated, or projected. For additional discussion of such risks, uncertainties, and assumptions, see "Item 1. Business--Risk Factors" included elsewhere in this report. ITEM 1. BUSINESS THE COMPANY Zydeco Energy, Inc. (the "Company"), a Delaware corporation incorporated in 1993, is an independent energy company engaged in the exploration for oil and gas utilizing advanced three-dimensional seismic ("3D") and computer-aided exploration ("CAEX") techniques. The Company has developed comprehensive in- house technology and software and expertise enabling it to use recent advances in such 3D seismic and CAEX technology. Such technology includes the Company's "Wavefield Imaging Technology", a patented data processing technique designed to substantially reduce the cost of 3D seismic data acquisition for certain surveys without significantly sacrificing the quality of the 3D subsurface image. The Company's primary business objective is to discover and develop oil and gas reserves and thereby increase revenues, net income and cash flows. As described below, changed market conditions have recently caused the Company to alter its business plan. However, implementing its strategy in the past, the Company had sought to (i) focus its efforts in geologic areas that it believed to be underexplored with 3D seismic techniques and to have potential for substantial oil and gas reserves, (ii) maintain its state-of-the-art 3D seismic capabilities through selective hardware and software acquisitions and exploitation of proprietary technology, and (iii) continue to pursue exploration and development alliances with industry participants in order to spread funding requirements and exploration risks. Before its business plan changed, the Company had sought to pursue its strategy in phases. First, the Company would identify areas with high oil and gas potential that are underexplored with advanced 3D seismic techniques. Second, the Company would secure seismic rights and implement a 3D seismic acquisition program using third party contractors or obtain access to third party seismic data for in-house processing and analysis. Third, through the use of its advanced 3D seismic processing techniques and the integration of geological and other data, the Company's staff of geophysicists and geologists would identify and rank potential drilling prospects. Fourth, the Company would secure lease positions or other drilling rights for its identified potential prospects through private landowner negotiations, state and federal public lease sales or negotiations with industry participants holding lease positions or drilling rights. Upon securing drilling rights, the prospects could then be drilled by contracting with industry participants. The Company intended to pursue relationships with industry participants who are experienced operators in the prospect area. Generally, the Company intended to retain nonoperating interests in its drilling prospects through "farmout" arrangements and prospect sales with retained interests, while permitting a more experienced operator to manage the drilling and production activities. The Company believes it is one of the few independent oil and gas exploration companies to have performed both 3D seismic data processing and seismic interpretation in-house. Most independent exploration companies use outside contractors to process their 3D data. The Company believes processes such as pre-stack migration analysis can be most effectively and efficiently accomplished by integrating seismic survey design, data processing and interpretation in-house. During 1998, the Company had completed all the stages of this strategy on its West Cameron Seismic Project (the "Project") and had begun to market for sale interests in various Project prospects to 1 industry participants. This Project has recently been the principal focus of the Company's exploration efforts and is located in southern Cameron Parish, Louisiana in an area known as the Louisiana Transition Zone. The Louisiana Transition Zone is an area of shoreline, near shore and within shallow coastal and bay waters where the combination of marine and land seismic and processing techniques are difficult and expensive. See "Louisiana Transition Zone". However, due mostly to potential prospect buyers' concerns over uncertainties of ownership interests in Project prospects prior to the arbitration ruling described in "Legal Proceedings - Cheniere Litigation" and market conditions thereafter, the Company has not generated sufficient sales of Project prospects and, therefore, has not produced adequate levels of cash inflows during the near term. Because market conditions for selling interests in prospects have significantly deteriorated, the Company has recently altered its business plan with a view to focusing its efforts on (1) conserving cash resources including, but not limited to, employee terminations and negotiations of deferred or foregone compensation with key executives, (2) concentrating exploration efforts strictly on marketing sellable Project prospects and (3) seeking alternate sources of capital for possible drilling participation and general working capital. The Company believes that this strategy will permit it to operate with existing cash resources into the year 2000 and withstand the current downturn in the oil and gas exploration industry. Should the Company be successful in selling interests in its prospects, an interest in the Project itself or raising alternate capital resources, sufficient capital may be available in the Company to expand its operations. Recent Director and Officer Resignations. Recently, Messrs. Charles Bradley, Harry C. Johnson, Edward R. Prince, Jr. and Phillip A. Tuttle voluntarily resigned their positions as directors of the Company. In addition, Messrs. Edward R. Prince, Jr. and John Misitigh voluntarily resigned their positions as executive officers of the Company. None of the directors or officers who resigned has indicated that their resignation was based on a disagreement over matters of policies, practices or procedures of the Company. The remaining sole director and executive officer of the Company is Mr. Sam B. Myers, Jr. SEISMIC TECHNOLOGY Traditionally, seismic analysis has involved the acquisition, processing and interpretation of seismic data collected along a single line of seismic detectors and sources. Processing the resulting data created a two dimensional cross-section ("2D seismic") of the earth's subsurface beneath this line. The advent of high speed, large storage capacity computers and advanced geophysical software development has permitted the acquisition, processing and interpretation of seismic data collected in an areal array, usually from multiple relatively closely spaced grids of seismic detectors and sources. Processing the resulting data creates a 3D seismic image of the earth's subsurface. 3D seismic provides a substantially improved image for interpretation and analysis over the cross-section created by 2D seismic. As a result of the adoption of 3D seismic technology, the industry's success rate with respect to the drilling of prospects has risen. Basic 3D seismic imaging and analysis are now routinely used by a majority of the companies involved in oil and gas exploration. The goal of 3D seismic processing is to image a cube of the subsurface for detailed structural and stratigraphic interpretation. Three common processes used in 3D seismic processing are Dip-Moveout ("DMO"), Common Depth Point stacking ("CDP") and post-stack migration, which adjust the collected seismic data to more accurately image the subsurface. Continuing improvements in computer speed and capacity have resulted in the development of more advanced 3D processing techniques such as pre-stack migration which the Company has utilized in processing its Project data. This processing technique generally improves the imaging of the subsurface. Wavefield Imaging Technology represents a further advancement of 3D seismic survey design, processing and analysis. Wavefield Imaging Technology permits the Company to use more broadly spaced seismic receivers in its surveys thereby reducing the cost of data acquisition for certain surveys. In its West Cameron Seismic Project seismic survey, the Company estimates that it acquired the survey for approximately one half the cost of a conventional transition zone survey. Under the survey configuration used by the Company in its West Cameron Seismic Survey, the Wavefield Imaging Technology is limited to analysis of seismic objectives below 8,000 feet. The technology may also be applied in the analysis of shallower objectives by increasing receiver and sound source densities, although with diminishing cost advantages. On July 1, 1997, the Company acquired all of the outstanding capital stock of Wavefield Image, Inc. ("Wavefield"), the owner of the Wavefield Imaging Technology. As a result of this acquisition, the Company owns the Wavefield Imaging Technology and a related United States patent subject to licenses granted previously by Wavefield. Prior to its acquisition, Wavefield granted partial or restricted licenses for the Wavefield Imaging Technology to one major oil company and one foreign company and offered a 2 license to another foreign company. Currently, the Company is not aware of any other company, including the licensees, employing Wavefield Imaging Technology in the design of its seismic surveys and processing of its seismic data. GEOLOGIC AND GEOPHYSICAL EXPERTISE The Company believes that in-house expertise is a critical factor in enabling the Company to effectively and efficiently use the most recent developments in 3D seismic imaging and interpretation. For this reason the Company employed 7 highly experienced geophysicists and 3 geologists during 1998 for the purpose of processing and interpreting the 3D seismic data. After certain cost reducing actions that resulted in employee terminations, the Company currently employs 2 geophysicists and 1 geologist whose primary responsibility is to market prospects for sale. These experts have an average of approximately 30 years of experience in the industry. LOUISIANA TRANSITION ZONE The Company's principal exploration efforts are focused in the Louisiana Transition Zone, a narrow trend paralleling the coastline of Louisiana. It is approximately six miles wide (three miles on either side of the beach) and extends approximately 300 miles from the Sabine River eastward to the Mississippi River. Water depths in the Louisiana Transition Zone extend to approximately 40 feet. The Louisiana Transition Zone contains the Miocene Trend which has produced many of the largest oil and gas fields developed in the continental United States and its territorial waters. Productive zones within the Miocene Trend have excellent reservoir characteristics and have historically exhibited multiple pay zones, which allow a single strategically placed well bore to drain multiple reservoirs. The western portion of the Louisiana Transition Zone contains the gas prolific Planulina sands. The Louisiana Transition Zone is populated with salt domes with numerous radial and tangential faults surrounding the salt domes. The use of advanced 3D seismic technology is essential to the exploration of such salt features and fault blocks. Until the last three years, there have been relatively few 3D seismic surveys conducted in the Louisiana Transition Zone because of the relatively high cost of such surveys compared to land or deepwater surveys. The high cost is a result of the problems associated with seismic surveys in coastal transition zones as discussed above. Activities in this area are controlled by sophisticated landowners onshore and the State of Louisiana within three miles of the beach offshore. Permits for 3D acquisition require the consent of all landholders and all leaseholders. Such consents are not required in federal waters. Thus, seismic contractors have been reluctant to conduct speculative 3D surveys due to the difficulty of permitting acreage in the Louisiana Transition Zone. Due to these limitations, this zone was considered a "seismically blind" area and was thus reflected on virtually every onshore and offshore 2D seismic coverage map for the State of Louisiana as an area of "no seismic coverage." Given the past scarcity of high quality 3D seismic surveys, which span both onshore and offshore areas, the Company believes that this zone has the potential for containing substantial undeveloped oil and gas reserves. Many of these prospective areas in the Louisiana Transition Zone are located in shallow waters near existing pipeline infrastructure. As a result, reserves underlying these areas are generally less costly to develop and connect to pipeline infrastructure than reserves in deeper water areas. WEST CAMERON SEISMIC PROJECT In August 1996, the Company commenced the West Cameron Seismic Project (the "Project"), an extensive 3D seismic exploration program conducted over approximately 230 square miles in a part of the Louisiana Transition Zone in western Cameron Parish, Louisiana. Options, Permits and Leases. In connection with the Project, the Company negotiated seismic options covering approximately 36,718 gross acres (33,225 net acres) and secured seismic permits covering approximately 119,557 gross acres (119,075 net acres). One of the permits was an exclusive permit obtained from the State of Louisiana that covered 51,000 non-leased acres in state waters. In connection 3 with the exclusive seismic permit, for eighteen months, commencing February 1996, the Company had the exclusive right to acquire seismic data on the State's acreage and nominate any of the acreage for competitive lease bids. On August 11, 1997, the Company paid $391,877 to the State of Louisiana to extend the deadline for delivery of the survey to February 18, 1998. Prior to the February 18, 1998 deadline, the Company nominated certain properties for bid. In Louisiana, a public auction of leases is held approximately 120 days after the property is nominated for bid and the auction is generally announced approximately 45 days prior to the auction date. A bidder at the auction may bid on all or only a portion of the property nominated for bid. Under the Company's seismic permit, the State of Louisiana is required to keep the information obtained from the survey confidential for a period of ten years. The Company timely delivered seismic data to the State of Louisiana in January 1998 in compliance with the terms of the exclusive seismic permit. In connection with the Project during the first half of 1998, the Company acquired approximately 12,000 gross acres on nine separate prospects through State of Louisiana lease sales, private land negotiations and a Federal lease sale. The Company's Project leases have expiration dates ranging from 2001 to 2003. The one Federal offshore lease provides for a minimum royalty of 16.667%, has a primary lease term of five years that covers approximately 3,100 acres, and is administered by the Minerals Management Service. The annual rental on this federal lease is $5.00 per acre. Louisiana state leases are administered by the State Mineral Board of the State of Louisiana and generally provide for: (i) a minimum royalty of 23%; (ii) a five year primary term; and (iii) annual rentals in an amount equal to 50% of the original lease acquisition cost. Generally, title to state and federal leases is merchantable in all respects and operations thereon are not normally subject to litigation resulting from the legal doctrine of adverse possession or any other similar challenge to title. Leases obtained from private landowners are on three year terms. Delay rental obligations vary pursuant to the terms of such leases. Data Acquisition and Analysis. Advanced seismic processing techniques, including initial iterations of pre-stack migration, amplitude variation with offset (AVO) and seismic inversion were applied to the data by year-end 1997. During 1998, the data was processed through pre-stack time migration, and a high quality result was achieved. A preliminary effort was made to further improve the imaging of the data by performing pre-stack depth migration. Interpretation of the data to identify potential drilling prospects began in late 1997 and continues to the present time. These interpretations led to the acquisition of oil and gas leases within the Project which the Company is currently marketing. The data is currently being interpreted by the Company's exploration staff to identify new prospects. There can be no assurance that the Company will have sufficient resources to assemble such additional prospects. Cheniere Exploration Agreement and Litigation. In April 1996, the Company executed an Exploration Agreement (the "Cheniere Agreement") with Cheniere Energy Operating Co., Inc., a wholly owned subsidiary of Cheniere Energy, Inc. and formerly known as FX Energy, Inc., (collectively "Cheniere") covering the area of Project land and waters in western Cameron Parish, Louisiana. In exchange for earning a 50% interest, Cheniere agreed to fund certain Project costs including, but not limited to, 3D seismic acquisition costs, including the purchase of seismic rights or lease options on the related onshore acreage of the Project, the purchase of other 3D seismic data, and processing of seismic data over the Project area. On April 17, 1998, Zydeco Exploration, Inc., a wholly owned subsidiary of the Company, filed a petition with the American Arbitration Association for arbitration in order to resolve certain disputes that arose with Cheniere. The arbitration claim sought to resolve differences over Cheniere's funding obligations, the parties' ownership in various leases and prospects, the scope of pre-drilling activities that Cheniere can conduct within the Project area, the dissemination by Cheniere of confidential seismic data covering the Project area, and a wide variety of related issues. Cheniere filed a counterclaim in the arbitration action, and the pleadings were amended to include the Company as well as Zydeco Exploration, Inc. (collectively "Zydeco"). On December 9, 1998 the three-member arbitration panel issued its decision in the arbitration proceedings brought by Zydeco against Cheniere. In its ruling, the panel confirmed Zydeco's position as program manager but recognized Cheniere's independent right to identify prospects and acquire leases in the West Cameron Seismic Project area. The arbitration panel directed that Cheniere has the right to 4 participate with a 50% working interest in most of the leases acquired by Zydeco or in prospects designated by Zydeco. Cheniere, however, must exercise its right of participation and pay its share of such costs within a thirty-day period following Zydeco's formal notice of prospect designation. For each prospect, Zydeco has the sole right to undertake the management and control of all prospect development for a reasonable period not to exceed 90 days following such formal notice. The arbitration panel also ruled that project seismic costs generally incurred after December 31, 1997, are not reimbursable to Zydeco as seismic costs. The Company believed that such costs, either in part or in whole, should be recouped from Cheniere as prospect costs. In addition, if certain criteria are met, then sale proceeds from certain marketing activities would be paid to Cheniere until Cheniere recoups $13.5 million of its investment in the project. Zydeco and Cheniere would share any such sales above that amount equally. Neither party received any damage awards or recovery of legal costs. As a result of the arbitration panel's decision, Zydeco and Cheniere informally agreed to share responsibilities and ownership for certain activities incurred in the maintenance, marketing and sale of prospects generated and assembled by the parties. Except for the costs of one prospect and certain other activities, neither party would seek reimbursement from the other for seismic and prospect costs generally incurred prior to the arbitration ruling. After considering the arbitration panel's ruling and the two parties' informal agreement, Cheniere's and Zydeco's shares of third party and processing costs incurred pursuant to the terms of the Cheniere Agreement were approximately $16,423,398 and $5,216,773, respectively, from inception to December 31, 1998. Project seismic costs amounting to $1,146,688 that previously had been attributable to Cheniere were charged by the Company to exploration expense. In addition, the Company acquired approximately $5,753,010 in unproved leases during 1998. PROPRIETARY RIGHTS AND LICENSES The Company believes that its success will depend primarily on the innovative skills, technical competence, and sales and marketing abilities of its personnel. See "Employees" and "Risk Factors--Dependence on Key Personnel." The Company has obtained licenses to use all software currently used in its business. On December 2, 1997, the Company was issued a patent on the Wavefield Imaging Technology by the United States Patent and Trademark Office. As discussed above, prior to the Wavefield acquisition, the Company acquired a non- exclusive license to use the Wavefield Imaging Technology throughout the world and an exclusive license to use it in the Louisiana Transition Zone. See "--Seismic Technology." COMPETITION AND MARKETS Competition for the acquisition of proved undeveloped acreage, as well as producing properties, is intense. Commencing in the latter half of 1998, competition for selling drillable prospects has also become intense. The Company competes with many other entities including major integrated oil and gas companies as well as numerous independent oil and gas companies and other producers of energy sources and fuels. Should the Company decide and have the resource to acquire additional leases within the Project, a substantial portion of acreage is subject to competitive closed bidding at federal and state lease sales. Currently, the Company has very limited resources to compete in such sales. Many of the Company's competitors have substantially greater financial resources and other competitive advantages over the Company, and therefore may be better able to compete and bid for leases, particularly in regions other than the Gulf Coast. In addition, such competitors may have financial resources and other competitive advantages that may make them better able to market prospects or offer more advantageous sale terms than the Company. The availability of a ready market for hydrocarbons and the price of any hydrocarbons produced will depend on many factors beyond the control of the Company, including the extent of domestic production and imports of foreign oil, the marketing of competitive fuels, the proximity and capacity of natural gas pipelines, the availability of transportation and other market facilities, the demand for hydrocarbons, the political conditions in the Middle East, the effect of federal and state regulation of allowable rates of production, taxation and the conduct of drilling operations, and federal regulation of 5 natural gas. In the past, as a result of excess deliverability of natural gas, many pipeline companies curtailed the amount of natural gas taken from producing wells, shut-in some producing wells, significantly reduced gas taken under existing contracts, refused to make payments under applicable "take-or-pay" provisions, and refused to contract for gas available from some newly completed wells. The Company can give no assurance that such problems will not affect these markets again. In addition, the ongoing restructuring of the natural gas pipeline industry will eliminate the gas purchasing activity of traditional interstate gas transmission pipeline buyers. See "--Governmental Regulation" and "Risk Factors--Competitive Industry." The Company's principal oil and gas exploration assets consist of interests in oil and gas prospects in its West Cameron Seismic Project and associated seismic data. The Company's business plan has been to market interests in these prospects to industry participants. Due primarily to the decrease in oil prices during 1998 and the consequent reductions in funds available for drilling exploratory prospects as well as changed industry outlook on projected returns from oil and gas exploratory drilling, the demand for participations in independently generated oil and gas prospects in the Gulf Coast region has been adversely affected. The Company's efforts to market its West Cameron prospects have been similarly adversely affected. This situation is not likely to recover substantially until the industry outlook on energy commodity prices and projected returns on oil and gas drilling changes favorably. Producers of natural gas, therefore, will be required to develop new markets among gas marketing companies, end users of natural gas, and local distribution companies. All of these factors, together with economic factors in the marketing area, generally may affect the supply and/or demand for oil and gas and thus the prices available for sales of oil and gas. GOVERNMENTAL REGULATION The Company's oil and gas exploration, development, production, and related operations are subject to extensive rules and regulations promulgated by federal and state agencies. Failure to comply with such rules and regulations could result in substantial penalties being imposed on the Company. The regulatory burden on the oil and gas industry increases the Company's cost of doing business and affects its profitability. Because such rules and regulations are frequently amended or reinterpreted, the Company is unable to predict the future cost or impact of complying with such rules and regulations. Production. In most, if not all, areas where the Company may conduct activities, there may be statutory provisions regulating the production of oil and natural gas under which administrative agencies may promulgate rules in connection with the operation and production of both oil and gas wells, determine the reasonable market demand for oil and gas, and establish allowable rates of production. Such regulations may restrict the rate at which the Company's wells produce oil or gas at levels below the rate at which such wells would be produced in the absence of such regulations, with the result that the amount or timing of the Company's revenues could be adversely affected. Louisiana State Regulation. The State of Louisiana imposes numerous requirements relating to the exploration and production of oil and gas, including permits for seismic or drilling operations, drilling bonds, and reports concerning operations. The State of Louisiana also has statutes or regulations addressing conservation matters, including provisions for the unitization or pooling of oil and gas properties, the establishment of maximum rates of production from wells, and the U.S. Department of Interior Minerals Management Service's(the "MMS") regulations of spacing, plugging, and abandonment of such wells. Offshore Leasing. The Company has acquired oil and gas leases in the Gulf of Mexico, which have been granted by the Federal government and are administered by the MMS. Such leases were issued through competitive bidding, contain relatively standardized terms, and require compliance with detailed MMS regulations and orders pursuant to the Outer Continental Shelf Lands Act (the "OCSLA") (which are subject to change by the MMS). For offshore operations, lessees must obtain the MMS's approval for exploration plans and development and production plans prior to the commencement of such operations. In addition to permits required from other agencies such as the Coast Guard, the Army Corps of Engineers, and 6 the Environmental Protection Agency (the "EPA"), lessees must obtain a permit from the MMS prior to the commencement of drilling. The MMS has promulgated regulations requiring offshore production facilities located on the Outer Continental Shelf to meet stringent engineering and construction specifications. Similarly, the MMS has promulgated other regulations governing the plugging and abandoning of wells located offshore and the removal of all production facilities. With respect to any Company operations conducted on offshore federal leases, liability may generally be imposed under the OCSLA for the costs of clean-up and damages caused by pollution resulting from such operations, other than damages caused by acts of war or the negligence of third parties. Under certain circumstances, including but not limited to, conditions deemed a threat or harm to the environment, the MMS may also require any Company operations on federal leases to be suspended or terminated in the affected area. Under the OCSLA, all oil and natural gas pipelines operating on the Outer Continental Shelf must provide "open and non-discriminatory" access to both owner and non-owner shippers. Consequently, the Company's gathering and transportation facilities located on the Outer Continental Shelf must be made available to third parties. Bonding and Financial Responsibility Requirements. The Company is required to obtain bonding, or otherwise demonstrate financial responsibility, at varying levels by governmental agencies in connection with obtaining state or federal leases or acting as operator on such leases. These bonds may cover such obligations as plugging and abandonment of nonproductive wells, removal of related production facilities, and pollution liabilities on federal and state leases. A substantially larger bond than the $300,000 bond currently issued on behalf of the Company is required in order to act as operator on Federal offshore leases. The Company will have to satisfy these increased bonding requirements in the event that it elects to operate any wells on Federal leases. The Company expects to be able to enter into participation arrangements on its prospects with industry participants who are qualified to act as operators on Federal leases. However, no such arrangements can be assured of occurring. In addition, the State of Louisiana recently adopted financial responsibility requirements with respect to plugging and abandonment liabilities on Louisiana leases. Natural Gas Marketing and Transportation. The interstate transportation of natural gas is regulated by the Federal Energy Regulatory Commission (the "FERC") under the Natural Gas Act of 1938 and, to a lesser extent, the Natural Gas Policy Act of 1978. Since the early 1990s, FERC's regulatory efforts have centered largely around its generic rulemaking proceeding, Order No. 636. Through Order No. 636 and successor orders, FERC has undertaken to restructure the interstate pipeline industry with the goal of providing enhanced access to, and competition among, alternative gas suppliers. By requiring interstate pipelines to "unbundle" their sales services and to provide their customers with direct access to any upstream pipeline capacity held by pipelines, Order No. 636 has enabled pipeline customers to choose the levels of transportation and storage service they require, as well as gas directly from third-party merchants other than the pipelines. In general, Order No. 636 has facilitated the transportation of gas and the direct access to end-user markets. With the completion of the Order No. 636 implementation process on the FERC level, FERC's natural gas regulatory efforts have turned towards a number of other important policies, all of which could significantly affect the marketing of gas. Some of the more notable of these regulatory initiatives include (i) two new generic initiatives seeking industry input regarding the pricing, availability, and terms of service for both the short-term and long-term natural gas capacity markets, (ii) FERC's ongoing efforts, aided by the participation of various industry segments through the rulemaking process that resulted in Order No. 587 and its successor orders, to implement uniform standards for pipeline electronic bulletin boards, electronic data exchange, and basic business and operational practices of the pipelines, (iii) the issuance of a merger policy statement, as well as the consideration and relatively expedient approval of a surge in merger applications (especially a number of so called "convergence" mergers between electric utilities and gas companies), (iv) increased acceptance of market and other non-cost-based rates, such as negotiated rates, for interstate pipeline transmission and storage capacity, (v) a newly modified rate-of-return on equity policy for interstate pipelines, and (vi) the examination, through a number of formal rulemaking proceedings, of certain general topics affecting the current energy industry (including a review of regulations governing communications, a proposed collaborative process for energy facility applications, an updated landowner 7 notification procedure for pipeline environmental assessments, and the proposed elimination of a number of outdated filing and reporting requirements for pipeline certification applications). In addition to natural gas regulatory concerns, the FERC's unbundling of the wholesale electric industry through generic rulemaking proceedings in Order Nos. 888 and 889 and their successor orders may impact the natural gas industry. The unbundling of the wholesale electricity industry, along with the recent trend toward the implementation of regional system operators and associated power exchanges, have already been recognized as forcing electric utilities to seek out more competitive sources of (or alternatives to) supplies for their gas-fired generation units. Oil Sales and Transportation Rates. FERC regulates the transportation of oil in interstate commerce pursuant to the Interstate Commerce Act. Sales of crude oil, condensate, and gas liquids by the Company are not regulated and are made at market prices. However, the price a company receives from the sale of these products is affected by the cost of transporting the products to market. Effective as of January 1, 1995, FERC implemented regulations establishing an indexing system for transportation rates for oil pipelines, which would generally index such rates to inflation, subject to certain conditions and limitations. Under the new regulations petroleum pipelines are able to change their rates within prescribed ceiling levels that are tied to the Producer Price Index for Finished Goods, minus one percent. Rate increases made pursuant to the index will be subject to protest, but such protests must show that the portion of the rate increase resulting from application of the index is substantially in excess of the pipeline's increase in costs. The new indexing methodology can be applied to any existing rate, even if the rate is under investigation. If such rate is subsequently adjusted, the ceiling level established under the index must be likewise adjusted. In the order adopting the new regulations, FERC said that as a general rule pipelines must utilize the indexing methodology to change their rates. FERC indicated, however, that it was retaining cost-of-service ratemaking, market- based rates, and settlements as alternatives to the indexing approach. A cost- of-service proceeding will be instituted to determine just and reasonable initial rates for new services. A pipeline can also follow a cost-of-service approach when seeking to increase its rates above index levels for uncontrollable circumstances. A pipeline can seek to charge market-based rates if it can establish that it lacks market power. Finally, a pipeline can establish rates pursuant to settlement if agreed upon by all current shippers. On May 10, 1996, the D.C. Circuit affirmed the new regulations. The Court held that by establishing a general indexing methodology along with limited exceptions to indexed rates, FERC had reasonably balanced its dual responsibilities of ensuring just and reasonable rates and streamlining ratemaking through generally applicable procedures. Because of the novelty and uncertainty surrounding the indexing methodology, as well as the possibility of the use of cost-of-service ratemaking and market-based rates, the Company is not able to predict with certainty what effect, if any, these regulations will have on it. However, other factors being equal, the regulations may tend to increase transportation costs or reduce wellhead prices for such commodities. Environmental. The Company's operations are subject to numerous laws and regulations governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws and regulations may require the acquisition of a permit before drilling commences, restrict the types, quantities, and concentration of various substances that can be released into the environment in connection with drilling and production activities, limit or prohibit drilling activities on certain lands lying within wilderness, wetlands, and other protected areas, and impose substantial liabilities for pollution resulting from the Company's operations. Moreover, the recent trend toward stricter standards in environmental legislation and regulation is likely to continue. For instance, legislation has been proposed in Congress from time to time that would reclassify certain oil and gas exploration and production wastes as "hazardous wastes" which would make the reclassified wastes subject to much more stringent handling, disposal, and clean-up requirements. If such legislation were to be enacted, it could have a significant impact on the operating costs of the Company, as well as the oil and gas industry in general. Initiatives to further regulate the disposal of oil and gas wastes are also pending in certain states, and these various initiatives could have a similar impact on the Company. 8 The Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA"), also known as the "Superfund" law, imposes liability, without regard to fault or the legality of the original conduct, on certain classes of persons that are considered to have contributed to the release of a "hazardous substance" into the environment. These persons include the owner or operator of the disposal site or sites where the release occurred and companies that disposed of or arranged for the disposal of the hazardous substances found at the site. Persons who are or were responsible for releases of hazardous substances under CERCLA may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources. It is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage. RISK FACTORS Limited Production and High Dependence on 3D Seismic and Exploratory Drilling Activities. The Company's producing activities to date have been limited. Such activities presently consist of a working interest in one well and an overriding royalty interest in another well. Both wells are located offshore Louisiana. No oil and gas reserves have been assigned by the Company at December 31, 1998 to the well in which it has a working interest. Currently, the Company's focus is directed to increasing its reserves, and thereby increasing its revenues, net income and cash flow, by relying on certain 3D seismic methods to identify potential hydrocarbon accumulations which will then require the successful drilling of such prospects. There is no assurance that those 3D seismic methods will identify potential hydrocarbon accumulations or that drilling will successfully test these prospects. The use of 3D seismic technology involves numerous risks in the acquisition, processing and interpretive phases including, but not necessarily limited to, acquiring seismic shooting rights over a prospective area, availability of trained seismic crews, subsurface conditions which may affect the quality of the acquisition of data, surface conditions, and availability of data from any nearby previously drilled wells. Drilling involves numerous risks, including the risk that no commercially productive oil or gas reservoirs will be encountered. The cost of drilling, completing, and operating wells is often uncertain and drilling operations may be curtailed, delayed, or abandoned as a result of a variety of factors, including unexpected drilling conditions, excessive pressure or irregularities in formations, equipment failures or accidents, weather conditions, and shortages or delays in the delivery of equipment. High Dependence on Sales of Prospects. Recently, the Company has experienced difficulty in selling prospects developed and assembled from its Project. It believes that the lack of sales has been caused by market conditions within the oil and gas industry as well as initial uncertainties with respect to ownership interests. The Company anticipated that sales of these Project interests would account for a substantial source of funds for the period commencing in the second half of 1998 and continuing into 1999, and such has not been the case. Despite past market conditions, the Company is continuing its marketing efforts to sell interests in prospects. However, there can be no assurance that the Company will be successful in selling such significant interests or in receiving sufficient funds for continuing operations. Each non-producing oil and gas lease acquired by the Company requires annual delay rental payments to maintain lease ownership rights. Because most of the Company's Project leases were acquired during the first half of 1998, significant delay rental payments are due during the first half of 1999. The Company contemplates that some portion of these leases may be retained by either paying the delay rental obligation or negotiating such obligation with a potential buyer. In addition, the Company and Cheniere Energy, Inc. have agreed to share the responsibilities of marketing and maintaining Project leases. There is no assurance that, absent negotiated prospect sales agreements that provide for a buyer to pay rentals, the Company and/or Cheniere will make some or all of such delay rental payments. The Company cannot predict what leases, if any, that it and/or Cheniere may decide to relinquish through non-payment of a delay rental when due, the impact of such action on the marketability of the prospect in which the lease was held or the cost of potentially reacquiring such lease. Lack of Diversification; Oil and Gas Industry Conditions; and Volatility of Prices for Oil and Gas. As an independent energy company, the Company's revenues, profits and ability to market its prospects will be substantially dependent on the 9 oil and gas industry in general and the prevailing prices for oil and gas in particular. Historically, the markets for oil and gas have been volatile and are likely to continue to be volatile in the future. Prices for oil and gas are subject to wide fluctuations in response to relatively minor changes in supply of and demand for oil and gas, market uncertainty, and a variety of additional factors that are beyond the control of the Company. These factors include political conditions in the Middle East, the domestic and foreign supply of oil and gas, the price of foreign imports, the level of consumer demand, weather conditions, domestic and foreign government regulations, the price and availability of alternative fuels, and overall economic conditions. Accordingly, it is impossible to predict future oil and gas price movements with any certainty. Declines in oil and gas prices would adversely affect the company's cash flow, liquidity, and profitability, and reduce the amount of the Company's oil and gas reserves that can be economically produced. In addition, various factors, including the availability and capacity of gas gathering systems and pipelines, the effect of federal regulations on production and transportation, general economic conditions, and changes in supply and demand, may adversely affect the Company's ability to market its oil and gas production. High Dependence upon Lease Acquisition Activities. Due to available capital resources, the Company does not expect to acquire any new leases in the near term. However, its business demands that it continually evaluate its lease holdings and potential new lease acquisitions. Should the Company seek additional lease holdings, then such activities may include attempts to acquire leases from federal agencies, state agencies or private individuals and companies. Both the United States Department of the Interior and the State of Louisiana award oil and gas leases on a competitive bidding basis. It is expected that other major and independent oil and gas companies having financial resources significantly greater than those of the Company will bid against the Company for the purchase of oil and gas leases. Accordingly, there can be no assurance that the Company will be successful in acquiring any leases on which it bids. Limited Operating Revenues; Need for Additional Financing. The Company presently has limited operating revenues and does not expect to generate substantial operating revenues in the immediate future. The Company expects that it will need substantial additional capital if it chooses to expand operations and to acquire additional oil and gas leases, producing properties, or to participate in the drilling of wells on prospects. Additional capital may be secured from a combination of funding sources that may include borrowings from financial institutions, vendor financings, production payment financings, debt offerings, additional offerings of the Company's stock and alliances with other industry participants. The Company's ability to access additional capital may depend on a variety of factors including, but not limited to, sales of its existing prospects, favorable drilling results on its prospects and the status of various capital markets at the time such additional capital is sought. The decline in oil prices over the past year and the poor performance of stock prices of public independent oil and gas companies has recently substantially limited available capital for companies like Zydeco. Accordingly, there can be no assurances that capital will be available to the Company from any source, at the time required or that, if available, it will be on terms acceptable to the Company. Should sufficient financing not be available because costs are higher than estimated or otherwise, the Company would have to consider alternatives such as a sale or merger of the Company or liquidation of its assets. The Company believes it has sufficient capital to sustain its reduced level of operations into the year 2000. Competitive Industry. The Company operates in a highly competitive industry. The Company competes with major and independent oil and gas companies for the acquisition of oil and gas leases as well as for the equipment and labor required to explore, develop and operate such properties. Many of these competitors have financial, technical, human, and other resources greater than those of the Company. Operating Risks. The Company's oil and gas operations are subject to all of the risks and hazards typically associated with the exploration for, and the development and production of, oil and gas in the Gulf of Mexico and any other areas in which the Company may, in the future, conduct such activities. Risks in drilling operations include blowouts, oil spills, fires, and offshore risks such as capsizing, collision, hurricanes, and other adverse weather and sea conditions. Such risks can result in personal injury and loss of life and substantial damage to or destruction of oil and gas wells, platforms, production facilities, or other property, suspension of operations, and liabilities to third parties, any and all of which could adversely affect the Company. In addition, the Company's operations could result in liability for oil spills, discharge of hazardous materials, and other environmental damages. 10 In accordance with customary industry practices, the Company maintains insurance against some, but not all, of such risks and some, but not all, of such losses. There can be no assurance, however, that any insurance the Company intends to carry will be available to the Company when applied for or, if available and carried, will be adequate to cover the Company's liability in all circumstances. The occurrence of an event not fully covered by insurance could have a material and adverse effect on the financial position and results of operations of the Company. In addition, the Company may be liable for environmental damages caused by previous owners of any property which may be purchased by the Company, which liabilities would not be covered by insurance. Many of the oil and gas leases the Company has acquired are located offshore in water depths of less than 130 feet. Drilling operations offshore in such water depths are by their nature more remote, exposed, and, consequently, more difficult than typical drilling operations conducted on land, and, as a result, could result in significantly higher drilling, completion, and connection costs. Risks of Turnkey Contracts. The Company intends to have other industry participants operate its wells and will attempt to obtain, wherever possible and desirable, turnkey contracts, subject to availability, for the drilling of wells on any of its prospects. In the event a turnkey contract is not economically beneficial to the Company or is otherwise unobtainable from proven industry participants, the Company may contract for drilling operations on either a footage or day rate basis. In this instance, the Company may be liable for significant cost overruns attributable to downhole drilling problems that otherwise would have been covered by a turnkey contract had one been negotiated. Dependence on Key Personnel. The Company believes that its success will be highly dependent on its ability to retain key employees. Should the Company return to a mid-1998 level of operations, then it also believes that its success will be highly dependent upon its ability to attract skilled managers and employees. In the event that the Company cannot obtain or retain the services of such key personnel, there could be a material adverse effect on the Company's business and prospects. See "Employees" and "The Company--Recent Director and Officer Resignations." Governmental Regulations. The Company's business will be regulated by certain federal, state, and local laws and regulations relating to the development, production, marketing, and transportation of oil, gas, and related products as well as certain environmental and safety matters. These laws may be changed from time to time in response to economic or political conditions. Matters subject to regulation include permits for drilling operations, drilling and abandonment bonds, reports concerning operations, the spacing of wells, unitization and pooling of properties, and taxation. From time to time, regulatory agencies have imposed price controls and limitations on production by restricting the rate of flow of oil and gas wells below actual production capacity in order to conserve supplies of oil and gas. In addition, the production, handling, storage, transportation, and disposal of oil and gas, by- products therefrom, and other substances and materials produced or used in connection with oil and gas operations are subject to regulation under federal, state, and local laws and regulations primarily relating to protection of human health and the environment. These laws and regulations have continually imposed increasingly strict requirements for water and air pollution control and solid waste management. The Company believes the trend of more expansive and stricter environmental legislation and regulations will continue and such legislation may result in costs to the Company in the future. Amendments to laws regulating the disposal of oil and gas exploration and production wastes have been considered by Congress and may be adopted. Moreover, from time to time new and additional taxes, such as a BTU tax or a gasoline tax, have been proposed on energy consumption. Such legislation or taxes, if enacted, could have a significant adverse impact on the Company's operating costs. FACILITIES The Company leases approximately 19,600 square feet of office space in Houston, Texas under two leases expiring in 1999. One lease, approximating 12,200 square feet, expired on January 31, 1999 while the other lease will expire October 31, 1999. 11 EMPLOYEES As of December 31, 1998, the Company had 12 full-time employees, including 5 geophysicists and 1 landman. None of the Company's employees are employed pursuant to a collective bargaining agreement, and the Company has not experienced any work stoppages. One employee of the Company has an employment agreement with the Company, while another employee who had an employment agreement resigned in December 1998. The Company considers its relations with its employees to be good. At the time of this report, the Company had reduced the number of its employees to 9 full-time individuals, including 2 geophysicists, 1 geologist and one landman. See "The Company" and "Geological and Geophysical Expertise." ITEM 2. PROPERTIES PROSPECTS AND LEASES Undeveloped Properties. The following table summarizes the Company's working interest ownership of undeveloped acreage. Undeveloped acreage is considered to be those lease acres on which the Company has a working interest but ownership in no wells that have been drilled or completed to a point that would permit the production of commercial quantities of oil or gas. Gross acreage represents the total acreage under lease, while net acreage is the Company's working interest share of such leased acreage. Gross Undeveloped Net Acreage State/Location Acreage To Zydeco ----------------- ----------- ----------- Louisiana 3,441 2,164 Texas 81 81 Gulf of Mexico 13,667 11,735 ------ ------ Total 17,189 13,980 ====== ====== ----------- If Cheniere Energy, Inc. elects participation in each lease held in the West Cameron Seismic Project pursuant to the terms of the Cheniere Exploration Agreement and the arbitration ruling dated December 9, 1998 by the arbitration panel convened to hear the Cheniere litigation matters, the above "Net Acreage to Zydeco", would total 9,079. Lease Terms. Most of the leased acres currently held by the Company are under federal or State of Louisiana offshore leases. The Company's leases have expiration dates ranging from 1999 to 2003. Federal offshore leases provide for minimum royalties of 16.67%, have a primary lease term of five years, and are administered by the MMS. Annual rentals on Federal leases are $5.00 per acre. In general, the Company's federal leases consist of portions of 5,000 acre lease blocks. If production is not established or an extension is not obtained during the primary term, the lease terminates. Louisiana state leases are administered by the State Mineral Board of the State of Louisiana and generally provide for: (i) a minimum royalty of 20%; (ii) a five year primary term; and (iii) annual rentals in an amount equal to 50% of the original lease acquisition cost. Generally, title to state and federal leases is merchantable in all respects and operations thereon are not normally subject to litigation resulting from the legal doctrine of adverse possession or any other similar challenge to title. Leases obtained from private landowners are on three year terms. Delay rental obligations vary pursuant to the terms of such leases. 12 OIL AND GAS RESERVES The Company engaged Petroleum Professionals International, LP ("PPI") and Ryder Scott Company, Petroleum Engineers ("Ryder Scott") to estimate the proved oil and gas reserves of the Company's properties for the years ended December 31, 1998 and 1997, respectively. Both PPI and Ryder Scott are independent oil and gas reserve engineering firms. These firms were also asked to estimate the future net revenues to be derived from such properties. In preparing their respective reports, these firms reviewed and examined such geological, economic, engineering, and other data provided by the Company as considered necessary under the circumstances, and examined the reasonableness of certain economic assumptions regarding estimated operating and development costs and recovery rates in light of economic circumstances as of December 31, 1998 and 1997. As of December 31, 1998, the proved oil reserves were estimated to be 269 Bbls and the proved gas reserves were estimated to be 105,571 Mcf. There are numerous uncertainties inherent in estimating quantities of reserves and in projecting future rates of production and timing of development expenditures, including many factors beyond the control of the producer. The reserve data set forth in this Annual Report on Form 10-K represent only estimates. Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way, and the accuracy of any reserve estimate is a function of the quality and quantity of available data and of engineering and geological interpretation and judgment. As a result, estimates of different engineers often vary. In addition, results of drilling, testing, and production subsequent to the date of an estimate may justify revision of such estimate. Accordingly, reserve estimates at a specific point in time are often different from the quantities of oil and gas that are ultimately recovered, which differences may be significant. Additionally, the estimates of future net revenues from proved reserves of the Company and the present value of future net revenues are based upon certain assumptions about future production levels, prices, and costs that may not prove correct over time. The meaningfulness of such estimates is highly dependent upon the accuracy of the assumptions upon which they were based. STATISTICAL INFORMATION - OIL AND GAS PROPERTIES PRODUCTION. The following table summarizes the sales volumes of the Company's net oil and gas production in the United States in barrels of oil and thousands of cubic feet of natural gas for each of the three years ended December 31, 1998, 1997, and 1996, respectively: YEAR ENDED DECEMBER 31, ---------------------------- 1998 1997 1996 -------- ------ ------ SALES VOLUMES Natural Gas (Mcf) 165,762 336,730 372,678 Crude Oil (Bbl) 1,187 9,377 20,186 The sales volumes in the table represent sales of "net production", i.e., production which is net to the Company and produced to its interest after deducting royalty and other similar interests. AVERAGE PRICES AND PRODUCTION COSTS. For each of the last three years, average unit prices and unit production costs are set forth below with respect to the Company's net share of production of oil and gas in the United States: 13
YEAR ENDED DECEMBER 31, -------------------------- 1998 1997 1996 ------- ------ ------ AVERAGE SALES PRICES Natural Gas ($/Mcf) $ 2.25 $ 2.59 $ 2.60 Crude Oil ($/Bbl) $13.71 $20.69 $22.39 Lease Operating Expense ($/NBOE)/(1)/ $ .60 $ .31 $ .27 Depletion, Depreciation, & Amortization ($/NBOE)/(1) $ - $ 1.20 $ 1.73
- ------------ (1) Net barrels of oil equivalent (NBOE) assuming natural gas converted at six Mcf per equivalent barrel. ACREAGE AND WELL SUMMARY. The information presented below relates to properties in the United States in which the Company has "working interests" which bear the cost of operations. The Company's total gross and net interests in productive wells and in developed acres at December 31, 1998, are summarized as follows: GROSS NET ------------ ------------ OIL GAS OIL GAS ----- ----- ------ ----- Productive Wells/(1)/ - 1 - .08 Developed Acres/(2)/ 349 28 _______________ /(1)/ "Productive Wells" are producing wells and wells capable of production, and include gas wells awaiting pipeline connections or necessary governmental certifications to commence deliveries and oil wells to be connected to production facilities. No oil and gas reserves have been assigned by the Company at December 31, 1998 to the well in which it has a working interest. /(2)/ "Developed Acres" include all acreage (on a leasehold basis in the United States) as to which proved reserves are attributed, whether or not currently producing, but exclude all producing acreage as to which the Company's interest is limited to royalty, overriding royalty, and other similar interests. DRILLING AND PRESENT ACTIVITIES. The following table summarizes the oil and gas drilling activities of the Company in the United States for each of the three years ended December 31, 1998, 1997, and 1996, respectively: 14
Year Ended December 31, 1998 -------------------------------------------- 1998 1997 1996 -------------- ----------- ------------- Gross Net Gross Net Gross Net ----- ---- ----- --- ----- ----- Development Wells Drilled (1) (2): Productive - - - - - - Dry - - - - - - Exploratory Wells Drilled (1) (2): Productive - - - - - - Dry - - - - 1.0 0.375 ---- ---- ----- --- ----- ----- Total - - - - 1.0 0.375 ==== ==== ===== === ===== =====
- -------------- (1) "Wells Drilled" refers to the number of wells completed at any time during the fiscal year, regardless of when drilling was initiated. The term "completed" refers to the installation of permanent equipment for the production of oil or gas, or, in the case of a dry hole, to the reporting of abandonment to the appropriate agency. (2) A dry hole is an exploratory or a development well found to be incapable of producing either oil or gas in sufficient quantities to justify completion as an oil or gas well. A productive well is an exploratory or a development well that is not a dry hole. At December 31, 1998, the Company was not participating in any drilling wells. However, the Company participated in one well that commenced drilling subsequent to December 31, 1998. After reaching total depth, the Company declined to participate in a completion attempt. The Company will classify this well as an exploratory dry hole in 1999. ITEM 3. LEGAL PROCEEDINGS Cheniere Litigation - On April 17, 1998, Zydeco Exploration, Inc. filed a petition with the American Arbitration Association for arbitration in order to resolve certain disputes that arose with Cheniere. The arbitration claim sought to resolve differences over Cheniere's funding obligations, the parties' ownership in various leases and prospects, the scope of pre-drilling activities that Cheniere can conduct within the West Cameron Seismic Project (the "Project") area, the dissemination by Cheniere of confidential seismic data covering the Project area, and a variety of related issues. Cheniere filed a counterclaim in the arbitration action, and the pleadings were amended to include the Company as well as Zydeco Exploration, Inc (together "Zydeco"). The parties sought conflicting declaratory and injunctive relief and damages from each other. In addition, on April 22, 1998, Zydeco initiated a civil suit in state district court in Harris County, Texas against two individuals who are parties to confidentiality agreements with Zydeco and who are employees of Cheniere. Through this litigation, Zydeco sought and obtained a Temporary Restraining Order on April 22, 1998, restraining the individuals from breaching the terms of their confidentiality agreements with Zydeco. Cheniere intervened in the litigation on April 27, 1998. On May 4, 1998, Zydeco, Cheniere and the two individuals agreed to the entry of an Agreed Temporary Injunction. The agreed Temporary Injunction expired on June 15, 1998, and the dispute, which led to the filing of the civil suit, was included in the arbitration action by agreement of the parties. On December 9, 1998 the three-member arbitration panel seated to rule in this matter issued its decision in the arbitration proceedings brought by Zydeco against Cheniere. In its ruling, the panel confirmed Zydeco's position as program manager but recognized Cheniere's independent right to identify prospects and acquire leases in the West Cameron Seismic Project area. The arbitration panel directed that Cheniere has the right to participate with a 50% working interest in most of the leases acquired by Zydeco 15 or in prospects designated by Zydeco. Cheniere, however, must exercise its right of participation and pay its share of such costs within a thirty-day period following Zydeco's formal notice of prospect designation. For each prospect, Zydeco has the sole right to undertake the management and control of all prospect development for a reasonable period not to exceed 90 days following such formal notice. The arbitration panel also ruled that project seismic costs generally incurred after December 31, 1997 are not reimbursable to Zydeco as seismic costs. The Company believed that such costs, either in part or in whole, should be recouped from Cheniere as prospect costs. In addition, if certain criteria are met, then sale proceeds from certain marketing activities would be paid to Cheniere until Cheniere recoups $13.5 million of its investment in the project. Zydeco and Cheniere would share any such sales above that amount equally. Neither party received any damage awards or recovery of legal costs. As a result of the arbitration panel's decision, Zydeco and Cheniere informally agreed to share responsibilities and ownership for certain activities incurred in the maintenance, marketing and sale of prospects generated and assembled by the parties. Except for the costs of one prospect and certain other activities, neither party would seek reimbursement from the other for seismic and prospect costs generally incurred prior to the arbitration ruling. Other - The Company is a party to various other legal proceedings consisting of routine litigation incidental to its business, but believes that any potential liabilities resulting from these proceedings are immaterial. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the stockholders of the Company during the fourth quarter of 1998. 16 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock and the Warrants have traded on The Nasdaq National Market since August 19, 1997, and on the Nasdaq SmallCap Market since December 23, 1995 under the symbols "ZNRG" and "ZNRGW"; prior to that date they were quoted on the OTC Bulletin Board under the symbols "TNER" and "TNERW", respectively. Prior to December 23, 1995, the Units were quoted on the OTC Bulletin Board under the symbol "TNERU"; the Units are no longer quoted on the OTC Bulletin Board. There is very limited trading of the Units and pricing information is not readily available. The high and low sales prices of the Common Stock, the Warrants, and the Units during each quarter are presented in the table below. The quotes represent "inter-dealer" prices without retail markups, markdown, or commissions and may not necessarily represent actual transactions.
Common Stock Warrants Units(1) ----------------- ---------------- ---------------- High Low High Low High Low ------ ---- ------ ----- ------ ----- Three Months Ended March 31, 1997 $7.875 $6.125 $3.000 $1.625 N/A N/A June 30, 1997 6.750 4.500 2.250 1.000 N/A N/A September 30, 1997 5.750 4.125 2.125 0.875 N/A N/A December 31, 1997 4.516 2.000 1.625 0.625 N/A N/A Three Months Ended March 31, 1998 3.250 1.938 1.188 0.688 N/A N/A June 30, 1998 2.875 1.500 1.000 0.250 N/A N/A September 30, 1998 2.750 0.750 0.969 0.125 N/A N/A December 31, 1998 1.297 0.500 0.391 0.047 N/A N/A
- ------------------ (1) The Units have not been quoted after December 23, 1995. The Company is currently not in compliance with the continued listing requirements of the Nasdaq National Market. The Company has received separate notifications from The Nasdaq Stock Market, Inc. that its Common Stock has failed to maintain a minimum closing bid price as well as a market value of public float of $5,000,000 during recent reviews of trade dates. If the Company's Common Stock does not comply with the closing bid requirement for a minimum of ten consecutive trading days, before June 9, 1999, then the Company's Common Stock and Warrants will be delisted at the opening of business on June 11, 1999. Likewise, if the Company's Common Stock does not comply with the minimum market value of public float requirement for a minimum of ten consecutive trading days, before June 23, 1999, then the Company's Common Stock and Warrants will be delisted at the opening of business on June 25, 1999. The Company has the right to request a hearing on these matters to stay the delisting of the Company's securities. Should the Company's stock be delisted from The Nasdaq National Market, the Company intends to pursue an application for a listing on either The Nasdaq SmallCap Market or the OTC Bulletin Board. As of March 22, 1999, there were 10,357,096 shares of the Company's Common Stock outstanding held by approximately 75 holders of record. The Company believes there are approximately 1,800 beneficial owners of the Common Stock. 17 DIVIDEND POLICY The Company has never paid a cash dividend on its Preferred Stock (prior to its conversion) or its Common Stock. The Company currently intends to retain its existing working capital and potential future earnings to finance the growth and development of its business and does not anticipate paying any cash dividends on the Common Stock in the foreseeable future. Any future change in the Company's dividend policy will be made at the discretion of the Company's Board of Directors in light of the financial condition, capital requirements, earnings, and prospects of the Company and any restrictions under any credit agreements, as well as other factors the Board of Directors may deem relevant. SALES OF UNREGISTERED SECURITIES On December 2, 1997, the Company issued 150,000 shares of Common Stock to the former shareholders of Wavefield Image, Inc. The merger agreement pursuant to which the Company acquired Wavefield in July 1997 obligated the Company to issue such shares upon the issuance of a U.S. patent claiming certain aspects of the Wavefield Imaging Technology. Such a patent was issued on December 2, 1997. The shares were issued to 4 individuals, all former shareholders of Wavefield, in reliance on Section 4(2) of the Securities Act of 1933, as amended. ITEM 6. SELECTED FINANCIAL DATA The selected financial data set forth below are derived from the Consolidated Financial Statements of the Company that have been audited by Arthur Andersen LLP, independent public accountants, whose current report contained an additional paragraph modifying its opinion to raise substantial doubt about the ability of the Company to continue as a going concern for the periods indicated. The financial data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's Consolidated Financial Statements and Notes thereto included elsewhere in this report. 18
PERIOD FROM INCEPTION YEAR ENDED DECEMBER 31, (MARCH 17, 1994) -------------------------------------------------------------------- THROUGH 1998 1997 1996 1995 DECEMBER 31, 1994 -------- ------- --------- -------- ------------------- SUMMARY OPERATIONS DATA: Operating Revenues $ 783,501 $ 958,304 $ 1,470,046 $ 586,752 $ - Operating Costs and Expenses (10,692,469) (7,433,982) (3,577,385) (1,736,584) (110,242) ------------ ----------- ----------- ----------- ---------- Operating Loss (9,908,968) (6,475,678) (2,107,339) (1,149,832) (110,242) Other Income (Expense), Net 297,230 323,551 249,207 (23,814) (22,639) ------------ ----------- ----------- ----------- ---------- Net Loss $ (9,611,738) $(6,152,127) $(1,858,132) $(1,173,646) $ (132,881) ============ =========== =========== =========== ========== Weighted Average Shares of Common Stock Outstanding (Basic and Diluted) 10,365,106 7,951,438 6,168,798 3,906,706 4,468,777 ============ =========== =========== =========== ========== Loss Per Share of Common Stock Outstanding (Basic and Diluted) $ (0.93) $ (0.77) $ (0.30) $ (0.30) $ (0.03) ============ =========== =========== =========== ========== DECEMBER 31, --------------------------------------------------------------------- 1998 1997 1996 1995 ------- -------- -------- --------- SUMMARY BALANCE SHEET DATA: Cash and Cash Equivalents $ 1,912,970 $12,200,306 $ 6,906,650 $ 517,781 Marketable Securities - - 845,852 10,938,674 Properties, Equipment, and Software - Net 3,295,315 949,690 1,371,235 699,279 Total Assets 6,689,658 15,676,450 9,911,602 12,582,405 Total Stockholders' Equity 5,178,230 15,186,968 6,339,407 8,188,618
19 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Formed in December 1995, the Company is an independent oil and gas exploration company engaged in acquiring leases, drilling and producing reserves utilizing focused geologic concepts and advanced 3D seismic and computer-aided exploration ("CAEX") technology, including enhanced structural and stratigraphic depth imaging and attribute analysis. The Company has developed comprehensive in-house technology, software and expertise enabling it to use recent advances in such 3D seismic and CAEX technology. Currently, the Company's efforts are focused primarily in the Louisiana Transition Zone, a narrow trend paralleling the coastline of Louisiana. This trend is approximately six miles wide (three miles on either side of the beach) and extends about 300 miles from the Sabine River eastward to the Mississippi River. During 1996, the Company negotiated seismic options covering approximately 36,718 gross acres (33,225 net acres) and secured other seismic permits covering approximately 119,557 gross acres (119,075 net acres) in the Louisiana Transition Zone. At the core of this project, named the West Cameron Seismic Project (the "Project") was a 51,000-acre exclusive seismic permit obtained from the State of Louisiana. Pursuant to the terms of the State of Louisiana permit, the state is required to keep the information obtained from the survey confidential for a period of ten years. The Company began onshore leasing and permitting in February 1996. Seismic data acquisition for this Project commenced over approximately 230 square miles during the second half of 1996 and was completed in July 1997. The Company timely delivered seismic data to the State of Louisiana in January 1998 in compliance with the terms of the exclusive seismic permit. The seismic processing phase of this Project immediately commenced during mid 1997 and was completed in October 1998. The interpretive phase also commenced during mid 1997 and continued throughout 1998. For the Project's initial leasing phase, the major portion of 1998 lease acquisitions occurred during the first half of the year and aggregated more than 12,000 gross acres through State of Louisiana lease sales, private land negotiations and a federal lease sale. For the near term, the Company intends to continue marketing its prospects with a view toward selling an interest in such prospects or an interest in the Project to industry participants. Depending on the Company's available cash and acquisition of additional sources of capital, it believes that the interpretive phase of this Project will continue well into 1999 and that it will continue to evaluate its lease acquisition activity throughout 1999. In April 1996, the Company executed an Exploration Agreement (the "Cheniere Agreement") with Cheniere Energy Operating Co., Inc., a wholly owned subsidiary of Cheniere Energy, Inc. and formerly known as FX Energy, Inc., (collectively "Cheniere") covering the area of Project land and waters in western Cameron Parish, Louisiana. In exchange for earning a 50% interest, Cheniere agreed to fund certain Project costs including, but not limited to, 3D seismic acquisition costs, including the purchase of seismic rights or lease options on the related onshore acreage of the Project, the purchase of other 3D seismic data, and processing of seismic data over the Project area. On April 17, 1998, Zydeco Exploration, Inc. filed a petition with the American Arbitration Association for arbitration in order to resolve certain disputes that arose with Cheniere. The arbitration claim sought to resolve differences over Cheniere's funding obligations, the parties' ownership in various leases and prospects, the scope of pre-drilling activities that Cheniere can conduct within the Project area, the dissemination by Cheniere of confidential seismic data covering the Project area, and a variety of related issues. Cheniere filed a counterclaim in the arbitration action, and the pleadings were amended to include the Company as well as Zydeco Exploration, Inc. (together "Zydeco"). The parties sought conflicting declaratory and injunctive relief and damages from each other. In addition, on April 22, 1998, Zydeco initiated a civil suit in state district court in Harris County, Texas against two individuals who are parties to confidentiality agreements with Zydeco and who are employees of Cheniere. Through this litigation, Zydeco sought and obtained a Temporary Restraining Order on April 22, 1998, restraining the individuals from breaching the terms of their confidentiality agreements with Zydeco. Cheniere intervened in the litigation on April 27, 1998. On May 4, 1998, Zydeco, Cheniere and the two individuals agreed to the entry 20 of an Agreed Temporary Injunction. The agreed Temporary Injunction expired on June 15, 1998, and the dispute, which led to the filing of the civil suit, was included in the arbitration action by agreement of the parties. On December 9, 1998 the three-member arbitration panel issued its decision in the arbitration proceedings brought by Zydeco against Cheniere. In its ruling, the panel confirmed Zydeco's position as program manager but recognized Cheniere's independent right to identify prospects and acquire leases in the Project area. The arbitration panel directed that Cheniere have the right to participate with a 50% working interest in most of the leases acquired by Zydeco or in prospects designated by Zydeco. Cheniere, however, must exercise its right of participation and pay its share of such costs within a thirty-day period following Zydeco's formal notice of prospect designation. For each prospect, Zydeco has the sole right to undertake the management and control of all prospect development for a reasonable period not to exceed 90 days following such formal notice. The arbitration panel also ruled that project seismic costs generally incurred after December 31, 1997, are not reimbursable to Zydeco as seismic costs. The Company believed that such costs, either in part or in whole, should be recouped from Cheniere as prospect costs. In addition, if certain criteria are met, then sale proceeds from certain marketing activities would be paid to Cheniere until Cheniere recoups $13.5 million of its investment in the project. Zydeco and Cheniere would share any such sales above that amount equally. Neither party received any damage awards or recovery of legal costs. As a result of the arbitration panel's decision, Zydeco and Cheniere informally agreed to share responsibilities and ownership for certain activities incurred in the maintenance, marketing and sale of prospects generated and assembled by the parties. Except for the costs of one prospect and certain other activities, neither party would seek reimbursement from the other for seismic and prospect costs generally incurred prior to the arbitration ruling. After considering the arbitration panel's ruling and the two parties' informal agreement, Cheniere's and Zydeco's share of third party and processing costs incurred pursuant to the terms of the Cheniere Agreement was approximately $16,423,398 and $5,216,773, respectively, from inception to December 31, 1998. The Company charged project seismic costs amounting to $1,146,688 that previously had been attributable to Cheniere to exploration expense. In addition, the Company acquired approximately $5,753,010 of unproved leases during 1998. In order to conserve its cash resources, the Company through terminations and resignations reduced the number of its employees by a combined total of approximately 17 in December 1998 and March 1999. In addition, the Chairman of the Board, whose annual salary is $150,000, has declined taking a salary effective March 15, 1999. The Vice Chairman's annual salary of $150,000 has been deferred indefinitely, effective January 1, 1999. The Company accounts for its oil and gas exploration and production activities using the successful efforts method of accounting. Under this method, acquisition costs for proved and unproved properties are capitalized when incurred. Exploration costs, including geological and geophysical costs and the costs of carrying and retaining unproved properties, are expensed. Exploratory drilling costs are initially capitalized, but charged to expense if and when the well is determined not to have found proved reserves. Costs of productive wells, developmental dry holes, and productive leases are capitalized and amortized on a property-by-property basis using the units-of-production method. The estimated costs of future plugging, abandonment, restoration, and dismantlement are considered as a component of the calculation of depreciation, depletion, and amortization. Unproved properties with significant acquisition costs are assessed periodically on a property-by-property basis and any impairment in value is charged to expense. On July 1, 1997, the Company acquired Wavefield Image, Inc., the owner and licensor of the rights to the Wavefield Imaging Technology. A patent in respect of the Wavefield Imaging Technology was issued by the United States Patent and Trademark Office on December 2, 1997, see "Business--Seismic Technology". On August 26, 1997, the Company completed an offering of 3,680,000 shares of Common Stock and warrants to purchase 320,000 shares of Common Stock (the "Offering"). Proceeds from the Offering were approximately $14.1 million, net of Offering expenses of approximately $1.6 million. 21 RESULTS OF OPERATIONS YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997 Compared to a loss of $6,152,127, or $.77 per share, in the year ended December 31, 1997, the Company posted a loss of $9,611,738, or $.93 per share, for the year ended December 31, 1998. The $3,459,611 increase in the net loss is mostly attributable to a combination of a charge for the impairment of unproved leases, an increase in legal fees and a decline in geological and geophysical expenses. The Company recorded an impairment of $3,000,000 in the 1998 fourth quarter in order to recognize a decline in the value of unproved leases that it had acquired mostly during the first half of 1998. There was no comparable impairment in 1997. Because it will continue to evaluate its lease holdings and its ability to make delay rental payments during 1999, the Company may be required to recognize additional impairments and/or writeoffs as a result of its future reviews. Geological and geophysical expenses declined $1,396,876 from $4,958,060 in 1997 to $3,561,184 in 1998 due mostly to lower Project seismic costs. This decline was primarily due to the completion of the substantially more expensive data acquisition phase during the 1997 third quarter. The Company did not incur any material expenses for data acquisition during 1998. The significantly less expensive seismic processing and interpretive phases commenced during mid 1997 with the processing phase completed during the 1998 fourth quarter and the interpretive phase continuing into 1999. Partly offsetting the decline in levels of Project seismic expenses, the Company's share of such expenses increased from 50% to 100% pursuant to the arbitration panel's ruling for Project seismic costs generally incurred after December 31, 1997. The Company expects that the overall level of exploration expenses will decline significantly during the near term due to a combination of a lower level of Project costs and the Company's restructured activities. However, because the Company utilizes the successful efforts method of accounting, exploration expenses typically vary materially from period to period based upon exploration program activities, the Company's cost participation and other factors. During the first quarter of 1999, the Company declined to participate in a completion attempt of an exploratory well drilled during such period. As a result, the Company will record a dry hole expense of approximately $500,000 during such period. General and administrative expenses rose $1,426,709 from $1,560,861 in 1997 to $2,987,570 in 1998 principally due to increased legal expenses. The Company had no comparable legal expenses in 1997 and does not expect any additional like expenses in the near term. Most of the balance of the general and administrative expense increase is attributable to increases in personnel that were made during the second half of 1997. Research and development expenses also increased by $281,230 due to the commencement of research and development activity during mid 1997. However, due to employee terminations, resignations and other restructuring costs, the Company expects declines in both general and administrative expenses and research and development expenses during 1999. Oil and gas revenues decreased from $1,066,689 in 1997 to $389,798 in 1998 due mostly to a 51% decline in gas sales volumes and an 87% decline in oil sales volumes. Gas sales volumes fell from 336,730 thousand cubic feet ("Mcf") in 1997 to 165,762 Mcf in 1998. In addition, oil sales volumes fell from 9,377 barrels of oil ("Bbls") to 1,187 Bbls in the respective periods. The decline in such sales volumes is mostly due to natural production declines in the two producing wells in which the Company has an interest. Although it expects that the production rates of these wells will continue to decline during the near term, the Company cannot ascertain whether the rates experienced in 1998 will continue throughout 1999. The Company has not assigned any oil and gas reserves at December 31, 1998 to one of these wells. During 1998, the Company recorded gains on the sales of properties amounting to $346,321 versus net losses of $108,385 in 1997. Because the Company expects to continue to market and sell some portion or all of its interest in prospects to other industry participants, the Company will continue to record gains or losses for these transactions. However, the timing of such sales and the extent of their gain or loss are due to a number of factors such as, but not limited to, the timing and cost of lease acquisitions, the availability of 22 leaseholds in particular prospect areas and market conditions, both generally and in the oil and gas industry, at the time of sale. The increase in the net loss per share from $.77 in 1997 to $.93 in 1998 was also affected by an increase in the weighted average number of the Company's Common Shares (basic and diluted) due to the issuance of 3,680,000 shares in the Offering in August 1997. YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996 The Company recorded a loss of $6,152,127, or $.77 per share, in the year ended December 31, 1997 compared to a loss of $1,858,132 or $.30 per share, in the year ended December 31, 1996. The increase in the loss is primarily due to a $3,402,930 increase in exploration expenses in 1997 over 1996. However, also contributing to the increase in the loss from 1996 to 1997 were a drop of $355,538 in oil and gas revenues and increases of $304,372 in general and administrative expenses and $128,010 in research and development expense. The increase in exploration expenses was primarily due to the Company's participation under the Cheniere Exploration Agreement governing activities on the Project. The Company's 50% share of costs directly attributable to this project amounted to $3,124,408 in 1997. The Company had no comparable exploration expense in 1996 because, pursuant to the terms of such agreement, Cheniere paid nearly all of this project's 1996 costs. The remainder of the exploration expenses increase is principally due to other geological and geophysical expenses which are mostly composed of salaries and related payroll burdens of the Company's exploration department staff. Other geological and geophysical expenses increased approximately $278,522 in 1997 over 1996 primarily due to an increase of the exploration staff from four individuals in late 1996 to ten individuals by mid 1997. General and administrative expenses also increased because of additional personnel costs and increased rent due to a move to a larger office space in mid 1996. In addition, the Company commenced a research and development program in mid 1997. The Company had no comparable research and development expense in 1996. Total revenues decreased $511,742 in 1997 from 1996 due to a combination of decreased oil and gas sales and a loss on the sale of the Company's interest in the Bay Marchand prospect area. However, the Company recorded a gain of $137,000 in 1998 and a gain of $100,000 in 1999 pursuant to the contingent provisions of such prospect's sales agreement. Oil and gas sales dropped from $1,422,227 in 1996 to $1,066,689 in 1997 primarily due to sales volumes of oil and gas declining 54% and 10%, respectively. The decline in such sales volumes is attributable to natural production declines of the two wells in which the Company has interests. The Company has not assigned any oil and gas reserves at December 31, 1997 to one of these wells. Compared to a $16,319 gain on sales of properties in 1996, the Company recorded a $108,385 loss on sales of properties in 1997. The increase in the net loss per share from $.30 in 1996 to $.77 in 1997 was also affected by an increase in the weighted average number of the Company's Common Shares (basic and diluted) due to the issuance of 3,680,000 shares in the Offering in August 1997. LIQUIDITY AND CAPITAL RESOURCES The Company has incurred net losses and negative cash flows from operations since its inception in 1994. In 1998, 1997 and 1996, the Company incurred net losses of $9,611,738, $6,152,127 and $1,858,132, respectively. The Company is principally engaged in one industry and geographic segment, oil and gas exploration and production, and has concentrated its exploration efforts since early 1996 in an area of the Louisiana Transition Zone, known as the West Cameron Seismic Project (the "Project"). Since inception of the Project, the Company and Cheniere have expended approximately $21,640,171 pursuant to the terms of the Project's agreement. In addition, during 1998 the Company expended approximately $5,753,010 on unproved property costs, almost all of which were on prospects within the Project. The source of funding for these activities has come from funds generated from public and private equity offerings, cash flow from 23 the Company's operations, and cash payments made to it under the Cheniere Exploration Agreement. Sources of funds include approximately $24.1 million from the sale of securities in 1993, 1994, 1995 and 1997, and $16.4 million provided under the Cheniere Exploration Agreement. The Company does not currently hold any funds advanced under that agreement. During early 1998, the Company anticipated that near term cash needs would be satisfied from a combination of available cash, sales of interests in Project prospects, sale(s) of interests in the Project itself and payments by Cheniere mandated by the arbitration panel convened to rule in the Cheniere litigation matters. The Company expected that cash inflows principally from prospect sales as well as available cash would be sufficient to bridge most of its interim cash needs. In the short term and thereafter, other sources of cash may have been sought through the issuance of additional equity securities, including the exercise of outstanding warrants and options on the Company's common stock. Also, in the event of successful oil and gas well completions, the Company anticipated that revenues from oil and gas sales as well as potential credit facilities could provide additional sources of cash. However, due mostly to potential buyers' concerns over uncertainties of ownership interests before the arbitration ruling and market conditions thereafter, the Company has not generated significant sales of Project prospects and, therefore, has not produced sufficient levels of cash inflows during the near term. Since the last half of 1998 and into the first half of 1999, market conditions for selling interests in prospects have significantly deteriorated. Furthermore, the arbitration ruling did not mandate any immediate cash payments from Cheniere to the Company. During mid 1998 subsequent to the acquisition of most of its current inventory of Project leases, the Company commenced marketing activities with a view to selling interests in Project prospects that were ready for sale. The Company understands that during this period suitable buyers were available and that such buyers were conducting exploration activities including the acquisition of prospects and the drilling of wells on such prospects. It believes that its marketing efforts were unsuccessful mostly because of uncertainties over the Cheniere litigation, primarily those matters relating to the Company's and Cheniere's Project lease ownership interests. Subsequent to the arbitration ruling in December 1998, the Company and Cheniere tentatively agreed to the resolution of certain matters in order that they could recommence their prospect marketing activities. However, market conditions have considerably deteriorated to the point that significantly fewer industry participants are actively acquiring oil and gas prospect interests. Although the Company believes that it will ultimately sell interests in its prospects, there can be no assurance that it will sell such interests in the near term and at sales prices that will be sufficient to permit it to expand its operations to levels comparable to the period before its restructuring. The Company cannot ascertain the duration of the current depressed market nor if it will be able to obtain alternate capital sources if an extended downturn exists into the year 2000. In addition, because each non-producing oil and gas lease acquired by the Company requires annual delay rental payments, if the Company does not successfully market Project prospects in the near term it may forfeit its interest in some number of leases due to insufficient cash resources to meet such commitments at the time such delay rentals are due. Because of these factors and its belief that such sale prices may not be sufficient to exceed the carrying value of the applicable prospects, the Company has recognized an unproved property impairment of $3,000,000 in the accompanying financial statements for 1998. Due to the adverse factors presented above, the Company has had to rely principally on available cash to continue its operations. However, in order to conserve its remaining cash resources, the Company has instituted certain cost reducing actions, including, but not limited to, employee terminations and negotiations of deferred or foregone compensation with key executives. By restructuring its operations for the near term the Company has narrowed its business strategy to focus its activities almost entirely on the marketing of prospects in order to achieve sufficient liquidity to maintain levels of operations. The Company does not expect to generate operating cash flow or net income in 1999 unless it sells substantial interests in Project prospects or interests in the Project itself. The Company contemplates that the sale of such interests would include prospect development commitments and financing provided by the purchasers coupled with retained interests and back-in rights to the Company, and additional cash 24 consideration to the Company for recoupment of costs incurred in identifying such prospective interests. As generally required by the successful efforts method of accounting, the Company has expensed all of its costs in the Project as of December 31, 1998, and accordingly, any payments for the recoupment of non-capitalized costs would be treated as income to the Company. There can be no assurance that the Company will be successful in the selling of significant interests or in receiving payments for the recoupment of the Company's costs incurred to date on this Project. In addition, there can be no assurance that the Company will have sufficient cash available or be able to acquire new cash resources if the Company is not successful in selling its desired level of interests in a Project prospect or on terms that require little or no cash resources for prospect commitments. The Company does not presently maintain any credit facilities. The Company currently maintains a $300,000 bond required to hold its present federal oil and gas leases. This bond is collateralized by a United States Treasury Note. In the event that the Company would act as operator on a federal offshore lease or is otherwise required to increase its bonding by federal or state authorities, significant amounts of capital may be required for additional collateral to satisfy bonding requirements. The Company is unaware of any possible exposure from actual or potential claims or lawsuits involving environmental matters. As such, no liability is accrued at December 31, 1998. YEAR 2000 COMPLIANCE The Year 2000 Issue is the result of computer programs being written using two digits rather than four to define a specific year. Absent corrective actions, a computer program that has date-sensitive software may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures, miscalculations or the corruption of databases, any of which could cause disruptions to various activities and operations. The Company has initiated assessments to identify the work efforts required to assure that systems supporting the business successfully operate beyond the turn of the century. The Company's program is designed to minimize the possibility of serious Year 2000 interruptions, which worst case scenarios include the interruption of a significant part of the Company's business as a result of critical information systems failures. There are two major components to the Company's computer based systems. One system is an office wide local area network ("LAN") comprised of several personal computer ("PC") based servers and numerous PC workstations. This system contains numerous applications including, but not limited to, geological and geophysical interpretive programs, general office applications and accounting software. The other "system" is comprised of several networked workstations (called "UNIX systems") currently utilized by the Company in its geological and geophysical interpretive process. The Company employs geological and geophysical programs from both systems in such process. The Company does not rely significantly on outside parties for goods and services and thus does not expect any material impact from failures of outside parties due to Year 2000 issues. The Company has reviewed both systems and believes that its LAN system is materially compliant on Year 2000 issues. It does not expect to incur any material costs on its LAN system directly on Year 2000 issues and does not expect that any failures that could occur from such issues will materially affect its business. With regards to its UNIX systems, the Company has identified two areas that will require modifications for Year 2000 compliance if the Company continues its UNIX systems use. The Company does not consider the costs of modifications to one of these two areas to be material, but estimates that the cost to bring the other area into Year 2000 compliance will be a minimum of $75,000 and a maximum of $150,000. During 1999, the Company will review whether to maintain its UNIX systems capability and incur the costs of modification. The Company has not accrued any costs as of December 31, 1998 to bring any of its systems into compliance. If the Company chooses to maintain its UNIX systems capability, then it will recognize the cost of modifications at that time. 25 ITEM 7A. QUANTITATIVE & QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company is exposed to market risk, including adverse changes in commodity prices. The Company operates principally in one industry and geographic segment - oil and gas exploration and production with a focus on marketing its Project prospects. The Company's primary market risk exposure is in the industry impact of the fluctuation of pricing of crude oil and natural gas, which is driven by the prevailing worldwide spot prices. Historically, prices received for oil and gas production have been volatile and unpredictable. Pricing volatility is expected to continue and could adversely impact the Company's ability to market its Project prospects. See Item 1 - "Risk Factors." ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements required by this Item are incorporated under Item 14 in Part IV of this report. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT* ITEM 11. EXECUTIVE COMPENSATION* ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT* ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS* - -------------- * Items 10, 11, 12, and 13 are incorporated by reference to the registrant's Definitive Proxy Statement to be filed with the Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934 within 120 days after the close of the registrant's fiscal year. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) FINANCIAL STATEMENTS See "Index to Consolidated Financial Statements" set forth on page F-1. (a)(2) FINANCIAL STATEMENT SCHEDULES Not applicable. 26 (a)(3) EXHIBITS See pages E-1 through E-3 for a listing of exhibits. The exhibits to this report have been included only with the copies of this report filed with the Securities and Exchange Commission. Copies of individual exhibits will be furnished to stockholders upon written request to Chief Accounting Officer, Zydeco Energy, Inc., 1710 Two Allen Center, 1200 Smith Street, Houston, Texas 77002 with payment of a reasonable fee. (b) REPORTS ON FORM 8-K The Company filed a Current Report on Form 8-K dated December 16, 1998, that announced the ruling by a three member arbitration panel in the arbitration proceedings brought by the Company against Cheniere Energy, Inc. and the terminations and resignations of 13 Company employees or approximately 52% of its total workforce. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Houston, State of Texas. ZYDECO ENERGY, INC. (Registrant) Date: March 30, 1999 By: /s/ SAM B. MYERS JR. --------------------------------- Sam B. Myers, Jr. Chairman of the Board, President CEO and COO Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature Title Date - --------- ----- ---- /s/ SAM B. MYERS, JR. Chairman of the Board, Director, President, March 30, 1999 - ---------------------------------- CEO And COO (Principal Executive Officer and Sam B. Myers, Jr. Principal Financial and Accounting Officer)
28 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page ---- REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS................................... F-2 CONSOLIDATED FINANCIAL STATEMENTS Consolidated Balance Sheets as of December 31, 1998 and 1997.......... F-3 Consolidated Statements of Operations for the Three Years Ended December 31, 1998.......................................... F-4 Consolidated Statements of Stockholders' Equity for the Three Years Ended December 31, 1998.......................................... F-5 Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1998.......................................... F-6 Notes to Consolidated Financial Statements............................ F-7
F-1 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS TO THE STOCKHOLDERS AND THE BOARD OF DIRECTORS OF ZYDECO ENERGY, INC.: We have audited the accompanying consolidated balance sheets of Zydeco Energy, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1998, and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Zydeco Energy, Inc. and subsidiaries as of December 31, 1998, and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Company has suffered recurring losses from operations and has substantially used most of its capital resources which raises substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 2. The financial statements do not include any adjustments relating to the recoverability or classification of asset carrying amounts or the amount or classification of liabilities that might result should the Company be unable to continue as a going concern. ARTHUR ANDERSEN LLP Houston, Texas March 21, 1999 F-2 ZYDECO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
December 31, ---------------------------------- 1998 1997 --------------- --------------- ASSETS Current Assets Cash and Cash Equivalents $ 1,912,970 $12,200,306 Oil and Gas Revenue Receivables 47,916 151,957 Exploration Receivable - 102,524 Prepaid Expenses 50,235 974,139 Other Current Assets 141,664 54,376 ----------- ----------- Total Current Assets 2,152,785 13,483,302 Oil & Gas Properties, Using Successful Efforts Method of Accounting Proved Properties 334,972 334,972 Unproved Properties 2,796,471 27,600 Equipment and Software, at Cost 2,331,361 2,254,139 ----------- ----------- 5,462,804 2,616,711 Less: Accumulated Depreciation, Depletion, and Amortization (2,167,489) (1,667,021) ----------- ----------- 3,295,315 949,690 Investment in Wavefield Imaging Technology 928,229 933,409 Operating Bond and Other Assets 313,329 310,049 ----------- ----------- TOTAL ASSETS $ 6,689,658 $15,676,450 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts Payable $ 1,181,387 $ 436,941 Accrued Liabilities 330,041 52,541 --------------- --------------- Total Current Liabilities 1,511,428 489,482 Commitments and Contingencies (Note 11) Stockholders' Equity Common Stock, Par Value $.001 Per Share; 50,000,000 Shares Authorized; 11,338,351 and 11,318,351 Shares Issued; 10,357,096 and 10,537,096 Shares Outstanding, Respectively 11,338 11,318 Additional Paid-In Capital 24,531,668 24,499,688 Accumulated Deficit (18,928,524) (9,316,786) Less Treasury Stock, at Cost; 981,255 and 781,255 Shares, Respectively (436,252) (7,252) --------------- --------------- Total Stockholders' Equity 5,178,230 15,186,968 --------------- --------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 6,689,658 $15,676,450 =============== ===============
The accompanying notes are an integral part of these financial statements. F-3 ZYDECO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, ------------------------------------------------------ 1998 1997 1996 --------------- --------------- --------------- Revenues Oil and Gas Sales $ 389,798 $ 1,066,689 $ 1,422,227 Gain/(Loss) on Sales of Properties 346,321 (108,385) 16,319 Other 47,382 - 31,500 ----------- ----------- ----------- 783,501 958,304 1,470,046 Expenses Exploration Expenses Geological and Geophysical 3,561,184 4,958,060 967,957 Impairment of Unproved Properties 3,000,000 - - Dry Hole and Other Costs 148,285 112,393 699,566 Production Costs 17,170 20,413 22,508 Research and Development Costs 409,240 128,010 - Depreciation, Depletion, and Amortization 569,020 654,245 630,865 General and Administrative 2,987,570 1,560,861 1,256,489 ----------- ----------- ----------- 10,692,469 7,433,982 3,577,385 Operating Loss (9,908,968) (6,475,678) (2,107,339) Other Income (Expense) Interest Income 297,352 336,513 293,414 Interest Expense (122) (12,962) (44,207) ----------- ----------- ----------- 297,230 323,551 249,207 Net Loss $(9,611,738) $(6,152,127) (1,858,132) =========== =========== =========== Per Common Share- Weighted Average Number of Common Shares Outstanding (Basic and Diluted) 10,365,106 7,951,438 6,168,798 =========== =========== =========== Net Loss Per Common Share (Basic and Diluted) $ (0.93) $ (0.77) $ (0.30) =========== =========== ===========
The accompanying notes are an integral part of these financial statements. F-4 ZYDECO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Convertible Preferred Stock Common Stock Additional -------------------------- ----------------------------------------- Paid-in Shares Amount Shares Outstanding Amount Capital ------------ ------------ ------------------------ -------------- ------------------- Balance at December 31, 1995 781,255 $ 781 5,781,275 $ 6,563 $ 9,495,053 Net Loss - - - - - Options & Warrants Exercised for Common Stock - - 31,154 31 8,890 Adjustment for Fractional Shares Paid in Cash - - (34) - - Conversion of Preferred Stock to Common Stock (781,255) (781) 781,255 781 - --------- ------ ----------- -------- ------------ Balance at December 31, 1996 - - 6,593,650 7,375 9,503,943 Net Loss - - - - - Options & Warrants Exercised for Common Stock - - 13,450 13 18,486 Issuance of Common Stock Related to the Wavefield Image, Inc. Acquisition - - 250,000 250 924,750 Issuance of Common Stock Related to the Public Offering - - 3,680,000 3,680 15,636,420 Costs of the Offering - - - - (1,583,911) Adjustment for Fractional Shares Paid in Cash - - (4) - - --------- ------ ----------- -------- ------------ Balance at December 31, 1997 - - 10,537,096 11,318 24,499,688 Net Loss - - - - - Options Exercised for Common Stock - - 20,000 20 31,980 Acquisition of Treasury Stock - - (200,000) - - ========= ====== =========== ======== ============ Balance at December 31, 1998 - $ - 10,357,096 $11,338 $24,531,668 ========= ====== =========== ======== ============
Total Accumulated Treasury Stockholders' Deficit Stock Equity ----------------- ---------------- ---------------- Balance at December 31, 1995 $ (1,306,527) $ (7,252) $ 8,188,618 Net Loss (1,858,132) - (1,858,132) Options & Warrants Exercised for Common Stock - - 8,921 Adjustment for Fractional Shares Paid in Cash - - - Conversion of Preferred Stock to Common Stock - - - ------------- ---------- ------------ Balance at December 31, 1996 (3,164,659) (7,252) 6,339,407 Net Loss (6,152,127) - (6,152,127) Options & Warrants Exercised for Common Stock - - 18,499 Issuance of Common Stock Related to the Wavefield Image, Inc. Acquisition - - 925,000 Issuance of Common Stock Related to the Public Offering - - 15,640,100 Costs of the Offering - - (1,583,911) Adjustment for Fractional Shares Paid in Cash - - - ------------- ---------- ------------ Balance at December 31, 1997 (9,316,786) (7,252) 15,186,968 Net Loss (9,611,738) - (9,611,738) Options Exercised for Common Stock - - 32,000 Acquisition of Treasury Stock - (429,000) (429,000) ============= ========== ============ Balance at December 31, 1998 $(18,928,524) $(436,252) $ 5,178,230 ============= ========= ============
The accompanying notes are an integral part of these financial statements. F-5 ZYDECO ENERGY, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, --------------------------------------------------- 1998 1997 1996 ---------------- --------------- --------------- Cash Flows from Operating Activities: Net Loss $ (9,611,738) $ (6,152,127) $ (1,858,132) Adjustments to Reconcile Net Loss to Net Cash Used in Operating Activities: Depreciation, Depletion, and Amortization 569,020 654,245 630,865 Impairment of Unproved Leases 3,000,000 6,570 28,005 (Gain)/Loss on Sales of Properties (346,321) 108,385 (16,319) Exploration and Dry Hole Costs 3,709,469 5,063,884 1,639,519 Changes in Operating Assets and Liabilities (Increase) Decrease in Oil & Gas Revenue Receivables 104,041 176,018 (260,951) (Increase) Decrease in Other Current Assets (67,003) 33,104 (105,193) Increase (Decrease) in Accounts Payable 790,568 (18,763) (185,288) Increase (Decrease) in Accrued Liabilities 39,978 (72,276) (123,095) Other (6,721) (6,085) - ------------ ------------ ------------ Net Cash Used in Operating Activities (1,818,707) (207,045) (250,589) Cash Flows from Investing Activities: Additions to Oil and Gas Properties $ (5,753,010) $ (37,347) $ (507,377) Exploration and Dry Hole Costs (2,557,121) (5,044,471) (1,639,519) Proceeds from the Sale of Properties 365,944 373,335 16,319 Cost Recovery on Exploration Agreement - - - Net Change in Exploration Obligation 280,741 (1,051,461) 90,214 Distributions to Exploration Participant - (2,114,638) (217,704) Increase In Prepaid Computer Lease - (909,880) - Purchases of Equipment and Software (418,313) (320,205) (818,497) Investment in Wavefield Imaging Technology 12,972 (25,272) - Proceeds from the Sale of (Investment in) Marketable Securities, Net - 845,852 10,092,822 ------------ ------------ ----------- Net Cash Provided by (Used in) Investing Activities (8,068,787) (8,284,087) 7,016,258 Cash Flows from Financing Activities: Treasury Stock Purchase $ (429,000) $ - $ - Principal Payments of Capital Lease Obligations - (157,537) (160,693) Repayments of Short-Term Debt - - (225,028) Proceeds from Options and Warrants Exercised 32,000 18,499 8,921 Proceeds from Common Stock Issuances, Net (2,842) 13,923,826 - ------------ ----------- ----------- Net Cash Provided by (Used in) Financing Activities (399,842) 13,784,788 (376,800) ------------ ----------- ----------- Net Increase (Decrease) in Cash and Cash Equivalents $(10,287,336) $ 5,293,656 $ 6,388,869 Cash and Cash Equivalents at Beginning of Year 12,200,306 6,906,650 517,781 ------------ ----------- ----------- Cash and Cash Equivalents at End of Year $ 1,912,970 $12,200,306 $ 6,906,650 ============ =========== =========== Cash Paid/(Received) during the Year for: Interest $ 122 $ 12,962 $ 46,296
The accompanying notes are an integral part of these financial statements. F-6 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES. Organization. Zydeco Energy, Inc. was incorporated in Delaware in June 1993, as a "special purpose acquisition corporation" under the name TN Energy Services Acquisition Corp. ("TN Energy"), for the purpose of raising funds and acquiring an operating business engaged in the energy services industry. Other than its efforts to acquire an energy services business, TN Energy did not engage in any business activities prior to December 1995. On December 20, 1995, TN Energy acquired all the outstanding common stock and preferred stock of Zydeco Exploration, Inc. ("Zydeco") pursuant to a merger (the "TN Acquisition") and changed its name to Zydeco Energy, Inc. As used herein, unless the context indicates otherwise, the term "Company" refers to Zydeco Energy, Inc., and its wholly-owned subsidiaries, Zydeco Exploration, Inc., Wavefield Image, Inc., and Eastern Energy, Inc. The Company is engaged in identifying drilling prospects, acquiring leases, drilling, and producing reserves from those properties utilizing advanced 3D seismic technology. The Company's current focus is to explore for oil and gas in the Louisiana Transition Zone, the region of land and shallow waters within a few miles of the Louisiana shoreline. The Company's future operations are dependent upon a variety of factors, including, but not limited to, sale of oil and gas prospects, successful application of 3D seismic evaluation and interpretation expertise in developing oil and gas prospects, profitable exploitation of future prospects, and the Company's ability to access capital sources necessary for continued growth. See "Note 2 - Financial Results and Liquidity." SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation. For accounting purposes, the TN Acquisition has been treated as a recapitalization of Zydeco with Zydeco as the acquiror (reverse acquisition). The consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiaries, Zydeco Exploration, Inc., Wavefield Image, Inc. (since July 1, 1997) (see "Note 4 - Acquisitions") and Eastern Energy, Inc. (since March 4, 1998). All significant intercompany transactions have been eliminated in consolidation. In connection with the Company's exploration agreements (See "Note 3 - Exploration Agreements"), advances to the Company are treated as exploration obligations and expenditures made by the Company pursuant to the exploration agreement are charged against the related exploration obligation. No costs or expenses incurred pursuant to the exploration agreement is recognized by the Company until the Company, pursuant to the terms of the exploration agreement, begins sharing in such costs. Cash and Cash Equivalents. The Company considers all highly liquid investments purchased with original maturities of three months or less to be cash equivalents. Oil and Gas Properties. The Company accounts for its oil and gas exploration and production activities using the successful efforts method of accounting. Under this method, acquisition costs for proved and unproved properties are capitalized when incurred. Exploration costs, including geological and geophysical costs and the costs of carrying and retaining unproved properties, are expensed. Exploratory drilling costs are initially capitalized, but charged to expense if and when the well is determined not to have found proved reserves. Costs of productive wells, developmental dry holes and productive leases are capitalized and amortized on a property-by-property basis using the units-of-production method. The estimated costs of future plugging, abandonment, restoration and dismantlement are considered as a component of the calculation of depreciation, depletion, and amortization. Unproved properties with significant acquisition costs are assessed periodically, as conditions warrant, on a property-by-property basis and any impairment in value is charged to expense. F-7 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Equipment. Hardware and software associated with the 3D seismic technology equipment, office furniture and equipment, and leasehold improvements are recorded at cost, and the related depreciation is calculated on a straight- line basis over the estimated useful lives of the assets, which range from 2 to 7 years. Impairment of Long-Lived Assets. In accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", management reviews its long-lived assets (i.e., proved oil and gas properties) whenever events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. If the carrying amounts of any of the Company's proved oil and gas properties are greater than their projected undiscounted future cash flows, an impairment loss to adjust such assets to fair value is recognized. The determination of future cash flows may be based on a variety of factors including, but not limited to, current proved oil and gas reserve estimates and current oil and gas prices and costs. Management's estimates of fair value may also reflect a discount factor on future cash flows consistent with the rate used by the Company in other fair-value determinations. Through December 31, 1998, no material loss has been recognized. Income Taxes. The Company follows SFAS No. 109 "Accounting for Income Taxes" which requires the asset and liability approach to accounting for income taxes. Under this approach, deferred income taxes are determined based upon differences between the financial statement and tax bases of the Company's assets and liabilities and operating loss carryforwards using enacted tax rates in effect for the years in which the differences are expected to reverse. Deferred tax assets are recognized if it is more likely than not that the future tax benefit will be realized. Oil and Gas Revenues. Oil and gas revenues are recorded using the entitlements method of accounting, whereby the Company recognizes oil and gas revenues as its entitled share is produced. Individually and in the aggregate, the Company has no material gas imbalances as of December 31, 1998. Earnings Per Share. Basic earnings per common share is based on the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is computed based on the weighted average shares of common stock plus the assumed issuance of common stock for all potentially dilutive securities. The Company's common stock options, common stock warrants, and convertible preferred stock are potential common shares but were anti-dilutive in all periods presented. Treasury Stock. Treasury stock is recorded at cost. Of the 981,255 common shares held in treasury, 781,255 common shares were purchased in January 1995 at a cost of $7,252 from an officer of the Company in consideration for an overriding royalty interest in certain properties in which the Company had an interest at the time of the treasury stock purchase. The Company had no proved reserves at the time of the transaction. This cost was determined on the basis of a pro-rata allocation of the Company's accumulated cost in unproved properties at the time of the transaction in comparison to the net revenue interest transferred. The remaining 200,000 common shares were purchased on January 15, 1998 from a former employee at the then current market price. Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant estimates with regard to these financial statements include the estimate of proved oil and gas reserve volumes and the related discounted future net cash flows therefrom. See "Note 14 - Oil and Gas Producing Activities". Reclassifications. Certain reclassifications of prior period amounts have been made to conform with current year presentation. F-8 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 2. FINANCIAL RESULTS AND LIQUIDITY The Company has incurred net losses of $9,611,738, $6,152,127 and $1,858,132 in 1998, 1997 and 1996, respectively. The Company is principally engaged in one industry and geographic segment, oil and gas exploration and production, and has concentrated its exploration efforts since early 1996 in an area of the Louisiana Transition Zone, known as the West Cameron Seismic Project ("Project"). Since inception of the Project, the Company and Cheniere have expended $21,640,171 pursuant to the terms of that Project's agreement. In addition, during 1998 the Company expended $5,753,010 on unproved property costs, almost all of which were on prospects within the Project. See Note 3 - "Exploration Agreements" for a description of that activity. The source of funding for these activities has come from funds generated from public and private equity offerings, cash flow from the Company's operations, and cash payments made to it under the Cheniere Exploration Agreement. Sources of funds include approximately $24.1 million from the sale of securities in 1993, 1994, 1995 and 1997, and $16.4 million provided under the Cheniere Exploration Agreement. During early 1998, the Company anticipated that near term cash needs would be satisfied from a combination of available cash, sales of interests in Project prospects, sale(s) of interests in the Project itself and payments by Cheniere mandated by the arbitration panel convened to rule in the Cheniere litigation matters. The Company expected that cash inflows principally from prospect sales as well as available cash would be sufficient to bridge most of its interim cash needs. In the short term and thereafter, other sources of cash may have been sought through the issuance of additional equity securities, including the exercise of outstanding warrants and options on the Company's common stock. Also, in the event of successful oil and gas well completions, the Company anticipated that revenues of oil and gas sales as well as potential credit facilities could provide additional sources of cash. During mid 1998 subsequent to the acquisition of most of its current inventory of Project leases, the Company commenced marketing activities with a view to selling interests in Project prospects that were ready for sale. The Company understands that during this period suitable buyers were available and that such buyers were conducting exploration activities including the acquisition of prospects and the drilling of wells on such prospects. It believes that its marketing efforts were unsuccessful mostly because of uncertainties over the Cheniere litigation, primarily those matters related to the Company's and Cheniere's Project lease ownership interests. Subsequent to the arbitration ruling in December 1998, the Company and Cheniere informally agreed to the resolution of certain matters in order that they could recommence their prospect marketing activities. However, market conditions have considerably deteriorated to the point that a significantly fewer industry participants are actively acquiring oil and gas prospect interests. Although the Company believes that it will ultimately sell interests in its prospects, there can be no assurance that it will sell such interests in the near term and at sales prices that will be sufficient to permit it to expand its operations to levels comparable to the period before its restructuring. The Company cannot ascertain the duration of the current depressed market nor if it will be able to obtain alternate capital sources if an extended downturn exists into the year 2000. In addition, because each non-producing oil and gas lease acquired by the Company requires annual delay rental payments, the Company may forfeit its interest in some number of leases due to insufficient cash resources to meet such commitments at the time such delay rentals are due. Because of these factors and its belief that such sale prices may not be sufficient to exceed the carrying value of the applicable prospects, the Company has recognized an unproved property impairment of $3,000,000 in the accompanying financial statements for 1998. F-9 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Due to the adverse factors presented above, the Company has had to rely principally on available cash to continue its operations. However, in order to conserve its remaining cash resources, the Company has instituted certain cost reducing actions, including, but not limited to, employee terminations and negotiations of deferred or foregone compensation to key executives. By restructuring its operations, for the near term the Company has altered its business strategy to more narrowly focus its activities almost entirely on the marketing of prospects in order to achieve sufficient liquidity to maintain minimum levels of operations. Should the Company be successful in selling interests in its prospects or an interest in the Project itself in the near term, sufficient capital may be raised to expand its operations. In addition, the Company will continue to seek other sources of capital including, but not limited to, the issuance of equity securities. There can be no assurance that the Company will be successful in selling interests in its prospects, the Project or issuing equity securities or obtaining any other form of financing. The uncertainties about the Company's future cash flows and the lack of firm commitments for additional capital at this time raise substantial doubt about the ability of the Company to continue as a going concern. The accompanying financial statements do not include any adjustments relating to the recoverability or classification of asset carrying amounts or the amount or classification of liabilities that might result should the Company be unable to continue as a going concern. 3. EXPLORATION AGREEMENTS. Fortune Exploration Agreement. In February 1995, Zydeco entered into an Exploration Agreement (the "Fortune Agreement") with a predecessor of Fortune Petroleum Corporation ("Fortune"). Under the Fortune Agreement, Fortune advanced $4.8 million in a series of payments to purchase a 50% interest in certain potential prospects ("Prospects") owned by the Company and to fund the initial development of the potential Prospects. At December 31, 1997, inception-to-date expenditures under the Fortune Agreement aggregated approximately $2,256,823, net of interest earned of $209,731 and revenue from the farmout and sale of interests of $277,154. Pursuant to the terms of the Fortune Agreement, in June 1997, at the request of Fortune, the Company returned $2,153,645 to Fortune, representing the unexpended funds previously advanced to the Company under the Fortune Agreement. The Company retained its undivided working interest in each of the properties acquired under the Fortune Agreement. Substantially all the cost of lease acquisition and seismic data acquisition had been incurred at the time of Fortune's election. The Company does not expect to incur any significant additional expenditures pursuant to the terms of such agreement. Cheniere Exploration Agreement and Litigation. In April 1996, the Company executed an Exploration Agreement (the "Cheniere Agreement") with Cheniere Energy Operating Co., Inc., a wholly owned subsidiary of Cheniere Energy, Inc. and formerly known as FX Energy, Inc., (collectively "Cheniere") covering an area of land and waters in western Cameron Parish, Louisiana ("Project"). The Cheniere Agreement, as amended, provided for Cheniere to fund the first $13.5 million of costs plus 50% of costs in excess of $13.5 million of the Project. The costs covered by the Cheniere Agreement included, but were not limited to, 3D seismic acquisition costs, including the purchase of seismic rights or lease options on the related onshore acreage of the Project, the purchase of other 3D seismic data, and processing of seismic data over the Project area. On April 17, 1998, Zydeco Exploration, Inc. filed a petition with the American Arbitration Association for arbitration in order to resolve certain disputes that arose with Cheniere. The arbitration claim sought to resolve differences over Cheniere's funding obligations, the parties' ownership in various leases and prospects, the scope of pre-drilling activities that Cheniere can conduct within the Project area, the dissemination by Cheniere of confidential seismic data covering the Project area, and a wide variety of related issues. Cheniere filed a counterclaim in the arbitration action, and the pleadings were amended to include Zydeco Energy, Inc. as well as Zydeco Exploration, Inc. (collectively "Zydeco"). F-10 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) On December 9, 1998, the three-member arbitration panel issued its decision in the arbitration proceedings brought by Zydeco against Cheniere. In its ruling, the panel confirmed Zydeco's position as program manager but recognized Cheniere's independent right to identify prospects and acquire leases in the West Cameron Seismic Project area. The arbitration panel directed that Cheniere has the right to participate with a 50% working interest in most of the leases acquired by Zydeco or in prospects designated by Zydeco. Cheniere, however, must exercise its right of participation and pay its share of such costs within a thirty-day period following Zydeco's formal notice of prospect designation. For each prospect, Zydeco has the sole right to undertake the management and control of all prospect development for a reasonable period not to exceed 90 days following such formal notice. The arbitration panel also ruled that project seismic costs generally incurred after December 31, 1997, are not reimbursable to Zydeco as seismic costs. The Company believed that such costs, either in part or in whole, should be recouped from Cheniere as prospect costs. In addition, if certain criteria are met, then sale proceeds from certain marketing activities would be paid to Cheniere until Cheniere recoups $13.5 million of its investment in the project. Zydeco and Cheniere would share any such sales above that amount equally. Neither party received any damage awards or recovery of legal costs. As a result of the arbitration panel's decision, Zydeco and Cheniere informally agreed to share responsibilities and ownership for certain activities incurred in the maintenance, marketing and sale of prospects generated and assembled by the parties. Except for the costs of one prospect and certain other activities, neither party would seek reimbursement from the other for seismic and prospect costs generally incurred prior to the arbitration ruling. After considering the arbitration panel's ruling and the two parties' informal agreement, Cheniere's and Zydeco's share of third party and processing costs incurred pursuant to the terms of the Cheniere Agreement was approximately $16,423,398 and $5,216,773, respectively, from inception to December 31, 1998. Project seismic costs amounting to $1,146,688 that previously had been attributable to Cheniere were charged to exploration expense. In addition, the Company paid approximately $5,753,010 for unproved leases during 1998. 4. ACQUISITIONS. On December 20, 1995, the shareholders of TN Energy approved a merger with Zydeco (the "Merger"). Pursuant to the Merger Agreement, each outstanding share of common stock of Zydeco, par value $.000333 per share, was converted into the right to receive 1.56251 shares of Common Stock of TN Energy, par value $.001 per share; each share of convertible preferred stock of Zydeco, par value $5.00 per share, was converted into the right to receive 1.56251 shares of Convertible Preferred Stock of TN Energy, par value $.001 per share, and any fractional shares settled in cash. In addition, TN Energy assumed Zydeco's existing stock options issued in connection with Zydeco's 1995 Employee Stock Option Plan (the "Plan"), substituting shares of Common Stock of TN Energy as the shares subject to purchase under the Plan. Further, TN Energy assumed each existing common stock warrant issued by Zydeco, substituting Common Stock of TN Energy as the shares subject to purchase under the warrants. The number of shares subject to purchase under option and warrant agreements was adjusted by multiplying the number of Zydeco option or warrant shares by the exchange ratio of 1.56251 shares. The exercise prices for Zydeco options and warrants were adjusted by dividing the stated exercise price by the exchange ratio. After completion of the Merger, TN Energy changed its name to Zydeco F-11 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Energy, Inc. At the conclusion of the Merger on December 21, 1995, Zydeco Energy, Inc. had 5,781,275 shares of Common Stock outstanding and 781,255 shares of Convertible Preferred Stock outstanding. The Merger was treated as a reverse acquisition for accounting purposes with Zydeco as the acquiror and TN Energy as the acquiree based upon Zydeco's then current officers and directors assuming management control of the resulting entity and the value and ownership interest being received by current Zydeco stockholders exceeding that received by TN Energy stockholders. The Merger, for accounting purposes, was treated as if Zydeco issued additional capital stock to TN Energy shareholders for cash. The net assets of TN Energy on the date of the Merger were $7,971,525 and, accordingly, the shares of common stock of TN Energy on such date were recorded as an increase in common stock and additional paid-in capital. The costs incurred in connection with the Merger of approximately $669,700 were charged to additional paid-in capital at December 31, 1995. On July 1, 1997, the Company acquired all of the outstanding capital stock of Wavefield Image, Inc. ("Wavefield"), a privately held company that develops and licenses a seismic data processing technique known as Wavefield Imaging Technology. The Company utilized Wavefield Imaging Technology in its West Cameron Seismic Project pursuant to a license agreement entered in May 1996. Pursuant to the terms of the acquisition agreement between the Company and the shareholders of Wavefield, the Company issued 100,000 shares of the Company's common stock at closing to the shareholders of Wavefield and an additional 150,000 shares of such stock to the former Wavefield shareholders in connection with the issuance of a patent on the Wavefield Imaging Technology by the United States Patent and Trademark Office. In connection with the issuances of Common Stock, the Company recorded an investment in the Wavefield Imaging Technology of $950,068 based on the prices of the Company's Common Stock on July 1, 1997, and December 2, 1997, the date of the patent issuance. The Company is amortizing this investment over approximately 19 years (the life of the patent received). Amortization for 1998 was $46,389. The historical operations of Wavefield were not significant to the Company's financial position or results of operations. The acquisition through the issuance of Common Stock was a non-cash investing activity and accordingly, has been excluded from the Consolidated Statements of Cash Flows. 5. INCOME TAXES. Significant components of the Company's deferred tax liabilities and assets are as follows: December 31, ---------------------------------- 1998 1997 --------------- --------------- Deferred Tax Liability $ - $ - ============= ============ Deferred Tax Assets Carryforwards $ 2,522,586 $ 2,052,298 Book/Tax Differences in Basis of Oil and Gas Assets 3,881,934 1,163,414 Less Valuation Allowance (6,404,520) (3,215,712) ------------- ------------ Total Deferred Tax Assets $ - $ - ============= ============ Net Deferred Tax Liability $ - $ - ============= ============ As of December 31, 1998, the Company had a net operating loss carryforward for federal income tax purposes of approximately $7,419,371, which will be available to reduce future taxable income. The full realization of the tax benefit associated with the carryforward depends predominantly upon the Company's ability to generate taxable income during the carryforward period. Because of the current uncertainty of realizing such tax asset in the future, a valuation allowance has been recorded equal to the amount of the F-12 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) net deferred tax asset, which caused the Company's effective tax rate to differ from the statutory income tax rate. The net operating loss carryforward, if not utilized, will begin to expire in the year 2009. In addition, the company has available $339,003 of statutory depletion as carryforward to apply against future taxable income. 6. INDEBTEDNESS. Capital Lease - Computer Hardware. In 1997, the Company completed its payments under a capital lease for certain computer hardware assumed from an affiliate of Mr. Sam B. Myers, Jr. in 1994. Amortization expense, calculated on a three-year, straight-line basis, aggregated $474,284 as of December 31, 1997. This lease had a stated interest rate of 19.45%. The lease was collateralized by the computer equipment utilized under the lease. Operating Leases. The Company incurred rental expense of $247,164, $151,006, and $125,734 in 1998, 1997, and 1996, respectively, in connection with its office leases. See "Note 8 - Related-Party Transactions". In addition, on December 1, 1997, the Company prepaid $1,091,856 for a 12-month operating lease, commencing on November 1, 1997, on a Hewlett- Packard SPP2000 supercomputer used in its 3D seismic processing. The Hewlett-Packard lease was not renewed. At December 31, 1998, future minimum lease payments for leases having initial or remaining noncancelable lease terms in excess of one year are presented below: Year Amount ------------ ---------------- 1999 $78,487 2000 $ 7,843 2001 $ 2,395 2002 $ - 2003 and thereafter $ - 7. COMMON STOCK, CONVERTIBLE PREFERRED STOCK, AND WARRANTS. Common Stock Offering. On August 26, 1997, the Company completed an offering of 3,680,000 shares of Common Stock and warrants to purchase 320,000 shares of Common Stock (the "Offering"). Proceeds from the Offering were $14,056,189, net of Offering expenses of $1,583,911. In connection with the Offering, the Company sold to the Underwriters, for nominal consideration, warrants to purchase 320,000 shares of Common Stock from the Company ("1997 Underwriter Warrants"). The 1997 Underwriter Warrants are exercisable, in whole or in part, at an exercise price of $5.10 (120% of the Offering price) at any time during the four-year period commencing August 26, 1998. The warrant agreement pursuant to which the 1997 Underwriter Warrants were issued contains provisions providing for adjustment of the exercise price and the number and type of securities issuable upon exercise of the 1997 Underwriter Warrants should any one or more of certain specified events occur. The 1997 Underwriter Warrants grant to the holders thereof demand and piggy-back registration rights for the securities issuable upon exercise of the 1997 Underwriter Warrants. Conversion of Preferred Stock. Shares of Convertible Preferred Stock, par value $.001, issued in December 1994 were subject to conversion at a rate of one share of Common Stock for each share of Convertible Preferred Stock upon either (i) the occurrence of a successful public offering or (ii) in the event the closing price for the Common Stock equaled or exceeded $6.50 for a period of 30 consecutive trading days. The price of the Common Stock exceeded the minimum price for the required period in June 1996, and, accordingly, the Company exercised its option to convert all shares of Convertible Preferred Stock to Common Stock effective July 15, 1996. F-13 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Placement Warrants. In connection with a 1994 Private Placement in December 1994, Zydeco issued 72,268 Common Stock purchase warrants ("Placement Warrants") to the participating placement agents, each of which entitles the holder to purchase one share of Common Stock at an exercise price of $1.60 per share at any time prior to their expiration on December 2, 1999. These warrants are subject to a cashless exercise provision (i.e., the exercise price may be satisfied by canceling a number of unexercised warrants valued by the difference between the exercise price and the market value of the shares). The initial value of such warrants issued in connection with the private placement was immaterial. No Placement Warrants had been exercised prior to 1996. In 1997 and 1996, Placement Warrants were exercised for 1,888 and 29,592 shares of Common Stock, respectively, net of 573 and 9,575 warrant shares, respectively, tendered in satisfaction of the exercise price. At December 31, 1998, there were 30,640 unexercised Placement Warrants outstanding. Redeemable Warrants. On December 26, 1993, the Company sold 1,500,000 units ("Units") in its initial public offering ("IPO"). Each Unit consists of one share of the Company's Common Stock, $.001 par value, and two redeemable Common Stock Purchase Warrants ("Redeemable Warrants"). Each Redeemable Warrant entitles the holder to purchase from the Company one share of Common Stock at an exercise price of $5.50, during the period commencing on the later of the consummation by the Company of a Business Combination or one year from the effective date of the IPO, or December 20, 1995, and ending seven years from the effective date of the IPO, or December 13, 2000. The Merger constituted a business combination under the terms of the Redeemable Warrants. The Redeemable Warrants will be redeemable at a price of $.01 per warrant upon 30 days' notice at any time, only in the event that the last sale price of the Common Stock is at least $10.00 per share for 20 consecutive trading days ending on the third day prior to the date on which notice of redemption is given. The Company also issued, in connection with the IPO, an aggregate of $150,000 of promissory notes to certain accredited investors. These notes bore interest at the rate of 10% per annum and were repaid on the consummation of the Public Offering with accrued interest thereon. In addition, the investors were issued 300,000 Redeemable Warrants valued at a nominal amount. At December 31, 1998, no Redeemable Warrants had been exercised. Unit Purchase Options. Also on December 21, 1993, the Company sold to the underwriters in the IPO and their designees, for nominal consideration, the right to purchase up to 195,652 units ("Unit Purchase Options") as adjusted for the Offering completed on August 26, 1997. Each Unit Purchase Option consists of one share of Common Stock and two Common Stock Purchase Warrants. Each Common Stock Purchase Warrant entitled the holder to purchase one share of Common Stock under terms similar to the terms of the Redeemable Warrants except that the Common Stock Purchase Warrants are not redeemable. The Unit Purchase Options were exercisable at $5.06 per unit ("Option Exercise Price"), as adjusted, until December 13, 1998, when they expired. In addition, the Common Stock Purchase Warrants were exercisable at $5.50 per warrant, and expired on the same date as the Unit Purchase Options. The Unit Purchase Options contained anti-dilution provisions providing for adjustment of the Option Exercise Price upon the occurrence of certain events, including the issuance of shares of Common Stock or other securities convertible into or exercisable for shares of Common Stock at a price per share less than the Option Exercise Price or the market price of the Common Stock, or in the event of any recapitalization, reclassification, stock dividend, stock split, stock combination, or similar transaction. No Unit Purchase Options were exercised prior to their expiration. Non-Redeemable Bridge Warrants. In December 1995, in connection with arranging the Bridge Financing, the Company issued to the Bridge Lenders warrants to purchase 225,028 shares of Common Stock ("Non-Redeemable Bridge Warrants"), at an exercise price of $5.33 per share. The terms of the Non- Redeemable Bridge Warrants are identical to the terms of the Redeemable Warrants, except that they are not redeemable and are subject to a cashless exercise provision. At December 31, 1998, no Non-Redeemable Bridge Warrants had been exercised. F-14 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 8. RELATED-PARTY TRANSACTIONS. On December 30, 1998, the Company sold a 6.25% working interest participation in a prospect to a limited partnership whose president and a vice president are the children of the Company's Chairman. The agreement provides that the limited partnership pay to the Company a total consideration of $204,000 for this interest which included the turnkey cost of drilling this prospect's first well. Pursuant to the terms of the agreement with such limited partnership, the basis of this partnership's participation in this prospect is on comparable terms of participation by an unrelated party. In connection with the informal agreement with Cheniere discussed in Note 3 - "Exploration Agreements - Cheniere Exploration Agreement and Litigation", the Company and Cheniere agreed to share all proceeds attributable to the sale of Project prospects, including cash and promoted interests. Cheniere's estimated share of the total consideration paid by the limited partnership is approximately $64,000. Subsequent to December 31, 1998, this prospect's first well was drilled and amounts related to the turnkey portion were earned by the Company. The Company and the limited partnership did not participate in a completion attempt on this well. The Company will expense approximately $500,000 as dry hole expense in the 1999 first quarter, such amount net of the Company's share of the turnkey contribution. (See "Note 12 - Subsequent Events"). The agreement also provides that the limited partnership has a one-time option to acquire a 6.25% working interest participation in an adjacent prospect for $62,500 and to pay its pro-rata share of the second prospect's drilling costs on a promoted basis. In connection with the acquisition of Wavefield, the Company agreed to assume the remaining office lease obligation of a shareholder of Wavefield who became an officer of the Company. The offices were used by Wavefield and the Wavefield shareholders. The remaining term of the lease at December 31, 1998 was 10 months requiring the payment of monthly rentals of $5,585. The Company expensed $66,367 and $33,510 during the years ended December 31, 1998 and 1997, respectively, related to the lease. In 1996, the Company licensed software and purchased related software maintenance services aggregating $325,768 from the subsidiary of an unaffiliated company. Subsequently, in October 1996, an officer and director of the Company became a director of the unaffiliated parent company. Software and services provided by the vendor aggregated $262,380 for the year ended December 31, 1997. The unaffiliated parent company sold its vendor subsidiary during 1997. The Company engaged the services of a law firm, including the services of a partner in the firm who is a relative of an officer and director of the Company. The Company incurred costs of approximately $176,505, $220,343, and $109,902 to this firm during the years ended December 31, 1998, 1997, and 1996, respectively. Effective January 1, 1995, Zydeco assumed an obligation for office facilities under an operating lease agreement expiring in March 1997, from a Myers Affiliate where certain officers of the Company were, at the time, also officers and/or directors of the Myers Affiliate. The lease agreement required base monthly payments of $3,122. In connection with the relocation of the Company's offices in June 1996, the Company bought out the remaining nine month term under this lease for $24,615. Rental expense related to this lease was $44,887 and is included in general and administrative expenses for the year ended December 31, 1996. 9. STOCK OPTION PLANS. At December 31, 1998, the Company had three stock-based compensation plans, which are described below. Each plan provides for the granting of options generally at not less than the per share market price on the date of grant. The Company applies APB Opinion 25 and related Interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plans. Had compensation cost for the Company's three stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123 "Accounting for Stock-Based Compensation", the Company's net loss and net loss per common share would have been increased to the pro forma amounts indicated below: F-15 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1998 1997 1996 ------------ ------------ ------------ Net Loss As Reported $ (9,611,738) $(6,152,127) $(1,858,132) Pro Forma $(10,482,914) $(6,854,165) $(2,296,904) Net Loss Per Common Share As Reported $ (0.93) $ (0.77) $ (0.30) (Basic and Diluted) Pro Forma $ (1.01) $ (0.86) $ (0.37)
For purposes of the above proforma disclosure, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used for grants in 1998, 1997, and 1996, respectively: no dividend yield for each of the three years, expected volatility of .56, .51, and .52, respectively, risk-free interest rates of 5.9%, 6.5% and 5.2%, respectively, and expected lives of 10 years for all options. In connection with the above assumptions, the estimated weighted average fair value of options granted in 1998, 1997, and 1996, is $1.69, $3.85, and $4.07 per share, respectively. In February 1995, Zydeco's Board of Directors approved the 1995 Employee Stock Option Plan (the "Zydeco Plan") for certain employees of the Company and any subsequently incorporated subsidiaries of the Company. Options to purchase 1,006,256 shares of stock at a price of $1.60 per share, as adjusted pursuant to the TN Acquisition, were granted in March 1995. Such options are non-compensatory, vest over a four-year period and terminate no later than March 2005. On January 4, 1996, the Board of Directors approved and adopted the Zydeco Energy, Inc. 1996 Incentive Equity Plan (the "1996 Incentive Plan") and amended such plan on March 3, 1997. The 1996 Incentive Plan authorizes the grant of various stock and stock-related awards to key management and other personnel on the basis of individual and corporate performance. The 1996 Incentive Plan, as amended, provides for the granting of stock options to purchase an aggregate of 950,000 shares of Common Stock, which are reserved for such purpose. Options under the 1996 Incentive Plan are non- compensatory, vest over a four-year period and terminate no later than ten years after the date of grant unless otherwise determined by the Compensation Committee. Also on January 4, 1996, the Board of Directors adopted the 1996 Non- employee Director Stock Option Plan (the "1996 Director Plan") and authorized and granted an aggregate of 45,000 shares of Common Stock to three non-employee directors. The options vest one third on April 1, 1997, 1998, and 1999, and have an exercise price of $6.69 per share. The options terminate no later than ten years after the date of grant. Both the 1996 Incentive Plan and the 1996 Director Plan were approved by the Company's shareholders at the Annual Meeting on July 9, 1996. The amended 1996 Incentive Plan was approved by the Company's shareholders at the Annual Meeting on May 15, 1997. Information about the Company's stock option plans for each of the three years in the period ended December 31, 1998, is set forth below: F-16 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
1998 1997 1996 ---------------------- ----------------------- ---------------------- Average Average Average Shares Grant Price Shares Grant Price Shares Grant Price --------- ------------- --------- ------------ --------- ----------- Outstanding at January 1 1,768,632 $3.33 1,444,694 $2.91 1,006,256 $1.60 Granted 221,000 2.21 504,000 5.55 540,000 6.06 Exercised (20,000) 1.60 (11,562) 1.60 (1,562) 1.60 Forfeited and Expired (468,626) 4.73 (168,500) 6.55 (100,000) 6.69 --------- --------- --------- Outstanding at December 31 1,501,006 2.75 1,768,632 3.33 1,444,694 2.91 ========= ========= ========= Shares Exercisable at December 31 1,218,506 2.40 855,317 2.18 501,565 1.60 ========= ========= ========= Shares Available for Future Grant 464,000 219,500 555,000(1) ========= ========= ========= Average Fair Value of Shares Granted During Year $ 1.69 $ 3.85 $ 4.07 --------- --------- ---------
Shares Outstanding Shares Exercisable --------------------------------- -------------------------- Weighted Weighted Weighted Average Average Average Range of Remaining Grant Grant Grant Prices Shares Life Price Shares Price - --------------------- --------------------------------- -------------------------- $1.00 to $3.00 1,098,256 7 years $1.70 983,756 $1.61 3.00 to 5.00 4,000 8 years 4.94 1,000 4.94 5.00 to 7.00 398,750 8 years 5.76 233,750 5.69 --------- --------- 1.00 to 7.00 1,501,006 7 years 2.78 1,218,506 2.40 ========= =========
- ------------ (1) Includes shares approved by the Company's shareholders at the May 15, 1997 Annual Meeting of Shareholders. F-17 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 10. SEGMENT INFORMATION. In June 1997, the Financial and Accounting Standards Board issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." This standard requires that companies report certain information about operating segments in complete sets of financial statements and in condensed financial statements of interim periods for fiscal years beginning after December 15, 1997. The Company adopted this statement for the fiscal year ending December 31, 1998. The Company operates principally in one industry and geographic segment - oil and gas exploration and production and as such the adoption of SFAS No. 131 had no impact on the Company's financial statements. Major Customers. Oil and gas sales to two customers of $348,636 and $24,892 in 1998, to two customers of $829,732 and $236,957 in 1997, and to two customers of $1,030,424 and $391,803 in 1996, each constituted more than 10% of consolidated revenue for such years. 11. COMMITMENTS AND CONTINGENCIES. In February 1996, the Company purchased an exclusive seismic option permit from the State of Louisiana covering approximately 51,000 acres of state waters in western Cameron Parish, Louisiana. The Company initially paid $783,754 for the permit and in August 1997, paid $391,877 for a six-month extension of the permit. Under the agreement with the state of Louisiana, the Company was obligated to deliver within 24 months a 3D seismic survey over the state acreage, which was delivered by the Company in January 1998. The State of Louisiana is required to keep the information obtained from the survey confidential for a period of ten years. In May 1996, the Company entered into a two year license agreement with Wavefield Image, Inc. to use a proprietary 3D seismic processing known as the Wavefield Imaging Technology, which required the payment of annual royalties. In July 1997, the Company acquired 100% of the outstanding capital stock of Wavefield Image, Inc., the owner of this technology (See "Note 4 - Acquisitions".) 12. SUBSEQUENT EVENTS. On January 11, 1999, the Company and Cheniere sold a seismic option for $500,000 to an unaffiliated industry participant. Pursuant to the terms of the seismic option agreement, the industry participant had 35 days to exercise the right to acquire an interest in any or all of three specific prospects developed from the Company's West Cameron Seismic Project. The industry participant did not exercise its right of acquisition. In accordance with the tentative agreement with Cheniere Energy, Inc. (See Note 3 - "Exploration Agreements"), the Company and Cheniere shared the option proceeds on the basis of 45% and 55%, respectively. The Company will record its $225,000 share of the proceeds in the 1999 first quarter as a reduction to its carrying value of unproved properties. On March 12, 1999, total drilling depth was reached in a well operated by the Company. The Company subsequently declined to participate in a completion attempt and non-consented the proposed operation pursuant to the terms of that well's operating agreement. The Company's estimated share of total well costs, amounting to approximately $500,000, will be expensed as dry hole expense in the 1999 first quarter. The cost of the related prospect, amounting to approximately $277,000, was fully impaired as of December 31, 1998. F-18 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 13. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED). Results of operations by quarter for the years ended December 31, 1998 and 1997 are set forth in the following table.
Quarter Ended ---------------------------------------------------------------- March 31 June 30 September 30 December 31 ------------ ------------- -------------- -------------- 1998 Operating Revenues $ 124,140 $ 113,506 $ 147,113 $ 398,742 Operating Loss (1,344,627) (1,504,995) (1,599,257) (5,472,681) Net Loss (1,205,774) (1,407,172) (1,558,434) (5,440,358) Net Loss Per Common Share (Basic and Diluted) $ (0.12) $ (0.14) $ (0.15) $ (0.53) 1997 Operating Revenues $ 373,994 $ 257,329 $ 437,877 $ (110,896) Operating Loss (617,148) (1,746,203) (2,040,287) (2,072,040) Net Loss (565,617) (1,701,400) (1,956,578) (1,928,532) Net Loss Per Common Share (Basic and Diluted) $ (0.09) $ (0.26) $ (0.24) $ (0.18)
F-19 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) 14. OIL AND GAS PRODUCING ACTIVITIES. Results of Operations from Oil and Gas Producing Activities The results of operations for oil and gas producing activities for the years indicated are presented below:
Year Ended December 31, ----------------------------------------------------- 1998 1997 1996 --------------- -------------- -------------- Oil and Gas Sales $ 389,798 $ 1,066,689 $ 1,422,227 Production (Lifting) Costs (17,170) (20,413) (22,508) Dry Hole and Other Costs (148,285) (112,393) (699,566) Impairment of Unproved Properties (3,000,000) - - Geological and Geophysical Expenses (3,561,184) (4,958,060) (967,957) Depreciation, Depletion, and Amortization (1) (424,669) (566,271) (592,996) Income Tax Benefit (Provision) - - - ------------- ------------ ----------- Results of Operations from Oil and Gas Producing Activities $ (6,761,510) $ (4,590,448) $ (860,800) ============= ============ =========== (1) Includes depreciation on seismic computer hardware and software.
CAPITALIZED COSTS RELATED TO OIL AND GAS PRODUCING ACTIVITIES The following table presents total capitalized costs of proved and unproved oil and gas properties and associated accumulated depreciation, depletion, and amortization:
December 31, ----------------------------------- 1998 1997 ---------------- --------------- Proved Oil and Gas Properties, at Cost $ 334,972 $ 334,972 Unproved Oil and Gas Properties 2,796,471 27,600 Equipment and Software 1,974,028 1,908,818 Less - Accumulated Depreciation, Depletion, and Amortization (1,969,652) (1,521,693) ------------ ----------- Net Capitalized Costs $ 3,135,819 $ 749,697 ============ ===========
COSTS INCURRED IN OIL AND GAS PROPERTY ACQUISITION, EXPLORATION AND DEVELOPMENT ACTIVITIES Presented below are costs incurred in oil and gas property acquisition, exploration and development activities:
Year Ended December 31, ------------------------------------------------------- 1998 1997 1996 ---------------- ---------------- -------------- Proved Property Acquisition Costs $ - $ 34,188 $ 7 Unproved Property Acquistion Costs 5,753,010 27,600 507,370 Exploration Costs 3,734,900 5,070,453 1,639,519 Equipment and Software Additions 92,378 565,163 569,973 ----------- ----------- ---------- Total for Year $9,580,288 $5,697,404 $2,716,869 =========== =========== ==========
F-20 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) RESERVE QUANTITY INFORMATION (UNAUDITED) The following unaudited information has been provided pursuant to SFAS No. 69, "Disclosures about Oil and Gas Producing Activities". There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production, including many factors beyond the control of the Company. The estimation of reserve quantities results from a process that cannot be measured in an exact way and employs judgements made by the Company's independent petroleum engineering firms. Accordingly, reserve estimates are often different from quantities of oil and gas that are ultimately recovered. The Company's proved oil and gas reserves were estimated by Petroleum Professionals International, LP as of December 31, 1998 and by Ryder Scott Company, Petroleum Engineers as of December 31, 1997 and 1996. PROVED DEVELOPED RESERVE QUANTITIES (UNAUDITED) The Company's oil and gas producing activities have been conducted solely in the United States. The Company had no proved undeveloped reserves at December 31, 1998, 1997, and 1996. The following table sets forth the changes in the Company's total proved reserves (all of which are developed) for the years ended December 31, 1998, 1997, and 1996:
December 31, ------------------------------------------------------- 1998 1997 1996 --------------- --------------- ---------------- Oil (Bbls) Total Proved Reserves: Proved Oil Reserves at the Beginning of the Year 2,614 10,052 15,899 Extensions, Discoveries, and Other Additions - - - Revisions of Previous Estimates (1,158) 1,939 14,339 Production (1,187) (9,377) (20,186) --------- -------- -------- Proved Oil Reserves at the End of the Year 269 2,614 10,052 ========= ======== ======== Gas (Mcf) Proved Gas Reserves at the Beginning of the Year 104,000 243,000 492,000 Extensions, Discoveries, and Other Additions - - - Revisions of Previous Estimates 167,333 197,730 123,678 Production (165,762) (336,730) (372,678) --------- -------- -------- Proved Gas Reserves at the End of the Year 105,571 104,000 243,000 ========= ======== ======== Proved Developed Reserves: End of Year - Oil (Bbls) 269 2,614 10,052 ========= ======== ======== Gas (Mcf) 105,571 104,000 243,000 ========= ======== ========
F-21 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVE QUANTITIES (UNAUDITED) The information that follows has been developed by the Company pursuant to procedures prescribed by SFAS No. 69 and utilizes reserve data estimated by the Company's independent petroleum engineering firms. In addition to the above discussion of uncertainties in estimated reserve quantities, the following calculations are based on year-end prices, costs and statutory tax rates that relate to existing proved oil and gas reserves in which the Company has an interest and are discounted at 10%. Because future projections are inherently imprecise, material revisions to reserve estimates may occur in the future. Actual sales prices and costs incurred may vary from those used in the calculations due to a number of factors including, but not limited to, wide fluctuations in world and/or regional markets. In addition, production of the oil and gas reserves may not occur in the periods assumed. The standardized measure information may be useful for certain comparative purposes but is not intended to represent the market value of the Company's reserves or as an estimate of the Company's future cash flows. See "Note 1 - Organization and Summary of Significant Accounting Policies". The following table sets forth the standardized measure of discounted future net cash flows from to estimated future production of the Company's proved oil and gas reserves as of December 31:
1998 1997 1996 --------------- --------------- --------------- Future Cash Inflows $ 224,307 $ 392,939 $ 1,116,568 Future Production and Development Costs(1) - - (72,225) Future Income Tax Expense - - - --------------- --------------- --------------- Undiscounted Future Net Cash Flows 224,307 392,939 1,044,343 Discount (14,627) (14,942) (44,525) --------------- --------------- --------------- Standardized Measure of Discounted Future Net Cash Flows $ 209,680 $ 377,997 $ 999,818 =============== =============== ===============
- ---------- (1) Estimated future costs associated with property development and plugging, abandonment, site restoration and dismantlement requirements at December 31, 1996 were approximately $32,500. In addition, the Company maintains an overriding royalty interest in its only property with proved reserves at December 31, 1998 and 1997. Accordingly, there are no future costs associated with such an overriding royalty interest. F-22 ZYDECO ENERGY, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) PRINCIPAL SOURCES OF CHANGE IN THE STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS (UNAUDITED) The following table sets forth changes in the standardized measure of discounted future net cash flows for the years ended December 31:
1998 1997 1996 --------------- --------------- -------------- Standardized Measure - Beginning of Year $ 377,997 $ 999,818 $ 1,307,337 Sales, Net of Operating Costs (372,628) (1,046,276) (1,399,719) Net Changes in Prices and Production Costs (132,609) (215,759) 343,316 Development Costs Incurred - 32,500 - Revisions of Quantity Estimates 322,880 658,065 685,619 Accretion of Discount 37,800 99,982 130,734 Other (23,760) (150,333) (67,469) --------- ----------- ----------- Standardized Measure - End of the Year $ 209,680 $ 377,997 $ 999,818 ========= =========== ===========
F-23 EXHIBIT INDEX
Exhibit No. DESCRIPTION - ----------- ----------- 3.1+ Certificate of Incorporation and Certificates of Amendment thereto (filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 3.2+ Form of Amended and Restated Bylaws (filed as Exhibit 3.2 to the Company's Registration Statement on Form S-1 (Reg. No. 33-65286)) 4.1+ Form of Certificate representing shares of Common Stock (filed as Exhibit 4.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 4.2+ Form of Certificate evidencing Common Stock Purchase Warrants (filed as Exhibit 4.2 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 4.3+ Unit Purchase Option Granted to Underwriters by the Company (filed as Exhibit 4.3 to the Company's Registration Statement on Form S-1 (Reg. No. 33-65286)) 4.4+ Warrant Agreement between Continental Stock Transfer & Trust Company and the Company (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-1 (Reg. No. 33-65286)) 4.5+ Certificate of Designation evidencing shares of Preferred Stock (filed as Exhibit 4.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 4.6+ Form of Certificate evidencing shares of Preferred Stock (filed as Exhibit 4.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 4.7+ Form of Stock Purchase Warrant granted by Zydeco and Letter to holders from the Company (filed as Exhibit 4.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 4.8+ Form of Warrant Agreement by and among the Company and Brean Murray & Co., Inc. and Gaines, Berland Inc. (filed as Exhibit 4.8 to the Company's Registration Statement on Form S-1 (Reg. No. 333-27679)) 10.1+ Share Escrow Agreement between the Company and Continental Stock Transfer & Trust Company (filed as Exhibit 10.6 to the Company's Registration Statement on Form S-1 (Reg. No. 33-65286)) 10.2+ Warrant Agreement (filed as Exhibit 4.4 to the Company's Registration Statement on Form S-1 (Reg. No. 33-65286)) 10.3+ Zydeco 1995 Employee Stock Option Plan and form of letter to Optionees from the Company (filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 10.4+ Employment Agreement between Zydeco and Stephen W. Knecht (filed as Exhibit
E-1
10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 10.5+ Employment Agreement between Zydeco and John W. McTigue, Jr. (filed as Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 10.6+ Exploration Agreement between Zydeco and Lagniappe Exploration, Inc. (predecessor to Fortune Petroleum, Inc.) (filed as Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 10.7+ Farmout Agreement between Zydeco and Bois D'Arc Exploration (filed as Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 10.8+ Farmout Agreement between Zydeco, Fortune and Southern Gas Company of Delaware (filed as Exhibit 10.8 to the Company's Annual Report on Form 10-K for the year ended December 31, 1995) 10.9+ Option Agreement dated February 7, 1996, between the Company and Norman Neidell concerning certain Wave field Imaging Technology (filed as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the three months ended March 31, 1996) 10.10+ Exploration Agreement between Zydeco Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX Energy, Inc.) dated April 4, 1996 (filed as Exhibit 10.10 to the Company's Quarterly Report on Form 10-Q for the three months ended June 30, 1996) 10.11+ Master Geophysical Data Acquisition Agreement dated June 12, 1996, (executed August 5, 1996) between Zydeco Exploration, Inc. and Grant Geophysical, Inc. (filed as Exhibit 10.11 to the Company's Quarterly Report on Form 10-Q for the three months ended September 30, 1996) 10.12+ Second Amendment to the Exploration Agreement between Zydeco Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX Energy, Inc.) dated August 5, 1996 (filed as Exhibit 10.12 to the Company's Quarterly Report on Form 10-Q for the three months ended September 30, 1996) 10.13+ Third Amendment to the Exploration Agreement between Zydeco Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX Energy, Inc.) dated October 31, 1996 (filed as Exhibit 10.13 to the Company's Quarterly Report on Form 10-Q for the three months ended September 30, 1996) 10.14+ Fourth Amendment to the Exploration Agreement between Zydeco Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX Energy, Inc.) dated November 29, 1996 (filed as Exhibit 11.1 to the Company's Annual Report on Form 10-K for the year ended December 31, 1996) 10.15+ Master Geophysical Data Acquisition Agreement dated March 14, 1997, between Zydeco Exploration, Inc. and Grant Geophysical, Inc. (filed as Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q for the three months ended March 31, 1997) 10.16+ 1996 Incentive Equity Plan (filed on May 20, 1997, as Exhibit 99.1 to the Company's Registration Statement on Form S-8)
E-2
10.17+ 1996 Non-employee Directors Stock Option Plan (filed on May 20, 1997, as Exhibit 99.1 to the Company's Registration Statement on Form S-8) 10.18+ Agreement and Plan of Merger dated July 1, 1997, by and between the Company, Wavefield Image, Inc. and certain stockholders of Wavefield Image, Inc. (filed on May 20, 1997, as Exhibit 99.1 to the Company's Registration Statement on Form S-8) 10.19+ Employment Agreement between Zydeco Energy, Inc. and Norman S. Neidell (filed on May 20, 1997, as Exhibit 99.1 to the Company's Registration Statement on Form S-8) 10.20+ Fifth Amendment to the Exploration Agreement between Zydeco Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX Energy, Inc.) dated April 28, 1997 (filed on May 20, 1997, as Exhibit 99.1 to the Company's Registration Statement on Form S-8) 10.21+ Sixth Amendment to the Exploration Agreement between Zydeco Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX Energy, Inc.) dated July 21, 1997 (filed on May 20, 1997, as Exhibit 99.1 to the Company's Registration Statement on Form S-8) 10.22+ Seventh Amendment to the Exploration Agreement between Zydeco Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX Energy, Inc.) dated August 28, 1997 (filed as Exhibit 10.22 to the Company's Quarterly Report on Form 10-Q for the three months ended September 30, 1997) 10.23+ Eighth Amendment to the Exploration Agreement between Zydeco Exploration, Inc. and Cheniere Energy, Inc. (formerly FX Energy, Inc.) dated October 30, 1997 (filed as Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 1997) 11.1 Computation of per share earnings 21.1 List of Subsidiaries 23.1 Consent of Arthur Andersen LLP 23.2a Consent of Ryder Scott Company 23.2b Consent of Petroleum Professionals International, LP 27 Financial Data Schedule - -----------------
+ Incorporated herein by reference to the indicated filing. E-3 EX-11.1 2 COMPUTATION OF PER SHARE EARNINGS EXHIBIT NO. 11.1 COMPUTATION OF EARNINGS PER SHARE YEAR ENDED DECEMBER 31, 1998
DATE COMMON STOCK AND EQUIVALENTS ----------- -------------------------------------------------- NO. OF SHARES WEIGHTED AVERAGE OUTSTANDING SHARES Common Stock: 12/31/97 Shares Outstanding 10,537,096 10,537,096 1/2/98 Options Exercised in 1998 20,000 19,946 1/16/98 Treasury Stock Purchase (200,000) (191,936) ------------ ------------ SHARES OUTSTANDING DECEMBER 31, 1998 10,357,096 10,365,106 COMMON STOCK EQUIVALENTS AT DECEMBER 31, 1998: Options to Purchase Common Stock 1,501,006 Anti-dilutive Placement Warrants 30,640 Anti-dilutive Redeemable Warrants 3,300,000 Anti-dilutive Underwriter Warrants 320,000 Anti-dilutive Non-Redeemable Bridge Warrants 225,028 Anti-dilutive ------------ ------------ 15,733,770 10,365,106 ============ ============ Since the Company had a net loss for the period ended December 31, 1998, the effect of any dilution from common stock equivalents would be anti-dilutive and consequently not considered. Therefore, primary and fully diluted earnings per share are the same as weighted average shares outstanding. LOSS PER SHARE COMPUTATION: Net Loss for the Year Ended December 31, 1998 $(9,611,738) Divided By Weighted Average Common Shares and Common Share Equivalents 10,365,106 ----------- LOSS PER SHARE $ (0.93) ===========
EX-21.1 3 LIST OF SUBSIDIARIES EXHIBIT 21.1 Zydeco Energy, Inc. List of Subsidiaries Zydeco Exploration, Inc. Wavefield Image, Inc. Eastern Energy, Inc. EX-23.1 4 CONSENT OF ARTHUR ANDERSEN LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into Zydeco Energy, Inc.'s previously filed Registration Statements File Nos. 333-27447 and 333-27463. ARTHUR ANDERSEN LLP Houston, Texas March 30, 1999 EX-23.2A 5 CONSENT OF RYDER SCOTT COMPANY (Company Letterhead Goes Here) EXHIBIT 23.2a CONSENT OF INDEPENDENT PETROLEUM ENGINEERS We hereby consent to the reference to our firm regarding the reserve report for the year ended December 31, 1997, in this Annual Report on Form 10-K for the year ended December 31, 1998, for Zydeco Energy, Inc. under the headings "Oil and Gas Reserves" and "Oil and Gas Producing Activities". RYDER SCOTT COMPANY PETROLEUM ENGINEERS March 24, 1999 EX-23.2B 6 CONSENT OF PETROLEUM PROFESSIONALS, INC. (Company Letterhead Goes Here) EXHIBIT 23.2b CONSENT OF INDEPENDENT PETROLEUM ENGINEERS We hereby consent to the reference to our firm in this Annual Report on Form 10-K for the year ended December 31, 1998, for Zydeco Energy, Inc. under the headings "Oil and Gas Reserves" and "Oil and Gas Producing Activities". PETROLEUM PROFESSIONALS INTERNATIONAL, LP PETROLEUM ENGINEERS March 23, 1999 EX-27 7 FINANCIAL DATA SCHEDULE
5 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 1,912,970 0 47,916 0 0 2,152,785 5,462,804 (2,167,489) 6,689,658 1,511,428 0 0 0 11,338 5,166,892 6,689,658 389,798 783,501 17,170 17,170 10,675,299 0 122 (9,611,738) 0 (9,611,738) 0 0 0 (9,611,738) (.93) (.93)
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