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10-Q
ZAZA ENERGY CORP filed this Form 10-Q on 11/12/2013
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: September 30, 2013

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 001-35432

 

ZAZA ENERGY CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware

 

45-2986089

(State or other jurisdiction of incorporation)

 

(I.R.S. Employer Identification Number)

 

ZaZa Energy Corporation
1301 McKinney St Suite 2800
Houston, Texas 77010

(Address of principal executive office)

 

Registrant’s telephone number, including area code: 713-595-1900

 

Indicate by check mark whether the Registrant (i) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the Registrant was required to file such reports), and (ii) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):

 

Large accelerated filer  o  Accelerated filer  o

 

Non-accelerated filer  ¨  Smaller Reporting company  x

 

 

 (Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of October 31, 2013, there were 107,287,481 shares of common stock, par value $0.01 per share, outstanding.

 

 

 



Table of Contents

 

ZAZA ENERGY CORPORATION

 

TABLE OF CONTENTS

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

Item 1

Financial Statements (unaudited)

 

 

Consolidated Balance Sheets - September, 2013 and December 31, 2012

2

 

Consolidated Statements of Operations and Comprehensive Income - three and nine months ended September 30, 2013 and 2012

3

 

Consolidated Statements of Changes in Stockholders’ Equity (Deficit) - nine months ended September 30, 2013

4

 

Consolidated Statements of Cash Flows - nine months ended September 30, 2013 and 2012

5

 

Notes to Consolidated Financial Statements

6

Item 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

23

Item 3

Quantitative and Qualitative Disclosures About Market Risk

32

Item 4

Controls and Procedures

32

 

 

PART II - OTHER INFORMATION

 

 

Item 1

Legal Proceedings

33

Item 1A

Risk Factors

33

Item 2

Unregistered Sales of Equity Securities and Use of Proceeds

34

Item 3

Default Upon Senior Securities

34

Item 4

Mine Safety Disclosures

34

Item 5

Other Information

35

Item 6

Exhibits

35

 

1



Table of Contents

 

PART I - FINANCIAL INFORMATION

 

ITEM 1 - FINANCIAL STATEMENTS

 

ZAZA ENERGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

(Unaudited)

 

 

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

6,646

 

$

34,649

 

Restricted cash

 

500

 

21,875

 

Accounts receivable

 

282

 

1,354

 

Prepayments and other current assets

 

983

 

1,134

 

Total current assets

 

8,411

 

59,012

 

 

 

 

 

 

 

Property and equipment:

 

 

 

 

 

Oil and gas properties, successful efforts method

 

51,021

 

151,828

 

Furniture and fixtures

 

1,855

 

2,947

 

Total property and equipment

 

52,876

 

154,775

 

Accumulated depletion, depreciation and amortization

 

(5,596

)

(4,705

)

Property and equipment, net

 

47,280

 

150,070

 

 

 

 

 

 

 

Restricted cash

 

15,000

 

 

Assets held for sale, net

 

 

9,965

 

Other assets

 

2,410

 

4,066

 

 

 

 

 

 

 

Total assets

 

$

73,101

 

$

223,113

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable - trade

 

$

1,541

 

$

8,431

 

Accrued liabilities

 

6,857

 

12,200

 

Deferred income taxes

 

 

14,568

 

Senior Secured Notes, net of discount

 

9,858

 

 

Convertible Senior Notes, net of discount

 

 

25,298

 

Embedded conversion options associated with Convertible Senior Notes

 

 

21,382

 

Income taxes payable

 

1,013

 

3,658

 

Total current liabilities

 

19,269

 

85,537

 

 

 

 

 

 

 

Long-term accrued liabilities

 

12,076

 

53

 

Asset retirement obligations

 

384

 

130

 

Deferred income taxes

 

490

 

32,597

 

Long-term payable - related parties

 

4,128

 

4,128

 

Senior Secured Notes, net of discount

 

12,563

 

23,647

 

Convertible Senior Notes, net of discount

 

27,267

 

 

Subordinated notes

 

47,330

 

47,330

 

Warrants associated with Senior Secured Notes

 

19,161

 

28,043

 

Embedded conversion options associated with Convertible Senior Notes

 

6,599

 

 

Total liabilities

 

149,267

 

221,465

 

 

 

 

 

 

 

Stockholders’ equity (deficit):

 

 

 

 

 

Common stock, $0.01 par value, 250,000,000 shares authorized; 107,287,481 and 102,519,001 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively

 

1,073

 

1,025

 

Additional paid-in capital

 

108,544

 

104,639

 

Accumulated retained deficit

 

(185,705

)

(104,048

)

Accumulated other comprehensive income (loss)

 

(78

)

32

 

Total stockholders’ equity (deficit)

 

(76,166

)

1,648

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity (deficit)

 

$

73,101

 

$

223,113

 

 

The accompanying notes are an integral part of these financial statements.

 

2



Table of Contents

 

ZAZA ENERGY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except per share data)

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Revenues and other income:

 

 

 

 

 

 

 

 

 

Oil and gas revenues

 

$

1,102

 

$

2,198

 

$

6,266

 

$

7,353

 

Other income

 

 

196,985

 

 

197,027

 

Total revenues and other income

 

1,102

 

199,183

 

6,266

 

204,380

 

 

 

 

 

 

 

 

 

 

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

Lease operating expense

 

688

 

845

 

1,627

 

2,992

 

Depreciation, depletion, amortization, and accretion

 

259

 

1,986

 

2,550

 

5,244

 

Impairment of oil and gas properties

 

9,204

 

2,160

 

102,349

 

2,160

 

General and administrative

 

4,230

 

17,313

 

23,642

 

71,048

 

Loss on asset divestitures

 

829

 

 

829

 

 

Total operating costs and expenses

 

15,210

 

22,304

 

130,997

 

81,444

 

 

 

 

 

 

 

 

 

 

 

Operating income (loss)

 

(14,108

)

176,879

 

(124,731

)

122,936

 

 

 

 

 

 

 

 

 

 

 

Other expenses:

 

 

 

 

 

 

 

 

 

Foreign currency exchange (gain) loss

 

15

 

(85

)

30

 

138

 

Loss on extinguishment of debt

 

405

 

15,224

 

16,568

 

15,224

 

Interest expense, net

 

3,491

 

3,802

 

10,378

 

10,767

 

(Gain) loss on fair value of warrants

 

(1,350

)

(27,106

)

(19,772

)

5,315

 

(Gain) loss on fair value of embedded conversion option

 

(1,408

)

 

(14,783

)

 

Total other expenses (income)

 

1,153

 

(8,165

)

(7,579

)

31,444

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations before income taxes

 

(15,261

)

185,044

 

(117,152

)

91,492

 

Income tax expense (benefit)

 

5,387

 

37,634

 

(35,445

)

71,362

 

Income (loss) from continuing operations

 

(20,648

)

147,410

 

(81,707

)

20,130

 

Income (loss) from discontinued operations, net of taxes

 

17

 

(13,578

)

50

 

(53,584

)

Net income (loss)

 

$

(20,631

)

$

133,832

 

$

(81,657

)

$

(33,454

)

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.20

)

$

1.45

 

$

(0.79

)

$

0.21

 

Discontinued operations

 

 

(0.13

)

 

(0.56

)

Total basic income (loss) per share

 

$

(0.20

)

$

1.32

 

$

(0.79

)

$

(0.35

)

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.20

)

$

1.15

 

$

(0.79

)

$

0.21

 

Discontinued operations

 

 

(0.13

)

 

(0.56

)

Total diluted income (loss) per share

 

$

(0.20

)

$

1.02

 

$

(0.79

)

$

(0.35

)

 

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

Basic

 

102,706

 

101,731

 

103,055

 

96,879

 

Diluted

 

102,706

 

105,020

 

103,055

 

96,879

 

 

 

 

 

 

 

 

 

 

 

Consolidated Statement of Comprehensive Loss

 

 

 

 

 

 

 

 

 

Net income (loss)

 

$

(20,631

)

$

133,832

 

$

(81,657

)

$

(33,454

)

Foreign currency translation, net of taxes

 

47

 

(4,398

)

(110

)

(2,218

)

Comprehensive income (loss)

 

$

(20,584

)

$

129,434

 

$

(81,767

)

$

(35,672

)

 

The accompanying notes are an integral part of these financial statements.

 

3



Table of Contents

 

ZAZA ENERGY CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)

(Unaudited)

(In thousands)

 

 

 

 

 

 

 

 

 

Accumulated

 

Accumulated

 

 

 

 

 

Common

 

 

 

Additional

 

Retained

 

Other

 

Total

 

 

 

Stock

 

Common

 

Paid-in

 

Earnings

 

Comprehensive

 

Stockholders’

 

 

 

(Shares)

 

Stock ($)

 

Capital

 

(Deficit)

 

Income (Loss)

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2012

 

102,519

 

$

1,025

 

$

104,639

 

$

(104,048

)

$

32

 

$

1,648

 

Stock-based compensation cost

 

3,268

 

33

 

2,540

 

 

 

2,573

 

Stock issuance

 

1,500

 

15

 

1,365

 

 

 

1,380

 

Comprehensive income (loss)

 

 

 

 

(81,657

)

(110

)

(81,767

)

Balance at September 30, 2013

 

107,287

 

$

1,073

 

$

108,544

 

$

(185,705

)

$

(78

)

$

(76,166

)

 

The accompanying notes are an integral part of these financial statements.

 

4



Table of Contents

 

ZAZA ENERGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

 

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

Cash flows from operating activities:

 

 

 

 

 

Net income (loss)

 

$

(81,657

)

$

(33,454

)

Adjustments to reconcile net income (loss) to net cash used in operating activities:

 

 

 

 

 

Depreciation, depletion, amortization, and accretion

 

2,550

 

5,271

 

Loss on asset divestitures

 

829

 

 

Gain on French divestiture

 

(50

)

 

Loss on impairment of oil and gas properties

 

102,349

 

2,160

 

Deferred income taxes

 

(35,636

)

63,306

 

Amortization of deferred debt issuance costs and discount

 

3,389

 

3,418

 

Loss on extinguishment of debt

 

16,247

 

11,724

 

Unrealized (gain) loss on value of warrants

 

(19,772

)

5,315

 

Unrealized (gain) loss on value of embedded conversion option

 

(14,783

)

 

Stock-based compensation expense

 

2,573

 

12,793

 

(Gain) on the Hess transaction

 

 

(196,985

)

Changes in operating assets and liabilities:

 

 

 

 

 

Restricted cash

 

6,375

 

111

 

Accounts receivable

 

1,184

 

16,230

 

Prepayments and other assets

 

(45

)

1,576

 

Accounts payable and accrued liabilities

 

(9,515

)

(25,112

)

Cash used in operating activities - continuing operations

 

(25,962

)

(133,647

)

Cash provided by operating activities - discontinued operations

 

50

 

62,283

 

Net cash used in operating activities

 

(25,912

)

(71,364

)

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Cash acquired in connection with the merger

 

 

4,118

 

Proceeds from divestitures

 

50,168

 

83,892

 

Capital expenditures

 

(47,099

)

(30,370

)

Cash provided by investing activities - continuing operations

 

3,069

 

57,640

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Issuance of common stock

 

1,380

 

 

Issuance of senior secured notes

 

 

100,000

 

Payment of senior secured notes

 

(6,430

)

(33,000

)

Payment of debt issuance costs

 

 

(4,500

)

Payment of notes payable - members

 

 

(3,000

)

Payment of revolving line of credit

 

 

(5,000

)

Payment of Toreador notes

 

 

(31,754

)

Cash provided (used) by financing activities - continuing operations

 

(5,050

)

22,746

 

 

 

 

 

 

 

Effects of foreign currency translation on cash and cash equivalents

 

(110

)

4,982

 

Net increase (decrease) in cash and cash equivalents

 

(28,003

)

14,004

 

Cash and cash equivalents, beginning of period

 

34,649

 

10,619

 

Cash and cash equivalents, end of period

 

$

6,646

 

$

24,623

 

 

 

 

 

 

 

Supplemental disclosures:

 

 

 

 

 

Cash paid during the period for interest

 

$

7,289

 

$

4,714

 

Cash paid during the period for income taxes

 

$

2,363

 

$

112

 

 

The accompanying notes are an integral part of these financial statements

 

5



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 1 - BASIS OF PRESENTATION

 

ZaZa Energy Corporation (“ZEC”, “ZaZa” or the “Company”) was formed on August 4, 2011 for the purpose of being a holding company of both ZaZa Energy, LLC (“ZaZa LLC”) and Toreador Resources Corporation (“Toreador”) upon completion of an Agreement and Plan of Merger and Contribution, dated August 9, 2011, as amended (the “Combination”). On February 21, 2012, upon the consummation of the transaction under the Agreement and Plan of Merger and Contribution, ZaZa became the parent company of ZaZa LLC and Toreador. In this quarterly report on Form 10-Q, unless the context provides otherwise, “we”, “our”, “us” and like references refer to ZaZa, its subsidiaries (including ZaZa LLC and Toreador) and each of their respective direct and indirect subsidiaries.

 

The accompanying Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012 include the accounts of ZaZa Energy Corporation and all subsidiaries, including ZaZa LLC and Toreador.  The Consolidated Statements of Operations and Comprehensive Income for three and nine months ended September 30, 2013 and 2012, the Consolidated Statements of Cash Flows for nine months ended September 30, 2013 and 2012, the Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2013, and Notes to the Consolidated Financial Statements include the results of our accounting predecessor, ZaZa LLC, through February 20, 2012 and all of our subsidiaries, including ZaZa LLC and Toreador, since February 21, 2012.  All figures presented are in thousands except per share data unless otherwise indicated.

 

The accompanying consolidated financial statements are prepared in accordance with generally accepted accounting principles and reflect all adjustments, consisting of only normal recurring adjustments, that are, in the opinion of management, necessary for a fair statement of the results for the period. All material intercompany accounts and transactions have been eliminated in consolidation.

 

The consolidated financial statements are unaudited and should be read in conjunction with the audited financial statements as of and for the year ended December 31, 2012, included in the Form 10-K which was filed with the SEC on April 2, 2013. Operating results for the nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

 

Combination of ZaZa LLC and Toreador Resources Corporation

 

On February 21, 2012, we consummated the combination of ZaZa LLC and Toreador Resources Corporation, on the terms set forth in the Agreement and Plan of Merger and Contribution, dated August 9, 2011, and as subsequently amended by Amendment No. 1 thereto on November 10, 2011 and Amendment No. 2 thereto on February 21, 2012 (as amended, the “Merger Agreement”), by and among us, ZaZa LLC, Toreador, and Thor Merger Sub Corporation, our wholly-owned subsidiary (“Merger Sub”).

 

We finalized the purchase price allocation during the first quarter of 2013 without any adjustments compared to the preliminary purchase price presented as of December 31, 2012 in our annual report on Form 10-K.

 

Sale of ZaZa Energy France SAS

 

On November 13, 2012, the Company, through its wholly-owned subsidiary ZaZa France SAS (“Seller”), and Vermilion REP SAS (“Buyer”), a wholly owned subsidiary of Vermilion Energy Inc., entered into a Share Purchase Agreement (the “Purchase Agreement” or “French divestiture”) pursuant to which Seller sold to Buyer all of its shares in Seller’s wholly-owned subsidiary, ZaZa Energy France SAS (“ZEF”), formerly Toreador Energy France SAS.  On December 21, 2012, the Company completed the sale of 100% of the shares in ZaZa Energy France SAS to Vermilion REP SAS.

 

Upon the closing, the net purchase price paid to Seller was approximately $76.0 million in cash following the application of certain closing adjustments required by the Purchase Agreement.  Following reductions for advisor fees, estimated liquidation costs and taxes, the net proceeds to the Company were approximately $68.0 million.  The Company used approximately half of the net proceeds to pay down a portion of the principal on its remaining Senior Secured Notes.  Additionally, as part of the Paris Basin Agreement signed with Hess Corporation (“Hess”) in July 2012, $15.0 million of the sales proceeds will be held in escrow until all exploration permits for the Paris Basin are successfully transferred to Hess.  In the second quarter of 2013, we concluded that the timing of the release of the $15 million held in escrow presented as restricted cash is uncertain.  Accordingly, we reclassified the escrowed funds from current to non-current restricted cash.  The remaining net proceeds were used by the Company to fund its development program in the United States.

 

6



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

As a result of the consummation of the Purchase Agreement and with the exception of a 5% overriding royalty interest retained under the Paris Basin Agreement with Hess, we no longer have any meaningful operations or assets in connection with oil and gas operations in France. The Company anticipates solely focusing its efforts and resources on its oil and gas operations based in the United States.  After the sale of ZEF, we now operate under one segment.

 

The results of operations of entities in France have been presented as discontinued operations in the accompanying consolidated statements of operations and comprehensive income.  Results for these entities reported as discontinued operations for the three and nine months ended September 30, 2013 and for the three months ended September 30, 2012 and for the period from February 21, 2012 to September 30, 2012 are shown in the table below.

 

 

 

 

 

 

 

 

 

Period from

 

 

 

Three Months

 

Three Months

 

Nine Months

 

February 21, 2012

 

 

 

Ended

 

Ended

 

Ended

 

to

 

 

 

September 30,
2013

 

September 30,
2012

 

September 30,
2013

 

September 30,
2012

 

 

 

 

 

 

 

 

 

 

 

Oil revenues

 

$

 

$

8,013

 

$

 

$

19,638

 

Operating loss

 

 

21,406

 

 

60,454

 

Other expenses (income)

 

 

(66

)

 

(768

)

Loss (income) on disposal of assets

 

(17

)

 

(66

)

 

Income tax expense (benefit)

 

 

(7,762

)

16

 

(6,102

)

Loss (income) from discontinued operations

 

$

(17

)

$

13,578

 

$

(50

)

$

53,584

 

 

Eaglebine/Eagle Ford East Joint Venture with EOG

 

On March 21, 2013, we entered into a Joint Exploration and Development Agreement with EOG Resources, Inc. (“our counterparty”), (that was amended on April 2, 2013 and restated and amended on September 25, 2013 and October 15, 2013) for the joint development of certain of our Eaglebine/Eagle Ford East properties located in Walker, Grimes, Madison, Trinity, and Montgomery Counties, Texas (the “Amended JEDA”).  Under the Amended JEDA, we and our counterparty will jointly develop up to approximately 110,000 acres in these counties.  Pursuant to the Amended JEDA, our counterparty will act as the operator and pay us certain cash amounts, bear 100% of the drilling and completion costs of certain specified wells, and pay for a portion of our share of any additional seismic or well costs.  Generally, ZaZa will retain a 25% working interest and our counterparty will earn a 75% working interest in the acreage subject to the Amended JEDA, that is currently 100% owned by ZaZa.  ZaZa will retain a 25% working interest and our counterparty will earn a 50% working interest in the acreage that is currently owned 75% by ZaZa and 25% by Range Texas Production, LLC (“Range”), a subsidiary of Range Resources Corporation, subject to the terms of our Participation Agreement (the “Range Agreement”) with Range as described in “Note 12 — Commitments and Contingencies.”  Range will retain its 25% interest in such acreage.  This joint development was initially divided into three phases.

 

The first phase commenced on April 2, 2013 and has been substantially completed.  In this phase we transferred approximately 20,000 net acres, of which approximately 15,000 came from our joint venture with Range, to our counterparty in exchange for a cash payment by our counterparty to us of $10 million and an obligation of our counterparty to drill and pay 100% of the drilling and completion costs of three wells.  The two Phase I wells have been completed, with the second being the substitute well that we are required to drill pursuant to our agreement with Range described in “Note 12 — Commitments and Contingencies.”

 

On September 25, 2013, ZaZa and its counterparty entered into a Second Amendment and First Restatement of Joint Exploration and Development Agreement and a Third Amendment and Second Restatement of the Joint Exploration and Development Agreement, that resulted in the following transactions being closed on October 15, 2013:

 

Phase II Acceleration.  Our counterparty accelerated Phase II of the joint venture, and we assigned approximately 20,000 net acres to our counterparty on October 15, 2013, in exchange for (i) cash consideration of $17 million and (ii) approximately $3 million of interests (based on an independent reserves report) in 15 producing wells of our counterparty located outside of the Area of Mutual Interest or “AMI” (established by the amended and restated JEDA).  Also, during Phase II, our counterparty will drill two horizontal wells and one vertical well in the parties’ AMI, carry ZaZa’s interests in those wells and provide a miscellaneous work and land carry of up to $1.25

 

7



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

million.  Our counterparty may, however, elect to drill one or more vertical wells in order to achieve carry parity value for drilling horizontal wells.  To complete its obligation in respect of the third well under Phase I of the Amended JEDA, our counterparty will pay for an additional $1.5 million of ZaZa’s costs for one or more additional vertical wells and has provided a further $1.5 million cash payment to ZaZa.

 

Phase III Acceleration.  Under the Amended JEDA, ZaZa assigned on October 15, 2013 approximately 7,800 net acres from the former Phase III acreage for which ZaZa will receive approximately $11 million of interests (based on an independent reserves report) in the 15 producing wells of our counterparty (part of Phase II and referenced above).  In addition, our counterparty has the option, until January 31, 2014, to acquire an interest in the remaining approximately 12,300 former Phase III net acres at a fixed price per net acre from ZaZa.

 

Exchange of Leases and Wells.  Our counterparty has acquired approximately 19,000 additional net acres and interests in related wells in the parties’ Area of Mutual Interest, and has assigned to ZaZa a 25% working interest in these leases and wells. In consideration for ZaZa’s participation in our counterparty’s leases and producing wells, ZaZa assigned to our counterparty approximately 13,875 additional net acres and paid approximately $700,000 in cash.

 

Sale of Moulton Properties

 

On April 5, 2013 the Company closed a purchase and sale agreement and sold certain of its properties in the Eagle Ford trend located in Fayette, Gonzalez and Lavaca Counties, Texas, which we refer to as our Moulton properties, for approximately $9.2 million. Net proceeds from the sale, after closing purchase price adjustments and expenses were approximately $8.8 million. We used approximately $4.6 million of the proceeds to pay down our Senior Secured Notes.

 

We also entered into an agreement on June 27, 2013 to sell approximately 10,000 net acres of our properties in the Eagle Ford trend located in Fayette, Gonzalez and Lavaca Counties, Texas, including seven producing wells located on the Moulton properties, for approximately $28.8 million.  We closed this transaction on July 26, 2013 and received cash proceeds of $29.3 million, inclusive of the $1.4 million deposit. We used $1.8 million to pay down our Senior Secured Notes reducing the principal balance to $26.8 million.

 

Revenues and lease operating expenses attributable to the Moulton properties for the three and nine months ended September 30, 2013 and 2012 were as follows:

 

 

 

Three Months

 

Three Months

 

Nine Months

 

Nine Months

 

 

 

Ended

 

Ended

 

Ended

 

Ended

 

 

 

September 30,
2013

 

September 30,
2012

 

September 30,
2013

 

September 30,
2012

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

443

 

$

1,027

 

$

4,586

 

$

1,547

 

Lease operating expenses

 

70

 

168

 

625

 

411

 

 

The following supplemental pro forma information presents consolidated results of operations as if the Moulton sale had occurred on January 1, 2012.  The information does not purport to represent what the actual consolidated results of operations of the Company would have been had the transactions occurred on January 1, 2012, nor are they necessarily indicative of future consolidated results of operations.

 

 

 

Three Months

 

Three Months

 

Nine Months

 

Nine Months

 

 

 

Ended

 

Ended

 

Ended

 

Ended

 

 

 

Pro Forma

 

Pro Forma

 

Pro Forma

 

Pro Forma

 

 

 

September 30,
2013

 

September 30,
2012

 

September 30,
2013

 

September 30,
2012

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

659

 

$

198,156

 

$

1,680

 

$

202,833

 

Operating income (loss)

 

(14,481

)

177,359

 

(120,167

)

123,145

 

Net income (loss)

 

(20,066

)

134,951

 

(76,270

)

(30,897

)

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

$

(0.20

)

$

1.33

 

$

(0.74

)

$

(0.32

)

Diluted earnings (loss) per share

 

$

(0.20

)

$

1.03

 

$

(0.74

)

$

(0.32

)

 

8



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Eagle Ford Joint Venture with Sabine

 

On September 17, 2013, we entered into an agreement with Sabine South Texas LLC (“Sabine”), a subsidiary of Sabine Oil & Gas LLC, for the joint development of our Sweet Home prospect in the Eagle Ford trend located in Lavaca and DeWitt Counties, Texas.  Under this agreement, Sabine will jointly develop with us up to approximately 7,600 net acres that we currently own and that comprise a portion of our interest in the Sweet Home prospect.  Sabine has agreed to bear 100% of the drilling and completion costs of two commitment wells and up to $750,000 of construction costs related to gathering and infrastructure in order to earn a 75% working interest in 7,600 acres of the Sweet Home prospect and the Boening well. Sabine has also agreed to carry up to $300,000 of ZaZa’s expenses related to the extension and renewal of certain leases in the Sweet Home prospect.

 

If Sabine completes the first commitment well by February 15, 2014, ZaZa will transfer to Sabine a 75% working interest in approximately 3,200 net acres and the Boening well.  If Sabine completes the second commitment well by April 15, 2014, ZaZa will transfer to Sabine a 75% working interest in the remaining net acres.  Assuming the initial two commitment wells (or substitute wells, if necessary) are successful in achieving production, participating interests in any additional wells drilled or lease acreage acquired in the Sweet Home prospect will be shared 75% by Sabine and 25% by ZaZa under an area of mutual interest that will expire on September 15, 2015.

 

NOTE 2 — GOING CONCERN

 

In connection with the audit of our financial statements for the year ended December 31, 2012, our independent registered public accounting firm issued their report dated April 1, 2013, that included an explanatory paragraph describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern due to our dependency on the sale of non-core assets and success of our Eaglebine/Eagle Ford East joint venture entered into subsequent to December 31, 2012.

 

In 2013, we consummated the sale of the majority of our non-core assets and entered into the first development phase of our Eaglebine/Eagle Ford East joint venture resulting in combined total cash proceeds of $49.6 million.  The cash proceeds received from these transactions were used to fund general corporate activities and to reduce both current liabilities and the outstanding principal on our Senior Secured Notes to $26.8 million as of September 30, 2013.  As discussed in “Note 1 — Basis of Presentation,” we entered into and closed the Amended JEDA with our counterparty on September 25, 2013 and October 15, 2013, respectively, and in exchange for approximately $18 million in non-producing properties we received approximately $16.3 million in cash (excluding $1.5 million that was received in the third quarter of 2013), carries worth over $8 million, and working interests in several proved producing wells with a fair value of approximately $17 million.

 

The Company’s Board of Directors and management team have taken and continue to take proactive steps to streamline and strengthen the Company’s balance sheet.  Over the next three months, we intend to fund approximately $4.2 million in general and administrative expenses and $3.5 million in interest payments. Additionally, we are required to further reduce the outstanding principal amount of Senior Secured Notes by $11.8 million to $15.0 million by February 28, 2014. We could fund the $11.8 million required principal payment in February 2014 by obtaining and borrowing under a reserve-based facility, which would be permitted under the terms of our Senior Secured Notes. We could secure the facility with approximately $17 million of working interest value in proved producing wells that we obtained in October 2013. However, we expect to utilize cash flow from operations and to access the capital markets by issuing equity and debt securities to fund our cash needs and to accomplish the balance sheet initiative described below in the section “Management’s discussion and analysis of financial condition and results of operations - liquidity and capital resources”.  There could be a material adverse effect on the Company’s liquidity and ability to continue as a going concern if we are unable to realize one or a combination of these alternatives.

 

Upon entering into the Amended JEDA, closing of the sale of the majority of our non-core assets, and the reduction in our general and administrative costs as a result of a reduction in the workforce, we believe that we have made significant progress in addressing the uncertainties that gave rise to this going concern qualification.  Our independent registered public accounting firm will provide a new opinion based on facts and circumstances at December 31, 2013 for the year then ended.

 

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Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Use of Estimates

 

The preparation of financial statements in conformity with United States generally accepted accounting principles requires us to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

Cash and Cash Equivalents

 

The Company considers investments in all highly liquid instruments with original maturities of three months or less at date of purchase to be cash equivalents.

 

Revenue Recognition

 

The Company derives its oil and gas revenue primarily from the sale of produced oil and gas. The Company uses the sales method of accounting for the recognition of gas revenue whereby revenues, net of royalties are recognized as the production is sold to the purchaser. The amount of gas sold may differ from the amount to which the Company is entitled based on its working interest or net revenue interest in the properties. Revenue is recorded when title is transferred based on our nominations and net revenue interests. Pipeline imbalances occur when production delivered into the pipeline varies from the gas we nominated for sale. Pipeline imbalances are settled with cash approximately 30 days from date of production and are recorded as a reduction of revenue or increase of revenue depending upon whether we are over-delivered or under-delivered. Settlements of oil and gas sales occur after the month in which the product was produced. We estimate and accrue for the value of these sales using information available at the time financial statements are generated. Differences are reflected in the accounting period during which payments are received from the purchaser.

 

Accounts Receivable

 

Accounts receivable include oil and gas revenues, joint interest billing, and related parties receivables. Management periodically assesses the Company’s accounts receivable and establishes an allowance for estimated uncollectible amounts. Accounts determined to be uncollectible are charged to operations when that determination is made. The Company usually does not require collateral.

 

Concentration of Credit Risk

 

The Company maintains its cash balances at several financial institutions, which are insured by the Federal Deposit Insurance Corporation. The Company’s cash balances typically are in excess of the insured limit. This concentration may impact the Company’s overall credit risk, either positively or negatively, in that it may be similarly affected by changes in economic or other conditions. The Company has incurred no losses related to these accounts.

 

Successful Efforts Method of Accounting for Oil and Gas Activities

 

The Company accounts for its natural gas and crude oil exploration and production activities under the successful efforts method of accounting. Oil and gas lease acquisition costs are capitalized when incurred. Lease rentals are expensed as incurred. Oil and gas exploration costs, other than the costs of drilling exploratory wells, are charged to expense as incurred. The costs of drilling exploratory wells are capitalized pending determination of whether they have discovered proved commercial reserves. Exploratory drilling costs are capitalized when drilling is complete if it is determined that there is economic producibility supported by either actual production or a conclusive formation test. If proved commercial reserves are not discovered, such drilling costs are expensed. In some circumstances, it may be uncertain whether proved commercial reserves have been found when drilling has been completed. Such exploratory well drilling costs may continue to be capitalized if the reserve quantity is sufficient to justify its completion as a producing well and sufficient progress in assessing the reserves and the economic and operating viability of the project is being made. Costs to develop proved reserves, including the costs of all development wells and related equipment used in the production of natural gas and crude oil, are capitalized. Unproved properties with individually significant acquisition costs are analyzed on a property-by-property basis for any impairment in value. If the unproved properties are determined to be productive, the appropriate related costs are transferred to proved oil and gas properties.

 

10



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Company’s third party engineers estimate proved oil and gas reserves, which directly impact financial accounting estimates, including depreciation, depletion, and amortization. Our proved reserves represent estimated quantities of oil and condensate, natural gas liquids and gas that geological and engineering data demonstrate, with reasonable certainty, to be recovered in future years from known reservoirs under economic and operating conditions existing at the time the estimates were made. The process of estimating quantities of proved oil and gas reserves is very complex requiring significant subjective decisions in the evaluation of all available geological, engineering, and economic data for each reservoir. The data for a given reservoir may also change substantially over time as a result of numerous factors including, but not limited to, additional development activity, evolving producing history, and continual reassessment of the viability of production under varying economic conditions. Consequently, material revisions (upward or downward) to existing reserve estimates may occur from time to time.

 

Amortization rates are updated at least annually to reflect: (1) the addition of capital costs, (2) reserve revisions (upwards or downwards) and additions, (3) property acquisitions and/or property dispositions, and (4) impairments. When circumstances indicate that an asset may be impaired, the Company compares expected undiscounted future cash flows at a producing field level to the amortized capitalized cost of the asset. If the future undiscounted cash flows, based on the Company’s estimate of future natural gas and crude oil prices, operating costs, anticipated production from proved reserves, and other relevant data, are lower than the amortized capitalized cost, the capitalized cost is reduced to fair value. Fair value is calculated by discounting the future cash flows at an appropriate risk-adjusted discount rate.

 

Asset Retirement Obligations

 

We follow ASC 410-20 which applies to obligations associated with the retirement of tangible long-lived assets that result from the acquisition, construction and development of the assets. ASC 410-20 requires that we record the fair value of a liability for an asset retirement obligation in the period in which it is incurred and a corresponding increase in the carrying amount of the related long-lived asset.

 

The following table summarizes the changes in our asset retirement liability during the nine months ended September 30, 2013 and September 30, 2012.

 

 

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Asset retirement obligations at beginning of period

 

$

130

 

$

309

 

Obligations assumed in the Combination

 

 

4,513

 

Obligations incurred

 

197

 

313

 

Revisions

 

157

 

 

Obligations extinguished

 

(119

)

(355

)

Accretion expense

 

19

 

411

 

Foreign currency exchange (gain)

 

 

(207

)

Asset retirement obligations at the end of period

 

$

384

 

$

4,984

 

 

Furniture and Fixtures

 

Furniture and fixtures are stated at cost. Depreciation is calculated using the straight-line method over the assets’ estimated useful lives as follows:

 

Office furniture and fixtures

 

2 - 5

 

Computing equipment

 

2 - 5

 

Vehicles

 

5 - 7

 

 

Other Assets

 

Other assets consist of long term restricted deposits related to letters of credit with the Texas Railroad Commission and other vendors as well as debt issuance costs associated with the non-current portion of our Long-Term Debt.  In 2012, debt issuance costs related to the current portion of our Long-Term debt are included in other current assets.  At September 30, 2013 and December 31, 2012 debt issuance costs were $2.5 million and $7.0 million, and accumulated amortization was $0.3 million and $3.3 million, respectively. The costs are being amortized over the life of the associated debt.

 

11



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Income Taxes

 

For financial reporting purposes, we generally provide taxes at the rate applicable for the appropriate tax jurisdiction. Management periodically assesses the need to utilize any unremitted earnings to finance our operations. This assessment is based on cash flow projections that are the result of estimates of future production, commodity prices and expenditures by tax jurisdiction for our operations. Such estimates are inherently imprecise since many assumptions utilized in the cash flow projections are subject to revision in the future.

 

Management also periodically assesses, by tax jurisdiction, the probability of recovery of recorded deferred tax assets based on its assessment of future earnings estimates. Such estimates are inherently imprecise since many assumptions utilized in the assessments are subject to revision in the future.

 

Earnings (Loss) Per Common Share

 

Basic earnings (loss) per share was calculated by dividing net income or loss applicable to common shares by the weighted average number of common shares outstanding during the periods presented. Diluted earnings (loss) per share incorporate the potential dilutive impact of options and unvested stock outstanding during the periods presented, unless their effect is anti-dilutive. In addition, the Company applies the if-converted method to our convertible debt instruments, the effect of which is that conversion will not be assumed for purposes of computing diluted earnings (loss) per share if the effect would be anti-dilutive.

 

Foreign Currency Translation

 

The United States dollar is the functional currency for all of ZaZa’s consolidated subsidiaries except for certain of its French subsidiaries, for which the functional currency is the Euro. For subsidiaries whose functional currency is deemed to be other than the United States dollar, asset and liability accounts are translated using the period-end exchange rates and revenues and expenses are translated at average exchange rates prevailing during the period. Translation adjustments are included in Accumulated Other Comprehensive Income (“AOCI”) on the Consolidated Balance Sheets. Any gains or losses on transactions or monetary assets or liabilities in currencies other than the functional currency are included in net income (loss) in the current period.

 

Stock-based Compensation

 

Stock-based compensation cost is measured at the date of grant, based on the fair value of the award, and is recognized as expense, generally on a straight line basis over the vesting period of the award.  Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods to reflect actual forfeitures. Awards subject to vesting requirements for non-employees are fair valued each reporting period, final fair value being determined at the vesting date.

 

Our policy is to issue new shares for the exercise of stock options, when restricted stock awards are granted, and at vesting of restricted stock units.  To date only restricted stock awards have been granted under the Long Term Incentive Plan (the “Plan”).

 

Recently adopted accounting pronouncements

 

In February 2013, the Financial Accounting Standards Board issued guidance on disclosure requirements for items reclassified out of accumulated other comprehensive income by component. This new guidance requires entities to present (either on the face of the income statement or in the notes) the effects on the line items of the income statement for amounts reclassified out of accumulated other comprehensive income. We adopted this pronouncement for our fiscal year beginning January 1, 2013. The adoption of this pronouncement did not have a material effect on our consolidated financial statements.

 

In December 2011, the Financial Accounting Standards Board issued guidance on disclosure requirements about the nature of an entity’s right to offset and related arrangements associated with its financial instruments and derivative instruments. The new guidance requires the disclosure of the gross amounts subject to rights of set-off, amounts offset in accordance with the accounting standards followed, and the related net exposure. In January 2013, the FASB clarified that the scope of this guidance applies to derivatives, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or subject to an enforceable master netting arrangement, or similar agreements. We

 

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Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

adopted this pronouncement for our fiscal year beginning January 1, 2013. The adoption of this pronouncement did not have a material effect on our consolidated financial statements.

 

In July 2013, the FASB issued ASU 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (“ASU 2013-11”). ASU 2013-11 is effective for the first interim or annual period beginning on or after December 15, 2013 with early adoption permitted. ASU 2013-11 amends ASC Topic 740, Income Taxes, to provide guidance and reduce diversity in practice on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists.  The Company has a net operating loss carryforward and recognized an uncertain tax position in the quarter ended September 30, 2013. We early adopted ASU 2013-11 in the quarter ended September 30, 2013. Except for the changes in the presentation, the initial application of the standard had no impact to the Company.

 

Accounting pronouncements not yet adopted

 

In March 2013, the Financial Accounting Standards Board issued AUS 2013-05 to clarify the accounting for the release of cumulative translation adjustment into net income when a parent either sells a part or all of its investment in a foreign entity or no longer holds a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within a foreign entity.  The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2013. We do not anticipate that this adoption will have a significant impact on our financial position, results of operations or cash flows.

 

13



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 4 — EARNINGS (LOSS) PER COMMON SHARE

 

The following table reconciles the numerators and denominators of the basic and diluted income (loss) per common share computation:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(In thousands, except per share data)

 

(In thousands, except per share data)

 

Basic income (loss) per share:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

(20,648

)

$

147,410

 

$

(81,707

)

$

20,130

 

Income (loss) from disc. operations, net

 

17

 

(13,578

)

50

 

(53,584

)

Net income (loss)

 

$

(20,631

)

$

133,832

 

$

(81,657

)

$

(33,454

)

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding

 

102,706

 

101,731

 

103,055

 

96,879

 

 

 

 

 

 

 

 

 

 

 

Basic income (loss) per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.20

)

$

1.45

 

$

(0.79

)

$

0.21

 

Discontinued operations

 

 

(0.13

)

 

(0.56

)

Total basic income (loss) per share

 

$

(0.20

)

$

1.32

 

$

(0.79

)

$

(0.35

)

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per share:

 

 

 

 

 

 

 

 

 

Numerator:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

$

(20,648

)

$

147,410

 

$

(81,707

)

$

20,130

 

Impact of assumed conversions on interest

 

 

 

 

 

Less: gain on fair value of warrants, net of tax

 

 

(27,106

)

 

 

 

 

(20,648

)

120,304

 

(81,707

)

20,130

 

Income (loss) from disc. operations, net

 

17

 

(13,578

)

50

 

(53,584

)

Net income (loss)

 

$

(20,631

)

$

106,726

 

$

(81,657

)

$

(33,454

)

 

 

 

 

 

 

 

 

 

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average common shares

 

102,706

 

101,731

 

103,055

 

96,879

 

Net warrants issued for secured debt under the treasury stock method

 

(a)

3,289

 

(a)

(a)

Weighted average shares associated with convertible debt

 

(b)

 

(b)

 

Unvested restricted stock

 

(c)

(c)

(c)

(c)

Weighted average diluted shares outstanding

 

102,706

 

105,020

 

103,055

 

96,879

 

 

 

 

 

 

 

 

 

 

 

Diluted income (loss) per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.20

)

$

1.15

 

$

(0.79

)

$

0.21

 

Discontinued operations

 

 

(0.13

)

 

(0.56

)

Total diluted income (loss) per share

 

$

(0.20

)

$

1.02

 

$

(0.79

)

$

(0.35

)

 


(a)         For the three and nine months ended September 30, 2013, the average ZaZa share price was lower than the exercise price of the warrants and therefore the anti-dilutive effect was not considered.  For the nine months ended September 30, 2012, 5.1 million common equivalent shares from warrants associated with the Senior Secured Notes were excluded from the calculation of diluted income per share due to their anti-dilutive effect.

(b)         For the three and nine months ended September 30, 2013, the number of shares used in the calculation of diluted income per share did not include 16.0 million common equivalent shares from the embedded convertible options associated with the Convertible Senior Notes issued in October 2012, due to their anti-dilutive effect.

(c)          For the three and nine months ended September 30, 2013, the number of shares used in the calculation of diluted income per share did not include 2.6 million unvested restricted common stock awards due to their anti-dilutive effect.  For the three and nine months ended September 30, 2012, the number of shares used in the calculation of diluted income per share did not include 4.3 million unvested restricted common stock awards due to their anti-dilutive effect.

 

14



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

NOTE 5 — LONG-TERM DEBT

 

As described in more detail in our 2012 annual report on Form 10-K, our long-term debt includes 8.00% Senior Secured Notes due 2017, 9.00% Convertible Senior Notes due 2017 and 8.00% Subordinated Notes. The fair market values of debt, warrants associated with the Senior Secured Notes and embedded conversion option associated with Convertible Senior Notes are disclosed in “Note 9 — Fair Value Measurement”.

 

Our long-term debt consisted of the following:

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Senior Secured Notes, net of discount (1)

 

$

22,421

 

$

23,647

 

Convertible Senior Notes, net of discount (2)

 

27,267

 

25,298

 

Subordinated notes

 

47,330

 

47,330

 

Total debt

 

97,018

 

96,275

 

Less: current portion (3)

 

(9,858

)

(25,298

)

Total long-term debt

 

$

87,160

 

$

70,977

 

 


(1)                      The Senior Secured Notes original issuance discount is amortized to the principal amount through the date of the first put right on February 21, 2017 using the effective interest rate method and rate of 12.8%.

(2)                      The Convertible Senior Notes original issuance discount is amortized to the principal amount through maturity on August 21, 2017 using the effective interest rate method and rate of 19.0%.

(3)                      The Convertible Notes are convertible, at the option of the holder, into shares of the Company’s common stock.  The initial conversion rate equates to an initial conversion price of $2.50 per share. Due to certain limitations under the indenture regarding the Company’s ability to settle the conversion in shares, the debt was classified as current until May 30, 2013.  As of May 30, 2013, shareholder approval of the issuance of common stock in excess of 20% of the outstanding shares allowed us to classify the debt as long-term.  We classified $9.9 million of our Senior Secured Notes as current as of September 30, 2013 consisting of principal of $11.8 million and a discount of $1.9 million pursuant to Amendment No. 5 to the Securities and Purchase Agreement, as defined below.

 

Sale of 8.00% Senior Secured Notes due 2017 and Warrants

 

The Senior Secured Notes will mature on February 21, 2017.  Subject to certain adjustments set forth in the Securities Purchase Agreement (the “SPA”), interest on the Senior Secured Notes accrues at 8% per annum, payable quarterly in cash. After giving effect to the shares issued to the entities controlled by Todd Alan Brooks, John E. Hearn Jr. and Gaston L. Kearby, the former managing members of ZaZa LLC (the “ZaZa LLC Members”) and the former stockholders of Toreador in the Combination, the Warrants initially represented approximately 20.6% of the outstanding shares of Common Stock on an as-exercised and fully-diluted basis.  As of September 30, 2013, 27,433,244 warrants with an exercise price of $1.98 per share and an expiration date of August 31, 2020 were outstanding.

 

On March 28, 2013, we entered into Amendment No. 5 to the SPA (“Amendment No. 5”).  Under Amendment No. 5, we agreed to make a prepayment on the Senior Secured Notes with the proceeds of an asset sale, which prepayment had previously been deferred, of approximately $4.6 million. Amendment No. 5 also provides for:

 

(a)         revisions to the prepayment provisions to permit the Company to voluntarily prepay the Senior Secured Notes at 105% of their principal amount plus accrued and unpaid interest, if the aggregate principal amount of the Senior Secured Notes exceeds $25 million, at 103% if the aggregate principal amount of the Senior Secured Notes exceeds $15 million, and at 100% if the aggregate principal amount of the Senior Secured Notes are $15 million or less;

 

(b)         the Company to make a prepayment to pay down the Senior Secured Notes to $15 million by February 28, 2014, and a provision that if the Senior Secured Notes have not been repaid in full by February 28, 2014, the interest rate will increase from 8% to 10% per annum;

 

(c)          the Company to make a prepayment on the Senior Secured Notes if the Company sells some of its acreage in Sweet Home or the Company receives the release of certain escrow funds, which funds were placed in escrow for the benefit of Hess in connection with the Company’s sale of its French subsidiary,

 

15



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

in each case prior to February 28, 2014, but solely to the extent to reduce the principal outstanding balance of the Senior Secured Notes to $15 million;

(d)         revision of consent rights on all joint ventures involving oil and gas properties to permit our recently announced joint venture in the Eaglebine/Eagle Ford East without any requirement to use the proceeds thereof to pay down the Senior Secured Notes and to permit joint ventures in Hackberry and Sweet Home as long as 10% of the gross proceeds in excess of $10 million are used to pay down the Senior Secured Notes;

(e)          the modification of the asset sale covenants to require (i) only 10% of the gross proceeds from asset sales in the Eaglebine/Eagle Ford East to be used to pay down the Senior Secured Notes, (ii) only 10% of the net proceeds from the sale of the Moulton properties to be used to pay down the Senior Secured Notes, and (iii) only 10% of the gross proceeds from asset sales in the Eagle Ford to be used to pay down the Senior Secured Notes until such time as the Notes have been paid down to $15 million, whereupon no such paydown shall be required subject to certain requirements regarding reinvestment of funds;

(f)           the exercise price of the warrants issued in connection with the Senior Secured Notes to be reduced to $2.00 per share and the exercise period was extended to August 31, 2020; and

(g)          the amendment of certain provisions of the lockup agreement entered into in connection with the SPA to permit certain additional categories of transfers.

 

Amendment No.5 was considered an extinguishment of debt. Accordingly, in the first quarter of 2013, we extinguished the Senior Secured Notes and associated discounts and debt issuance costs of $33.2 million, $9.1 million and $1.2 million, respectively.  We recognized a loss on extinguishment of debt of $15.1 million consisting of a loss from the modification of the terms of the warrants of $10.9 million and a difference between the fair value and book value of debt of $4.2 million.  We recorded the modified debt at its fair market value of $27.1 million, consisting of a principal amount of $33.2 million and discount of $6.1 million.

 

In the second and third quarters of 2013, we recognized a loss on extinguishment of debt of $1.1 million and $0.4 million, respectively, associated with penalties on the prepayments of principal on our Senior Secured Notes.  On September 30, 2013, the Senior Secured Notes, which had a book value of $22.4 million, had a fair value of approximately $23.1 million.  At September 30, 2013 and December 31, 2012, the unamortized issuance discount related to Senior Secured Notes was $4.4 and $9.6 million respectively.  At September 30, 2013 and December 31, 2012, the outstanding principal on the Senior Secured Notes was $26.8 million and $33.2 million respectively.

 

9.00% Convertible Senior Notes due 2017

 

The Company has $40,000,000 aggregate principal amount of 9% Convertible Senior Notes due 2017 (the “Convertible Notes”).  The Convertible Notes are the senior, unsecured obligations of the Company, bear interest at a fixed rate of 9.0% per year, payable semiannually in arrears and mature August 1, 2017 unless earlier converted, redeemed or repurchased.  The Convertible Notes are convertible, at the option of the holder, at any time prior to the close of business on the second business day immediately preceding the maturity date, into shares of the Company’s common stock, par value $0.01 per share (the “Conversion Shares”), and cash in lieu of fractional shares of common stock.  The initial conversion rate will be 400 shares per $1,000 Convertible Note, reflecting a conversion premium of approximately 32.28% of the closing price of the Company’s common stock on the pricing date of the offering, which equates to an initial conversion price of $2.50 per share.

 

At September 30, 2013 and December 31, 2012, the unamortized issuance discount related to Convertible Senior Notes was $12.7 million and $14.7 million, respectively.  The outstanding principal on the Convertible Senior Notes was $40.0 million at both September 30, 2013 and December 31, 2012.

 

8.00% Subordinated Notes

 

In February 2012, we issued Subordinated Notes in an aggregate amount of $47.33 million to the ZaZa LLC Members. These Subordinated Notes accrue interest at a rate of 8% per annum payable monthly in cash, and mature on August 17, 2017.

 

16



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Interest expense

 

For the three and nine months ended September 30, 2013 and 2012, interest expense consisted of the following:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Interest expense on Senior Secured Notes

 

$

582

 

$

1,523

 

$

1,829

 

$

4,412

 

Interest expense on Convertible Senior Notes

 

900

 

 

2,700

 

 

Interest expense on Subordinated Notes

 

946

 

994

 

2,840

 

2,361

 

Interest expense on revolving credit line

 

 

 

 

45

 

Interest expense on Members’ Notes

 

 

 

 

50

 

Amortization original issuance discount on Senior Secured Notes

 

295

 

1,077

 

1,091

 

3,072

 

Amortization of issuance costs on Senior Secured Notes

 

 

122

 

58

 

346

 

Amortization original issuance discount on Convertible Senior Notes

 

673

 

 

1,969

 

 

Amortization of issuance costs on Convertible Senior Notes

 

95

 

 

271

 

 

Other interest (income) expense, net

 

 

86

 

(34

)

481

 

Capitalized interest

 

 

 

(346

)

 

Total interest expense, net

 

$

3,491

 

$

3,802

 

$

10,378

 

$

10,767

 

 

NOTE 6 — ASSETS HELD FOR SALE

 

Following the sale of the Moulton properties and impairments in 2013 on the remaining non-producing leasehold costs previously classified as held for sale, no assets held for sale remain at September 30, 2013.

 

The following table summarizes the assets and liabilities associated with assets held for sale (current and non-current).

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Accounts receivable - revenue receivable

 

$

 

$

113

 

Oil and gas properties

 

 

13,095

 

Accumulated depletion

 

 

(3,060

)

Asset retirement obligations

 

 

(183

)

Accounts payable and accrued liabilities

 

 

 

Total assets held for sale, net (current and non-current)

 

$

 

$

9,965

 

 

NOTE 7 —INCOME TAXES

 

We are subject to income taxes in the United States and France. The current provision for taxes on income consists primarily of income taxes based on the tax laws and rates of the countries in which operations were conducted during the periods presented. Due to the uncertainty related to our effective tax rate for the year, the income tax provision is calculated based on the year to date actual effective tax rate.  All interest and penalties related to income tax is charged to general and administrative expense. We compute our provision for deferred income taxes using the liability method. Under the liability method, deferred income tax assets and liabilities are determined based on differences between financial reporting and income tax basis of assets and liabilities and are measured using the enacted tax rates and laws. The measurement of deferred tax assets is adjusted by a valuation

 

17



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

allowance, if necessary, to reduce the future tax benefits to the amount, based on available evidence it is more likely than not deferred tax assets will be realized.  Additionally, we paid approximately $2.4 million in the second quarter of 2013 related to capital gains taxes from the wind up of our foreign subsidiaries that had been previously accrued.

 

The primary reasons for the difference between tax expense at the statutory federal income tax rate and our provision for income taxes for the three and nine months ended September 30, 2013 and 2012 were:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Statutory tax at 34%

 

$

(5,358

)

$

63,850

 

$

(41,020

)

$

31,107

 

(Gain) Loss on Warrants

 

(473

)

(9,540

)

(3,109

)

1,807

 

Adjustments to valuation allowance

 

11,707

 

(17,642

)

8,384

 

37,959

 

Foreign rate differential and other

 

(489

)

966

 

300

 

489

 

Income tax expense (benefit)

 

$

5,387

 

$

37,634

 

$

(35,445

)

$

71,362

 

 

Income tax expense for the three months ended September 30, 2013 was $5.4 million while the nine months ended September 30, 2013 was a benefit of $35.4 million.  The difference between the federal statutory tax benefit of $5.4 million and the tax expense of $5.4 million for the three months ended September 30, 2013 is primarily related to an increase in the valuation allowance.  The difference between the federal statutory tax benefit of $41.0 million and the tax benefit of $35.4 million for the nine months ended September 30, 2013 is primarily related to an increase in the valuation allowance offset partially by non-taxable gains on warrants.

 

Income tax expense for the three and nine months ended September 30, 2012 was $37.6 and $71.4 million, respectively.  The difference between the federal statutory tax expense of $63.9 million and the tax expense of $37.6 million for the three months ended September 30, 2012 is primarily related to a decrease in the valuation allowance and non-taxable gains on warrants.  The difference between the federal statutory tax expense of $31.1 million and the tax expense of $71.4 million for the nine months ended September 30, 2012 is primarily related to an increase in the valuation allowance.

 

The following is a tabular reconciliation of the total amounts of unrecognized tax benefits:

 

 

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Balance at the beginning of period

 

$

 

$

 

Gross increases - tax positions in current period

 

10,500

 

 

Gross increases - tax positions in prior periods

 

5,900

 

 

Settlement

 

 

 

Lapse of statute of limitations

 

 

 

Balance at the end of period

 

$

16,400

 

$

 

 

Included in the balance of unrecognized tax benefits as of September 30, 2013, and 2012, are $16.4 million and zero, respectively, of tax benefits that, if recognized, would affect the effective tax rate. Also included in the balance of unrecognized tax benefits at September 30, 2013, and 2012, are $16.4 million and zero, respectively, of tax benefits that, if recognized, would result in adjustments to other tax accounts, primarily deferred taxes.

 

The total amounts of interest and penalties recognized in the statement of operations and the total amounts of interest and penalties recognized in the statement of financial position are not material for the nine month periods ended September 30, 2013 and 2012.

 

NOTE 8 — FAIR VALUE MEASUREMENTS

 

“ASC 820 - Fair value measurements and disclosures,” establishes a fair value hierarchy which prioritizes the inputs to valuation techniques used to measure fair value into three levels. The fair value hierarchy gives the highest priority to quoted market prices (unadjusted) in active markets for identical assets or liabilities (Level 1) and

 

18



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

the lowest priority to unobservable inputs (Level 3). Level 2 inputs are inputs, other than quoted prices included within Level 1, which are observable for the asset or liability, either directly or indirectly.

 

Effective January 1, 2012, we adopted the authoritative guidance that applies to all financial assets and liabilities required to be measured and reported on a fair value basis. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The guidance requires disclosure that establishes a framework for measuring fair value expands disclosure about fair value measurements and requires that fair value measurements be classified and disclosed in one of the following categories:

 

Level 1:        Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. We consider active markets as those in which transactions for the assets or liabilities occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

 

Level 2:        Quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that we value using observable market data. Substantially all of these inputs are observable in the marketplace throughout the full term of the derivative instrument, can be derived from observable data or supported by observable levels at which transactions are executed in the market place.

 

Level 3:          Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e., supported by little or no market activity). Our valuation models for derivative contracts are primarily industry-standard models that consider various inputs including: (a) quoted forward prices for commodities, (b) time value, (c) volatility factors, (d) counterparty credit risk and (e) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Level 3 instruments primarily include warrants and embedded conversions. Although we utilize third-party broker quotes to assess the reasonableness of our prices and valuation techniques, we do not have sufficient corroborating market evidence to support classifying these assets and liabilities as Level 2.

 

The carrying amounts of financial instruments including cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value at September 30, 2013 and December 31, 3012, due to the short-term nature or maturity of the instruments.

 

The warrants were valued as written call options using a Binomial Lattice Model. Key inputs into this valuation model are our current stock price, US Treasury rate and the underlying stock price volatility.  The debt was valued under the income approach using discounted cash flows.  The discounting utilized the US Treasury rate and our credit spread.  The current stock price, US Treasury rate and stock price volatility are based on observable market data and are considered Level 2 inputs.  Our credit spread is unobservable and considered a Level 3 input.  A binomial lattice model designed to value the Convertible Senior Note, which model is further described below, was used to estimate our credit spread.   It was calculated by solving for a premium to the US Treasury rate that produces a value of the Convertible Senior Note as of the issuance date that equates to proceeds received.  The fair value measurements are considered a Level 3 measurement within the fair value hierarchy.  An increase in the volatility by 5% results in a $1.1 million increase in the fair value of the warrants. On September 30, 2013, the Senior Secured Notes, which had a book value of $22.4 million (net of unamortized discount of $4.4 million), had a fair value of approximately $23.1 million.  An increase in the credit spread by 500 basis points results in a $1.5 million decrease in the fair value of the note.

 

The embedded conversion option and Convertible Senior Notes were valued using a Binomial Lattice Model designed to capture incremental value attributed to the conversion option in addition to the value of the note.   Key inputs into this valuation model are our current stock price, US Treasury rate, our credit spread and the underlying stock price volatility.  The current stock price, US Treasury rate and stock price volatility are based on observable market data and are considered Level 2 inputs.  Our credit spread is unobservable and considered a Level 3 input. The valuation model was used to estimate our credit spread by solving for a premium to the US Treasury rate that produces a value of the Convertible Senior Note as of the issuance date that equates to proceeds received.  The fair value measurements are considered a Level 3 measurement within the fair value hierarchy.  An increase in the volatility by 5% results in a $0.5 million increase in the fair value of the conversion option.  On September 30, 2013, the Convertible Senior Notes, which had a book value of $27.3 million (net of unamortized discount of $12.7 million), had a fair value of approximately $34.1 million.  An increase in the credit spread by 500 basis points results in a $2.8 million decrease in the fair value of the note.

 

19



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following tables summarize the valuation of our liabilities measured on a recurring basis at levels of fair value at September 30, 2013 and December 31, 2012.

 

 

 

Fair Value Measurement using

 

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

At September 30, 2013

 

 

 

 

 

 

 

 

 

Warrants

 

 

 

19,161

 

19,161

 

Embedded conversion option

 

 

 

6,599

 

6,599

 

Total

 

$

 

$

 

$

25,760

 

$

25,760

 

 

 

 

Fair Value Measurement using

 

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Total

 

At December 31, 2012

 

 

 

 

 

 

 

 

 

Warrants

 

 

 

28,043

 

28,043

 

Embedded conversion option

 

 

 

21,382

 

21,382

 

Total

 

$

 

$

 

$

49,425

 

$

49,425

 

 

The following is a reconciliation of changes in fair value of our liabilities classified as Level 3 during the nine months ended September 30, 2013 and 2012:

 

 

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

Balance at beginning of period

 

$

49,425

 

$

 

Issuance of warrants

 

 

33,632

 

Amendment to warrant agreement

 

10,890

 

 

Unrealized (gain) loss on warrants included in earnings

 

(19,772

)

5,315

 

Unrealized (gain) loss on embedded conversion option included in earnings

 

(14,783

)

 

Balance at end of period

 

$

25,760

 

$

38,947

 

 

NOTE 9 — IMPAIRMENT OF ASSETS

 

The Company reviews non-producing leasehold costs and proved oil and gas properties on a field-by-field basis for impairment when events or circumstances indicate a possible decline in the recoverability of the carrying value of such property. We compare the carrying value of the property to its estimated undiscounted future cash flows. If the carrying value of the property exceeds its estimated undiscounted future cash flows, the carrying value is reduced to its estimated fair value and any impairment is charged to expense in the period incurred. Fair value is estimated using comparable market data, a discounted future cash flow method, or a combination of the two. Significant Level 3 assumptions are used in the fair value determination and include management’s expectations of future production, commodity prices, operating and development costs, risk-adjusted discount rate and other relevant data.

 

In the second quarter of 2013, non-producing leasehold costs and producing oil and gas properties with combined carrying values of $145.5 million were written down to their fair values of $52.4 million, resulting in pretax impairment charges of $93.1 million. Included in the $93.1 million impairment charge are non-producing leasehold costs impairments of $56.9 million and producing oil and gas properties impairments of $36.2 million.  The impairments of the non-producing leasehold costs primarily relate to reversals of book gains recorded in 2012 in connection with the Hess joint-venture dissolution.  The impairments of producing oil and gas properties relate to the Boening, Commodore and Stingray wells.

 

In the third quarter of 2013, non-producing leasehold costs with carrying values of $13.1 million were written down to their fair values of $4.1 million and we wrote down the carrying value of our inventory by $0.2 million, resulting in pretax impairment charges of $9.2 million. The impairment of non-producing leasehold costs in the third quarter of 2013 was triggered by lease expirations in our Sweet Home, Hackberry/Oakland, and Dilley prospects.

 

20



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

We recorded $2.2 million in asset impairments for both the three and nine months ended September 30 2012.  Included in the $2.2 million impairment charge are non-producing leasehold cost impairments of $0.4 million triggered by lease expirations in our Hackberry/Oakland and Eaglebine/Eagleford East prospects.  Producing oil and gas properties in Hackberry with carrying values of $3.2 million were also written down to their fair value of $1.4 million, resulting in a pretax impairment charge of $1.8 million.

 

NOTE 10 — STOCK-BASED COMPENSATION

 

Long Term Incentive Plan (the “Plan”)

 

We currently have 9.1 million shares authorized for issuance under the Plan adopted in March 2012.  At September 30, 2013, approximately 4.4 million shares were available for future grants under the Plan.

 

Stock-based compensation costs for the three and nine months ended September 30, 2013 were $0.6 million and $2.4 million, respectively.  Stock-based compensation costs for the three and nine months ended September 30, 2012 were $8.0 million and $12.8 million, respectively.

 

The following table presents the changes in restricted stock awards pursuant to the Plan:

 

 

 

Number

 

Weighted Average

 

 

 

of Shares

 

Grant Date

 

 

 

(in thousand)

 

Fair Value per Share

 

Unvested balance at December 31, 2012

 

155

 

$

4.32

 

Granted

 

3,508

 

1.54

 

Vested

 

(979

)

1.70

 

Cancelled/Forfeited

 

(80

)

1.32

 

Unvested balance at September 30, 2013

 

2,604

 

$

1.65

 

 

At September 30, 2013, we had $3.2 million of total unrecognized compensation costs related to unvested awards which is expected to be recognized over a weighted average period of 1.95 years.  As of September 30, 2012, there was $6.8 million of total unrecognized compensation cost related to unvested awards which is expected to be recognized over a weighted average period of 0.44 years.

 

NOTE 11 — SEVERANCE COSTS

 

In April 2013, ZaZa announced a significant reduction in workforce and terminated approximately 37 employees and contractors, and closed offices in Corpus Christi and Dallas. In the second quarter of 2013, we recognized $3.9 million in severance expense and $0.7 million in onerous contracts for a total expense of $4.6 million included in general and administrative expenses. As of September 30, 2013, we have a remaining liability of $3.4 million of which $2.4 million is recorded in current accrued liabilities and $1.0 million is recorded in non-current accrued liabilities.

 

NOTE 12 — COMMITMENTS AND CONTINGENCIES

 

FLMK/Emerald Leasing Claims

 

On August 9, 2012, ZaZa LLC filed a lawsuit in Harris County District Court against certain lease brokers, consultants and law firms who were involved in the leasing of acreage for the company in DeWitt and Lavaca Counties.  ZaZa paid certain of these brokers for approximately 3,924 acres of leases which the brokers have not delivered to the company. Additionally, there are net lease acreage shortages for which ZaZa has made a claim. The relief sought by ZaZa includes economic damages, exemplary damages, and reasonable attorney’s fees.  To the extent that ZaZa receives any such settlement as a result of these claims, it is required to share one-half of such settlement with Hess pursuant to the terms of the agreement dissolving the Hess joint venture. Certain of the defendants have settled, and ZaZa continues to pursue its claims against the remaining defendants, which include Emerald Leasing LLC, FLMK Acquisition, LLC, John T. Lewis, Billy Marcum, Brad Massey, Max Smith, Heroux & Helton PLLC, W&L Holdings, LLC, Rock Leasing, LLC, Nwk Resources, LLC, and Hlk Acquisitions, LLC.

 

21



Table of Contents

 

ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Sankalp Americas, Inc. Casing Collar Failure

 

On March 13, 2013, ZaZa LLC filed a lawsuit in Harris County District Court against Sankalp Americas, Inc. (“Sankalp”).   The dispute arose due to the catastrophic loss of a 17,000 plus foot horizontal well, the Stingray A-1H, drilled by ZaZa LLC in Walker County, Texas.  While ZaZa LLC worked to complete the sixteenth stage of its hydraulic fracturing operations, a casing collar manufactured by Sankalp failed, separating completely, and causing a downhole restriction.  This restriction, which could not be remediated, ultimately resulted in the loss of the entire horizontal portion of the well.  ZaZa LLC seeks to recover its economic damages and court costs from Sankalp for its substantial losses caused by such failure.  The case is set for trial in the second quarter of 2014.

 

Range Transaction

 

On March 28, 2012, ZaZa LLC entered into a Participation Agreement with Range under which ZaZa LLC agreed to acquire a 75% working interest from Range in certain leases located in Walker and Grimes Counties, Texas (the “Leases”).  Pursuant to the terms of the Range Agreement, Range retained a 25% working interest in the Leases and ZaZa LLC committed to drill a well (the “Commitment Well”).  ZaZa LLC drilled the Commitment Well but ceased completion operations due to a restriction.  As a result of the restriction, the lateral section of the well was lost and, because of the resulting operational delay, effective January 16, 2013, ZaZa LLC and Range entered into an Amendment No. 5 to the Range Agreement (the “Amendment”).  The Amendment requires ZaZa LLC to (i) commence re-completion operations on the Commitment Well by March 16, 2013 (the Company timely commenced such operations), (ii) commence drilling operations of a substitute Commitment Well (the “Substitute Well”) by July 17, 2013 (the Company timely commenced such operations), and (iii) initiate sales of oil and/or gas from the Substitute Well by September 1, 2013.  Failure to do so will require ZaZa to assign a 25% working interest in the Leases to Range and relinquish operatorship.  On March 25, 2013, ZaZa entered into the Sixth Amendment to the Range Agreement (the “Sixth Amendment”).  The Sixth Amendment extended the deadline for initiating sales of oil and/or gas from the Substitute Well from September 1, 2013 to November 1, 2013.  The Substitute Well has been completed, and sales have been initiated as of November 1, 2013.  Discussions are ongoing with Range regarding the Substitute Well, whether ZaZa’s obligations to Range now have been fulfilled and whether Range will elect (or not) into certain leases acquired within the parties area of mutual interest.

 

Other

 

From time to time, we are named as a defendant in other legal proceedings arising in the normal course of business. In our opinion, the final judgment or settlement, if any, which may be awarded with any such suit or claim would not have a material adverse effect on our financial position, results of operations or cash flows.

 

NOTE 13 — SUBSEQUENT EVENTS

 

The Company evaluated its September 30, 2013 financial statements for subsequent events. Other than as noted herein, we are not aware of any subsequent events which would require recognition or disclosure in the consolidated financial statements.

 

As discussed in “Note 1 — Basis of Presentation”, we entered into and closed the Amended JEDA with our counterparty on September 25, 2013 and October 15, 2013, respectively, and in exchange for approximately $18 million in non-producing properties we received approximately $16.3 million in cash (excluding $1.5 million that was received in the third quarter of 2013), carries worth over $8 million, and working interests in several proved producing wells with a fair value of approximately $17 million.  The carry, worth over $8 million, includes our counterparty’s requirement to drill two horizontal wells and one vertical well totaling approximately $7 million in net expenditures and a carry for miscellaneous expenses of $1.25 million. The Amended JEDA will be accounted for as a business combination and will require us to recognize and measure identifiable assets acquired and liabilities assumed at their fair value.  Accordingly, we expect to recognize a net increase to oil and gas properties including carries of approximately $12 million and an associated gain ranging between $28 and $33 million in the fourth quarter of 2013.

 

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

DISCLOSURES REGARDING FORWARD-LOOKING STATEMENTS

 

Certain matters discussed under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report may constitute “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and, as such, may involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. When used in this report, the words “anticipates,” “estimates,” “plans,” “believes,” “continues,” “expects,” “projections,” “forecasts,” “intends,” “may,” “might,” “will,” “would,” “could,” “should,” and similar expressions are intended to be among the statements that identify forward-looking statements. The factors that may affect our expectations regarding our operations include, among others, the following:

 

·                  our registered public accounting firm has expressed doubt about our ability to continue as a going concern;

·                  our ability to optimize our balance sheet and to raise necessary capital in the future;

·                  the effect of our indebtedness on our financial health and business strategy;

·                  whether our joint venture partners elect to move forward with subsequent phases of our joint ventures;

·                  our ability to maintain or renew our existing oil and gas leases or obtain new ones;

·                  possible title impairments to our properties;

·                  our ability to obtain equipment and personnel;

·                  uncertainties in reserve and production estimates;

·                  our ability to replace oil reserves;

·                  the loss of the current purchaser of our oil production;

·                  our ability to market and transport our production;

·                  our ability to compete in a highly competitive oil industry;

·                  the loss of senior management or key employees;

·                  assessing and integrating acquisitions;

·                  hurricanes, natural disasters or terrorist activities;

·                  change in legal rules applicable to our activities;

·                  extensive regulation, including environmental regulation, to which we are subject;

·                  volatility in oil and natural gas prices;

·                  our ability to execute our business strategy and be profitable;

·                  volatility in the financial and credit markets;

·                  changes in general economic conditions;

·                  drilling and operating risks;

·                  production expense estimates;

·                  the impact of derivative positions;

·                  the effects of delays in completion of, or shut-ins of, gas gathering systems, pipelines and processing facilities; and

·                  other matters that are discussed in our filings with the SEC.

 

In addition to these factors, important factors that could cause actual results to differ materially from our expectations (“Cautionary Statements”) are disclosed under “Risk Factors” included under Item 1A of Part II of this quarterly report and under Item 1A of Part I in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on April 2, 2013 and that are incorporated by reference herein.

 

All written and oral forward-looking statements attributable to us are expressly qualified in their entirety by the Cautionary Statements.  We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events, or otherwise unless required by law.

 

We produce both oil and natural gas. Throughout this Quarterly Report, when we refer to “total production,” “total reserves,” “percentage of production,” “percentage of reserves,” or any similar term, we have converted our natural gas reserves or production into barrel of oil equivalents. For this purpose, six thousand cubic feet of natural gas is equal to one barrel of oil, which is based on the relative energy content of natural gas and oil. Natural gas liquids are aggregated with oil in this Quarterly Report.

 

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EXECUTIVE OVERVIEW

 

ZaZa is a Delaware corporation formed for the purpose of being a holding company of both Toreador Resources Corporation, a Delaware corporation (“Toreador”), and ZaZa Energy LLC, a Texas limited liability company (“ZaZa LLC”), from and after completion of the Combination, as described below. Prior to the Combination on February 21, 2012, ZaZa had no assets and had not conducted any material activities other than those incident to its formation. However, upon the consummation of the Combination, ZaZa became the parent company of ZaZa LLC and Toreador. In this Quarterly Report on Form 10-Q, unless the context provides otherwise, “we”, “our”, “us” and like references refer to ZaZa and its subsidiaries.

 

Recent Developments

 

Eaglebine/Eagle Ford East Joint Venture with EOG

 

On March 21, 2013, we entered into a Joint Exploration and Development Agreement with EOG Resources, Inc. (“our counterparty”), (that was amended on April 2, 2013 and restated and amended on September 25, 2013 and October 15, 2013) for the joint development of certain of our Eaglebine/Eagle Ford East properties located in Walker, Grimes, Madison, Trinity, and Montgomery Counties, Texas (the “Amended JEDA”).  Under the Amended JEDA, we and our counterparty will jointly develop up to approximately 110,000 acres in these counties.  Pursuant to the Amended JEDA, our counterparty will act as the operator and pay us certain cash amounts, bear 100% of the drilling and completion costs of certain specified wells, and pay for a portion of our share of any additional seismic or well costs.  Generally, ZaZa will retain a 25% working interest and our counterparty will earn a 75% working interest in the acreage subject to the Amended JEDA, that is currently 100% owned by ZaZa.  ZaZa will retain a 25% working interest and our counterparty will earn a 50% working interest in the acreage that is currently owned 75% by ZaZa and 25% by Range Texas Production, LLC (“Range”), a subsidiary of Range Resources Corporation, subject to the terms of our Participation Agreement (the “Range Agreement”) with Range as described in “Note 12 — Commitments and Contingencies.”  Range will retain its 25% interest in such acreage.  This joint development was initially divided into three phases.

 

The first phase commenced on April 2, 2013 and has been substantially completed.  In this phase we transferred approximately 20,000 net acres, of which approximately 15,000 came from our joint venture with Range, to our counterparty in exchange for a cash payment by our counterparty to us of $10 million and an obligation of our counterparty to drill and pay 100% of the drilling and completion costs of three wells.  The two Phase I wells have been completed, with the second being the substitute well that we are required to drill pursuant to our agreement with Range described in “Note 12 — Commitments and Contingencies.”

 

On September 25, 2013, ZaZa and its counterparty entered into a Second Amendment and First Restatement of Joint Exploration and Development Agreement and a Third Amendment and Second Restatement of the Joint Exploration and Development Agreement, that resulted in the following transactions being closed on October 15, 2013:

 

Phase II Acceleration.  Our counterparty accelerated Phase II of the joint venture, and we assigned approximately 20,000 net acres to our counterparty on October 15, 2013, in exchange for (i) cash consideration of $17 million and (ii) approximately $3 million of interests (based on an independent reserves report) in 15 producing wells of our counterparty located outside of the Area of Mutual Interest or “AMI” (established by the amended and restated JEDA).  Also, during Phase II, our counterparty will drill two horizontal wells and one vertical well in the parties’ AMI, carry ZaZa’s interests in those wells and provide a miscellaneous work and land carry of up to $1.25 million.  Our counterparty may, however, elect to drill one or more vertical wells in order to achieve carry parity value for drilling horizontal wells.  To complete its obligation in respect of the third well under Phase I of the Amended JEDA, our counterparty will pay for an additional $1.5 million of ZaZa’s costs for one or more additional vertical wells and has provided a further $1.5 million cash payment to ZaZa.

 

Phase III Acceleration.  Under the Amended JEDA, ZaZa assigned on October 15, 2013 approximately 7,800 net acres from the former Phase III acreage for which ZaZa will receive approximately $11 million of interests (based on an independent reserves report) in the 15 producing wells of our counterparty (part of Phase II and referenced above).  In addition, our counterparty has the option, until January 31, 2014, to acquire an interest in the remaining approximately 12,300 former Phase III net acres at a fixed price per net acre from ZaZa.

 

Exchange of Leases and Wells.  Our counterparty has acquired approximately 19,000 additional net acres and interests in related wells in the parties’ Area of Mutual Interest, and has assigned to ZaZa a 25% working interest in these leases and wells. In consideration for ZaZa’s participation in our counterparty’s leases and

 

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producing wells, ZaZa assigned to our counterparty approximately 13,875 additional net acres and paid approximately $700,000 in cash.

 

The Amended JEDA will be accounted for as a business combination and will require us to recognize and measure identifiable assets acquired and liabilities assumed at their fair value.  Accordingly, we expect to recognize a net increase to oil and gas properties including carries of approximately $12 million and an associated gain ranging between $28 and $33 million in the fourth quarter of 2013.

 

The following table presents the acreage position following the Amended JEDA:

 

 

 

Gross Acres Held
by ZaZa (a)

 

Net Acres to
Partner (a)

 

Net Acres to
ZaZa (a)

 

Phase I

 

36,667

(b)

20,025

 

6,675

 

Phase II

 

26,700

 

20,025

 

6,675

 

Former Phase III

 

10,424

 

7,818

 

2,606

 

Partner AMI

 

19,000

 

14,250

 

4,750

 

Retained Acreage

 

18,500

 

13,875

 

4,625

 

Sub Total

 

111,291

 

75,993

 

25,331

 

 

 

 

 

 

 

 

 

Former Phase III Option (c)

 

12,311

 

9,233

 

3,078

 

 

 

 

 

 

 

 

 

Total with Former Phase III Option Election

 

123,602

 

85,226

 

28,409

 

Total without Former Phase III Option Election

 

111,291

 

75,993

 

37,642

 

 


(a)              All acreage figures are approximate.

(b)              Gross acres include currently owned by Range acreage.

(c)               Partner can participate in up to 12,311 remaining former Phase III net acres on or before January 31, 2014 for cash consideration at a fixed price per acre.

 

Sale of Moulton acreage (collectively “Moulton Transactions”)

 

On April 5, 2013 the Company closed a purchase and sale agreement and sold certain of its properties in the Eagle Ford trend located in Fayette, Gonzalez and Lavaca Counties, Texas, which we refer to as our Moulton properties, for approximately $9.2 million. Net proceeds from the sale, after closing purchase price adjustments and expenses were approximately $8.8 million. We used approximately $4.6 million of the proceeds to pay down our Senior Secured Notes.

 

We also entered into an agreement on June 27, 2013 to sell approximately 10,000 net acres of our properties in the Eagle Ford trend located in Fayette, Gonzalez and Lavaca Counties, Texas, including seven producing wells located on the Moulton properties, for approximately $28.8 million.  We closed this transaction on July 26, 2013 and received cash proceeds of $29.3 million, inclusive of the $1.4 million deposit. We used $1.8 million to pay down our Senior Secured Notes reducing the principal balance to $26.8 million.

 

Revenues and lease operating expenses attributable to the Moulton properties for the three and nine months ended September 30, 2013 and 2012 were as follows:

 

 

 

Three Months

 

Three Months

 

Nine Months

 

Nine Months

 

 

 

Ended

 

Ended

 

Ended

 

Ended

 

 

 

September 30,
2013

 

September 30,
2012

 

September 30,
2013

 

September 30,
2012

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

443

 

$

1,027

 

$

4,586

 

$

1,547

 

Lease operating expenses

 

70

 

168

 

625

 

411

 

 

The following supplemental pro forma information presents consolidated results of operations as if the Moulton sale had occurred on January 1, 2012.  The information does not purport to represent what the actual consolidated results of operations of the Company would have been had the transactions occurred on the dates assumed, nor are they necessarily indicative of future consolidated results of operations.

 

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Three Months

 

Three Months

 

Nine Months

 

Nine Months

 

 

 

Ended

 

Ended

 

Ended

 

Ended

 

 

 

Pro Forma

 

Pro Forma

 

Pro Forma

 

Pro Forma

 

 

 

September 30,
2013

 

September 30,
2012

 

September 30,
2013

 

September 30,
2012

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

659

 

$

198,156

 

$

1,680

 

$

202,833

 

Operating income (loss)

 

(14,481

)

177,359

 

(120,167

)

123,145

 

Net income (loss)

 

(20,066

)

134,951

 

(76,270

)

(30,897

)

 

 

 

 

 

 

 

 

 

 

Basic earnings (loss) per share

 

$

(0.20

)

$

1.33

 

$

(0.74

)

$

(0.32

)

Diluted earnings (loss) per share

 

$

(0.20

)

$

1.03

 

$

(0.74

)

$

(0.32

)

 

Eagle Ford Joint Venture with Sabine

 

On September 17, 2013, we entered into an agreement with Sabine South Texas LLC (“Sabine”) for the joint development of our Sweet Home prospect in the Eagle Ford trend located in Lavaca and DeWitt Counties, Texas.  Under this agreement, Sabine will jointly develop with us up to approximately 7,600 net acres that we currently own and that comprise a portion of our interest in the Sweet Home prospect.  Sabine has agreed to bear 100% of the drilling and completion costs of two commitment wells and up to $750,000 of construction costs related to gathering and infrastructure in order to earn a 75% working interest in 7,600 acres of the Sweet Home prospect and the Boening well. Sabine has also agreed to carry up to $300,000 of ZaZa’s expenses related to the extension and renewal of certain leases in the Sweet Home prospect.

 

If Sabine completes the first commitment well by February 15, 2014, ZaZa will transfer to Sabine a 75% working interest in approximately 3,200 net acres and the Boening well.  If Sabine completes the second commitment well by April 15, 2014, ZaZa will transfer to Sabine a 75% working interest in the remaining net acres.  Assuming the initial two commitment wells (or substitute wells, if necessary) are successful in achieving production, participating interests in any additional wells drilled or lease acreage acquired in the Sweet Home prospect will be shared 75% by Sabine and 25% by ZaZa under an area of mutual interest that will expire on September 15, 2015.

 

Financial Summary

 

For the nine months ended September 30, 2013:

 

·                  Production was 87 MBOE of which 62 MBOE was oil production (71%).

·                  Revenues and other income from continuing operations were $6.3 million.

·                  Operating costs of continuing operations were $131.0 million, including $102 million of asset impairments driven primarily by the reversal of upward fair value adjustments recorded in 2012.

·                  Net loss from continuing operations was $81.7 million, including $66.5 million of asset impairments.

 

At September 30, 2013, we had:

 

·                  Cash and cash equivalents of $6.6 million.

·                  Current ratio (current assets/current liabilities) of 0.44 to 1.

 

RESULTS OF OPERATIONS

 

The results of operations include the results of our accounting predecessor, ZaZa LLC, from January 1, 2012 through February 20, 2012 and all of our subsidiaries, since February 21, 2012 excluding ZEF which was sold on December 21, 2012 and is presented as discontinued operations.  The discussion below relates to our continuing corporate activities and oil and gas exploration and production operations, and excludes discontinued operations.

 

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Revenue and other income

 

Oil and gas revenue

 

Oil and gas revenue for the three months ended September 30, 2013 was $1.1 million (of which $0.85 million was oil and $0.25 million was gas), compared to $2.2 million for the three months ended September 30, 2012. This decrease in revenue is primarily due to the loss of the Cotulla revenues ($0.8 million) as a result of the Hess dissolution and decrease in Moulton production ($0.6 million) following sale to Sanchez on July 26, 2013, partially offset by the Boening well (Sweet Home) beginning test production on February 3, 2013 ($0.3 million).

 

Oil and gas revenue for the nine months ended September 30, 2013 was $6.3 million (of which $5.7 million was oil and $0.5 million was gas), compared to $7.4 million for the nine months ended September 30, 2012. Revenues decreased due to the loss of Cotulla production ($5.4 million) as a result of the Hess dissolution offset partially by the Boening well (Sweet Home) which began test production on February 3, 2013 ($0.6 million), Eaglebine/Eagle Ford East ($0.4 million), and an increase in Moulton production for the Crabb Ranch well ($1.8 million) and the Ring Unit wells ($1.3 million), and other non operated ($0.3 million).

 

The following table presents our production and average prices obtained for our production for the three and nine months ended September 30, 2013 and 2012:

 

 

 

Three Months Ended September 30,

 

Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Production:

 

 

 

 

 

 

 

 

 

Oil (Bbls):

 

10,251

 

24,263

 

62,098

 

74,051

 

Gas (Mcf):

 

72,494

 

38,547

 

149,414

 

114,323

 

Equivalents (BOE):

 

22,333

 

30,688

 

87,001

 

93,104

 

 

 

 

 

 

 

 

 

 

 

Average Price:

 

 

 

 

 

 

 

 

 

Oil ($/Bbl):

 

$

83.17

 

$

86.61

 

$

92.51

 

$

95.15

 

Gas ($/Mcf):

 

$

3.45

 

$

2.50

 

$

3.49

 

$

2.69

 

 

The following tables present our production data for the referenced geographic areas for the periods indicated: