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Requeim or Ressurection? Management`s Discussions: 10QSB, ZYDECO ENERGY INC SATURDAY, NOVEMBER 13, 1999 1:39 PM Company Name: ZYDECO ENERGY INC (SYMBOL:ZNRG) MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Formed in 1993, the Company is an independent energy company engaged in the exploration for oil and gas utilizing advanced three-dimensional ("3D") seismic and computer-aided exploration ("CAEX") techniques. The Company has developed comprehensive in-house technology and software and expertise, enabling it to employ recent advances in such 3D seismic and CAEX technology. Such technology included the Company's "Wavefield Imaging Technology", a patented data processing technique designed to substantially reduce the cost of 3D seismic data acquisition for certain surveys without significantly sacrificing the quality of the 3D subsurface image. The Company's primary business objective is to discover and develop oil and gas reserves and thereby increase revenues, net income and cash flows. In order to achieve this objective, it has utilized the described technologies and software in its principal exploration areas. Because market conditions for selling interests in prospects significantly deteriorated during the second half of 1998 and the first nine months of 1999, the Company altered its business plan. As a result, it focused its efforts on (1) conserving cash resources including, but not limited to, employee terminations and negotiations to defer compensation with the key executive and restructuring of vendor obligations; (2) concentrating exploration efforts strictly on marketing sellable West Cameron Seismic Project ("Project") prospects, and sale of assets; (3) seeking alternate sources of capital for possible drilling participation and general working capital. The Company believes that its revised strategy will permit it to operate with existing cash resources into the year 2000 and withstand the current downturn in the oil and gas exploration industry. Should the Company be successful in selling interests in its assets, prospects, or an interest in the Project itself or raising alternate capital resources, sufficient capital may be available in the Company to quickly expand its operations. However, during the 1999 first quarter, the Company's first Project well was completed as a dry hole. No project wells, in which the Company had an interest, were drilled in the second or third quarter. The Company has temporarily ceased active marketing efforts of its Project prospects. Should industry conditions improve, then the Company may recommence such marketing efforts. Since early 1996, the Company focused most of its exploration efforts on its Project, located in western Cameron Parish, Louisiana in an area known as the Louisiana Transition Zone. The Louisiana Transition Zone is an area of shoreline, near shore and within shallow coastal and bay waters where the combination of marine and land seismic and processing techniques are difficult and expensive. During 1998, the Company had begun to market for sale interests in various Project prospects to industry participants. However, due mostly to potential prospect buyers' concerns over uncertainties of ownership interests in Project prospects prior to the December 1998 arbitration ruling described below and market conditions thereafter, the Company has not generated sufficient sales of Project prospects and, therefore, has not produced adequate levels of cash inflows during the near term. The Project was completed in phases. Seismic data acquisition for this Project commenced over approximately 230 square miles during the second half of 1996 and was completed in July 1997. The seismic processing phase of this Project immediately commenced during mid 1997 and was completed in October 1998. The interpretive phase commenced also during mid 1997 and continued throughout 1998. For the Project's initial leasing phase, the major portion of 1998 lease acquisitions occurred during the first half and aggregated more than 12,000 gross acres through State of Louisiana lease sales, private land negotiations and a federal lease sale. However, during 1999, failing to pay the yearly rentals has caused the Company to drop all but approximately 5, 000 gross acres. The Company did not have sufficient capital resources to drill exploratory wells on the terminated leases. In April 1996, the Company executed an Exploration Agreement (the "Cheniere Agreement") with Cheniere Energy Operating Co., Inc., a wholly owned subsidiary of Cheniere Energy, Inc. and formerly known as FX Energy, Inc., (collectively "Cheniere") covering the area of Project land and waters in western Cameron Parish, Louisiana. In exchange for earning a 50% interest, Cheniere agreed to fund certain Project costs including, but not limited to, 3D seismic acquisition costs, including the purchase of seismic rights or lease options on the related onshore acreage of the Project, the purchase of other 3D seismic data, and processing of seismic data over the Project area. On December 9, 1998 a three- member arbitration panel issued its decision in the arbitration proceedings brought by Zydeco against Cheniere. The arbitration claim and Cheniere's counterclaim sought to resolve differences over Cheniere's funding obligations, the parties' ownership in various leases and prospects, the scope of pre- drilling activities that Cheniere can conduct within the Project area, the dissemination by Cheniere of confidential seismic data covering the Project area, and a variety of related issues. As a result of the arbitration panel's decision, Zydeco and Cheniere informally agreed to share responsibilities and ownership for certain activities incurred in the maintenance, marketing and sale of prospects generated and assembled by the parties. Except for the costs of one prospect and certain other activities, neither party sought reimbursement from the other for seismic and prospect costs generally incurred prior to the arbitration ruling. In order to conserve its cash resources, the Company through terminations and resignations reduced the number of its employees by a combined total of approximately 17 in December 1998 and March 1999. In addition, the Chairman of the Board, whose annual salary is $150,000, has deferred his salary effective March 15, 1999. Prior to June 30, 1999, the Company terminated an additional three employees. During the quarter, two additional employees resigned. The Company presently has three employees. The Company intends to pay to its Chairman and CEO on November 15, 1999 all salary deferred and owed such executive, including approximately $81,250 owed as of September 30, 1999. The amount of this payment will be approximately $100,000. Thereafter, the Company will resume his regular wage payments, calculated on a salary of $150,000 per year. The Company accounts for its oil and gas exploration and production activities using the successful efforts method of accounting. Under this method, acquisition costs for proved and unproved properties are capitalized when incurred. Exploration costs, including geological and geophysical costs and the costs of carrying and retaining unproved properties, are expensed. Exploratory drilling costs are initially capitalized, but charged to expense if and when the well is determined not to have found proved reserves. Costs of productive wells, developmental dry holes, and productive leases are capitalized and amortized on a property-by-property basis using the units-of-production method. The estimated costs of future plugging, abandonment, restoration, and dismantlement are considered as a component of the calculation of depreciation, depletion, and amortization. Unproved properties with significant acquisition costs are assessed periodically on a property-by-property basis and any impairment in value is charged to expense. RESULTS OF OPERATIONS THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1998 The Company recorded a loss of $261,915, or $.03 per share, for the three months ended September 30, 1999 compared to a loss of $1,558,434, or $.15 per share, in the three months ended September 30, 1998. The decrease in the loss is primarily due to a decline in general and administrative expenses and exploration expenses. General and administrative expenses decreased from $873,034 in the 1998 third quarter to $120,731 in the comparable 1999 period mostly due to cost reducing actions that commenced in December 1998 and the restructuring of vendor obligations. The Company expects that general and administrative expenses will continue to decline in the near term compared to the similar 1998 period due to the impact of further cost reductions that have been made since January 1, 1999. Exploration expenses decreased from $646,068 in the 1998 third quarter to $4,112 in the comparable 1999 period. Most of the 1998 third quarter's exploration expense was composed of Project geological and geophysical expense. The Company had no comparable expense in the 1999 third quarter. With the completion of the Project seismic processing activity during the 1998 fourth quarter, the Company does not anticipate significant spending for geological and geophysical expenses in the near term. However, because the Company utilizes the successful efforts method of accounting, exploration expenses typically vary materially from period to period based upon exploration program activities, the Company's cost participation and other factors. Revenues decreased from $147,113 in the 1998 third quarter to a negative $44,988 in the 1999 third quarter due to declines in oil and gas sales volumes and losses on the sales of furniture, fixtures and office equipment. Although the Company expects that the combined production rates of its producing wells will continue to decline during the near term, the Company cannot ascertain whether the rate of decline experienced from the 1998 third quarter to the comparable 1999 period will continue in the near term. In addition, one of these wells which is not presently commercial will be plugged and abandoned. During the 1999 third quarter, the Company sold most of its furniture, fixtures and office equipment and recorded a loss on such sales that amounted to approximately $94,000. The Company had no comparable activity during the 1998 third quarter. Interest income decreased from $40,823 to $13, 308 due to a decreased level of cash available for investment. Because the Company believes that the marketing and sale of prospects may recommence when industry conditions improve, the Company may record gains or losses for sale transactions resulting from these activities. However, the timing and amount of such sales and the extent of their gain or loss are uncertain due to a number of factors such as, but not limited to, the timing and cost of lease acquisitions, the availability of leaseholds in particular prospect areas and market conditions, both generally and in the oil and gas industry, at the time of such activities. NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1998 The Company recorded a loss of $1,786,550, or $.17 per share, for the nine months ended September 30, 1999 compared to a loss of $4,171, 380, or $.40 per share, in the nine months ended September 30, 1998. The decrease in the loss is primarily due to a decline in general and administrative expenses. General and administrative expenses decreased from $2,177,416 in the nine month period ended September 30, 1998 to $222,160 in the comparable 1999 period mostly due to cost reducing actions that commenced in December 1998 and the restructuring of vendor obligations. As discussed in the "Results of Operations" for the three-month period and "Overview", the Company terminated employees, deferred certain executive compensation and was successful in negotiating reduced payment terms on various invoices incurred during 1998 and 1999. The Company expects that general and administrative expenses will continue to decline in the near term compared to the similar 1998 period due to the impact of these and other cost reductions. Oil and gas revenues declined from $313,634 in the nine months ended September 30, 1998 to $126,087 in the similar 1999 period due to the natural production declines discussed in the preceding section. As also discussed in the "Overview" section, the Company may record gains and/or losses from the sales of prospects in the near term. However, there can be no assurance that such sales may occur. Interest income decreased from $277,499 to $47,205 due to a decreased level of cash available for investment. Although the Company expects that its level of exploration expenses will decline significantly in the near term compared to the previous year's periods, exploration expenses may vary materially due to exploration program activities, the Company's cost participation and other factors. LIQUIDITY AND CAPITAL RESOURCES The Company has incurred net losses and negative cash flows from operations since its inception. For the nine months ended September 30, 1999 and the twelve months ended December 31, 1998, 1997 and 1996, the Company incurred net losses of $1,786,550, $9,611,738, $6,152,127 and $1,858,132, respectively. The Company is principally engaged in one industry and geographic segment, oil and gas exploration and production, and has concentrated its exploration efforts since early 1996 in an area of the Louisiana Transition Zone, known as the West Cameron Seismic Project (the "Project"). Since inception of the Project, the Company and Cheniere have expended approximately $21,640,171 pursuant to the terms of the Cheniere Agreement. In addition, during 1998 the Company expended approximately $5,753,010 on unproved property costs, almost all of which were on prospects within the Project. The source of funding for these activities has come from funds generated from public and private equity offerings, cash flow from the Company's operations, and cash payments made to it under the Cheniere Agreement. Sources of funds include approximately $24.1 million from the sale of securities in 1993, 1994, 1995 and 1997, and $16.4 million provided under the Cheniere Agreement. The Company does not currently hold any funds advanced under that agreement. The cost of capitalized leases that expired during the nine months ended September 30, 1999 for non-payment of rentals amounted to approximately $3,342,411. The Company and Cheniere will continue to evaluate their lease inventory, cash resources, market conditions and other factors in the near term with a view to retaining its interests or forfeiting some portion of its interests in such leases. There can be no assurance that the Company and Cheniere will pay any or all portions of any such remaining delay rentals or enter into sale agreements with other participants who would share the cost of such commitments. Should the Company forfeit its interest in some portion of its remaining leases, then it may be required to recognize a material charge to expense for such forfeitures. The Company's remaining net unproved property cost amounted to $1,870,488 as of September 30, 1999. During mid 1998 subsequent to the acquisition of most of its current inventory of Project leases, the Company commenced marketing activities with a view to selling interests in Project prospects that were ready for sale. However, market conditions considerably deteriorated to the point that significantly fewer industry participants are actively acquiring oil and gas prospect interests. Due to the adverse factors presented above, the Company has had to rely principally on available cash to continue its operations. However, in order to conserve its remaining cash resources, the Company instituted certain cost reducing actions, including, but not limited to, employee terminations and negotiations to defer compensation with the key executive, office lease cancellations, sales of surplus office furniture and equipment and negotiations restructuring obligations with vendors. For the near term, the Company's principal business strategy is to conserve cash until improved industry conditions permit the resumption of lease acquisition and prospect marketing activities. There can be no assurance when such industry conditions may improve and permit the resumption of such activities. The Company does not expect to generate operating cash flow or net income in 1999 unless it sells substantial interests in remaining Project prospects or interests in the Project itself or makes an asset sale. The Company contemplates that the sale of such interests would include prospect development commitments and financing provided by the purchasers coupled with retained interests and back-in rights to the Company, and additional cash consideration to the Company for recoupment of costs incurred in identifying such prospective interests. As generally required by the successful efforts method of accounting, the Company has expensed all of its seismic and other geological and geophysical costs in the Project, and accordingly, any payments for the recoupment of non-capitalized costs would be treated as income to the Company. There can be no assurance that the Company will be successful in the selling of significant interests or in receiving payments for the recoupment of the Company's costs incurred to date on this project. In addition, there can be no assurance that the Company would be able to acquire new cash resources if the Company is not successful in selling assets or in selling its desired level of interests in a Project prospect or on terms that require little or no cash resources for prospect commitments. The Company does not presently maintain any credit facilities. In order to hold its federal oil and gas leases, the Company has maintained a $300,000 bond collateralized by a United States Treasury Note. In the event that the Company would act as operator on a federal offshore lease or is otherwise required to increase its bonding by federal or state authorities, significant amounts of capital may be required for additional collateral to satisfy bonding requirements. However, with the expiration and other disposition of certain federal leases, the Company has requested that the bond be decreased and the collateral reduced, permitting a refund to the Company of some portion of the collateral. The Company expects that such approval from federal authorities will be granted in the near term and will receive a $250,000 refund. The Company is unaware of any possible exposure from actual or potential claims or lawsuits involving environmental matters. As such, no liability is accrued at September 30, 1999. SUBSEQUENT EVENTS The Company had a carried working interest in the S.L. 16208 #1, which was completed as a dry hole on October 29, 1999. Although the Company incurred no dry hole expense on this well, its remaining carrying cost of its leasehold amounts to approximately $176,000. The Company may, from time to time, purchase shares of its common stock in the open market at the prevailing market price at the time of purchase. The Company does not intend to cause its shares to be delisted under Section 12 of the Securities and Exchange Act of 1934. On October 14, 1999, the Company sold its overriding royalty interest in three producing wells located in the Bay Marchand area of Louisiana. During the 1999 fourth quarter, the Company will recognize a gain of approximately $137,000 on these wells, which had been placed on production during the 1999 third quarter. On November 15, 1999, the Company's Chairman and CEO will be paid his deferred salary of $100,000, including approximately $81,250 deferred by the Company as of September 30, 1999. Thereafter, the Company will pay his regular wages equal to $150,000 per year. The Company has reduced the stock option price for one of its employees to $.12 1/2 per share. The employee has an option for 52,500 shares. | ||||||||||||
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