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ZAZA > SEC Filings for ZAZA > Form 10-Q on 13-Nov-2012All Recent SEC Filings

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Quarterly Report


The following discussion is intended to assist in understanding the business and results of operations together with our present financial condition. This section should be read in conjunction with our Consolidated Financial Statements and the accompanying notes included elsewhere in this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the year ended December 31, 2011, which was filed with the Securities and Exchange Commission ("SEC") on June 15, 2012.

Certain previously recorded amounts have been reclassified to conform to this period presentation.


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 raise necessary capital in the future;

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

? our ability to maintain or renew our existing exploration permits or exploitation concessions or obtain new ones;

? currency fluctuation risk;

? political, legal and economic risks associated with having international operations;

? possible title impairments to our properties;

? our ability to obtain equipment and personnel;

? reserves estimates turning out to be inaccurate;

? 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 or permits and concessions;

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

? declines in prices for crude oil; and

? our ability to execute our business strategy and be profitable.

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 this quarterly report and under Item 1A of Part I in our Annual Report on Form 10-K for the year ended December 31, 2011, filed with the SEC on June 15, 2012, as updated in Item 1A of Part II in our quarterly report on Form 10-Q for the period ended June 30, 2012, filed with the SEC on September 13, 2012, which 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.


ZaZa Energy Corporation ("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, its two subsidiaries (ZaZa LLC and Toreador) and each of their respective subsidiaries.

Combination with ZaZa LLC and Toreador Resources Corporation

On February 21, 2012, we consummated the combination (the "Combination") of ZaZa LLC and Toreador, 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"), as previously described in our Current Report on Form 8-K filed on February 22, 2012.

Pursuant to the Merger Agreement, (i) Merger Sub merged with and into Toreador (the "Merger"), with Toreador continuing as the surviving entity, (ii) the three former members of ZaZa LLC (the "ZaZa LLC Members"), holding 100% of the limited liability company interests in ZaZa LLC, directly and indirectly contributed all of such interests to us (the "Contribution"), and (iii) the holders of certain profits interests in ZaZa LLC contributed 100% of such interests to us (the "Profits Interests Contribution"). Upon the consummation of the Combination, Toreador and ZaZa LLC became our wholly owned subsidiaries.

The Combination has been treated as a reverse merger under the purchase method of accounting in accordance with GAAP. For accounting purposes, ZaZa LLC is considered to have acquired Toreador in the Combination. Under the purchase method of accounting, the assets and liabilities of Toreador have been recorded at their respective fair values and added to those of ZaZa LLC in our financial statements.

At the effective time of the Merger, each share of common stock, par value $0.15625 per share, of Toreador issued and outstanding immediately prior to the effective time of the Merger was converted into the right to receive one share of ZaZa common stock, par value $0.01 per share (the "Common Stock"), which in the aggregate represented 25% of the issued and outstanding shares of Common Stock immediately after the consummation of the Combination (but without giving effect to the shares of Common Stock issuable upon exercise of the Warrants as discussed below).

Simultaneously with the consummation of the Merger, and pursuant to the Contribution Agreement dated August 9, 2011 among the ZaZa LLC Members and ZaZa (the "Contribution Agreement"), the ZaZa LLC Members contributed all of the direct or indirect limited liability company interests in ZaZa LLC to us in exchange for (i) a number of shares of Common Stock that, in the aggregate, represented 75% of the issued and outstanding shares of Common Stock immediately after the consummation of the Combination (but without giving effect to the shares of Common Stock issuable upon exercise of the Warrants as discussed below), and (ii) subordinated notes in an aggregate amount of $38.25 million issued to the ZaZa LLC Members as partial consideration for the Combination (the "Seller Notes"). In addition, as required under the terms of the Merger Agreement and the Contribution Agreement, we issued subordinated notes in an aggregate amount of $9.08 million to the individuals that own and control the ZaZa LLC Members, Todd Alan Brooks, Gaston L. Kearby and John E. Hearn Jr. (together, the "ZaZa Founders"), in respect of certain unpaid compensation amounts owing to the ZaZa Founders by ZaZa LLC (the "Compensation Notes") for back salary, bonuses, incentive compensation or other compensation payable to them by ZaZa LLC in connection with or in respect of periods prior to the consummation of the Combination. The Seller Notes and Compensation Notes accrue interest at a rate of 8% per annum, are payable monthly in cash, and mature on August 17, 2017. Subject to certain conditions, we may make regularly scheduled interest payments to the ZaZa LLC Members and the ZaZa Founders on these notes and may prepay these notes at any time. We are required to repay these notes, pro rata, with 20% of the proceeds of any subordinated debt financing and 20% of the proceeds of any equity financing completed on or after the third anniversary of the issuance of the Senior Secured Notes, which are described below. We have not been making regular interest payments on these notes. On September 11, 2012, we made a partial interest payment on the notes and the holders of the notes agreed, subject to board approval, to defer any further accrued interest, as well as any interest that accrues after such date, until the earlier of (i) the occurrence of an event providing us with liquidity sufficient to make such payments and (ii) February 21, 2013. On October 22, 2012, we completed the issuance of $40 million 9% Convertible Senior Notes due 2017 which allowed us to pay $1.6 million in back interest on the Subordinated Notes. Interest will now be due and paid on the last day of each month.

Immediately after the consummation of the Merger and Contribution, and pursuant to the Net Profits Interest Contribution Agreement, dated August 9, 2011, among ZaZa, ZaZa LLC and the holders of net profits interests in ZaZa LLC the holders of certain profits interests in ZaZa LLC completed the Profits Interests Contribution in exchange for $4.8 million in cash.

Additionally, in connection with the Combination, we issued senior secured notes with a principal amount of $100 million maturing in 2017 (the "Senior Secured Notes") in a private placement to a group of investors led by MSD Energy Partners, L.P. and Senator Investment Group LP. The Notes bear interest at a rate of 8% per annum, payable quarterly. In connection with the issuance of the Senior Secured Notes, ZaZa also issued to the investors warrants to purchase an aggregate of approximately 26.3 million shares of our common stock at $3.15 per share (the "Warrants") representing 20.6% of the outstanding shares of our common stock at the Closing of the Combination, on a fully diluted and on an as-converted basis. The Warrants expire in five years and are exercisable at any time after the six month anniversary of the issuance date. As a result of the anti-dilution adjustments in the Warrants, the number of outstanding shares of our common stock represented by the Warrants was increased from 26,315,789 to 27,226,223 and the exercise price per share was reduced to $3.10 per share on October 22, 2012 following the issuance of our convertible notes.

Subsidiaries of ZaZa Energy Corporation

ZaZa Energy, LLC

ZaZa LLC is a privately-held independent exploration and production company focused on the exploration and development of unconventional onshore oil and gas resources in the United States of America, until February 21, 2012 when it was contributed to ZaZa as part of the Combination. ZaZa LLC was controlled by the ZaZa Founders who each beneficially owned one-third of the outstanding limited liability company interests of ZaZa LLC. ZaZa LLC's operations are concentrated in south Texas, including its largest exploration area in the core area of the Eagle Ford shale formation and in the eastern extension of the Eagle Ford/Woodbine formation, which we refer to as the "Eaglebine."

Toreador Resources Corporation

Toreador was a publicly held independent energy company engaged in the exploration and production of crude oil with interests in developed and undeveloped oil properties in the Paris Basin, France. Toreador currently operates solely in the Paris Basin, which covers approximately 170,000 km2 of northeastern France, centered 50 to 100 km east and south of Paris. As of September 30, 2012 and 2011, production from the Neocomian Complex and Charmottes fields oil fields represented a majority of Toreador's total revenue and substantially all of Toreador's sales and other operating revenue.

Recent Developments

Range Transaction

On March 29, 2012, ZaZa LLC entered into a transaction with Range Texas Production, LLC ("Range"), a subsidiary of Range Resources Corporation, to expand ZaZa's position in the Eaglebine to a total holding of approximately 143,400 gross acres (90,000 net acres). Under the terms of the transaction, ZaZa LLC: obtained a 75% working interest in the acquired acreage; was designated as operator; committed to drill one well (estimated cost between $8-10 million); was obligated and satisfied its obligation to commence operations on the commitment well on or before August 1, 2012; and committed to and made two cash payments to Range. ZaZa LLC is on schedule to satisfy all its obligations relative to the commitment well.

Rationale for Hess Joint Venture Dissolution

Based on public communications from Hess, it became obvious that Hess and ZaZa had different understandings about Hess's obligations under the EDAs relating to our joint venture. Correspondence and communications between the parties relating to the disagreements between the parties led to the conclusion that it would be in the best interest of both parties to dissolve the joint venture and divide the combined assets. These disagreements included overhead allocations and reimbursements, timing of the delivery of lease assignments and net acreage shortfalls (some of which disagreements are the subject of our claim against FLMK/Emerald Leasing discussed in "Note 11 - Commitments and Contingencies"), timing and amounts of payments, drilling obligations and drilling schedules, obligations to transfer undrilled acreage to ZaZa prior to lease expiration, and the interpretation of the other rights and obligations of the parties. Accordingly, the parties entered into a Heads of Agreement on June 8, 2012 outlining the terms of a division of assets to dissolve the joint venture, and the parties entered into definitive agreements regarding such division of assets and dissolution of the joint venture on July 25, 2012.

The EDAs for the Hess joint venture required ZaZa LLC to operate the Hess joint venture properties during the first year of drilling, after which Hess had an election to take over operatorship. This provision enabled ZaZa LLC to build an operating track

record during this first year of drilling. As operator of the Hess joint venture, ZaZa LLC successfully drilled and completed 18 Eagle Ford wells. Hess elected to take over operatorship, and the transition from ZaZa LLC to Hess commenced in November 2011 and was expected to be completed in July 2012. In conjunction with the operatorship transition, Hess also made public announcements in the first quarter of 2012 that indicated that they intended to pursue a drilling program in 2012-2013 that was slower than ZaZa LLC had anticipated. The combination of Hess taking over operatorship and the expectation that Hess would slow the drilling program led ZaZa LLC to negotiate an exit from the EDA in July 2012. As a result of this exit, ZaZa LLC relinquished the Cotulla Area and regained operational control of approximately 60% of the venture's former acreage (totaling 72,000 net acres). TEF also exited the Investment Agreement (subject to French regulatory approval), which had stalled due to French governmental regulations. This resulted in the Company converting its 50% working interest to a 5% non-cost bearing revenue interest for up to $130 million in cash receipts. In addition to the aforementioned land transitions, the Company also received $69 million in cash.

Hess Joint Venture Dissolution Agreement

In order to resolve our disagreements with Hess relating to our joint venture, on June 8, 2012, ZaZa, ZaZa LLC, ZaZa Energy France S.A.S. (formerly known as Toreador Energy France S.A.S.)("ZEF"), Hess and Hess Oil France S.A.S. ("Hess France") entered into a Heads of Agreement ("HoA"), that provided for the termination of the ongoing obligations of the parties under the EDAs and the agreements between ZEF and Hess France, including that certain Investment Agreement dated May 10, 2010, as amended, and that certain agreement dated July 21, 2011 with Vermillion REP, S.A.S., (the "French Agreements"), and the division of the assets covered by the EDAs and the French Agreements.

In connection with the execution of the HoA, ZaZa LLC and Hess entered into an amendment to the Exploration and Development Agreement Eagleford Shale Area dated April 28, 2010, as amended, and the applicable joint operating agreements, to eliminate Hess's obligation to carry the cost of the wells under those agreements in the Cotulla Prospect Area, in exchange for a cash payment by Hess to ZaZa LLC of $15 million. This $15 million was paid to ZaZa on June 8, 2012. ZaZa LLC had the right under the amendment to reinstate Hess's well-carry obligations at any time prior to September 28, 2012, if the Exploration and Development Agreement was still in effect, by paying Hess $15 million. Given the uncertainty surrounding the EDA, the proceeds received were recognized as a deferred gain in the second quarter financial statements, contingent on the signing of definitive documentation. The gain was recognized in the third quarter in connection with the termination of the EDA.

On July 25, 2012, the Company and its subsidiaries entered into the definitive documentation to carry out the transactions contemplated by the HoA and consummated the transactions contemplated by the HoA (and such definitive documentation). The definitive documentation included the following:

? A Texas Division of Assets Agreement, by and among the Company, ZaZa LLC and Hess, pursuant to which the ongoing obligations of ZaZa LLC and Hess under the Eagle Ford Agreements, including funding for additional leases, well carry or carry for expenses, were terminated and the assets covered by the Eagle Ford Agreements were divided; and

? A Paris Basin Purchase and Sale Agreement, by and among Hess France and ZEF, pursuant to which, following governmental approval, the ongoing obligations of the parties thereto under the French Agreements, including funding for additional leases, well carry or carry for expenses, were terminated and the assets covered by the French Agreements were divided, in each case following regulatory approval which was obtained on September 19, 2012.

Pursuant to the Texas Division of Assets Agreement and the Paris Basin Purchase and Sale Agreement (collectively, the "Hess Agreements"), ZaZa received the following:

? Approximately $69 million in cash, in addition to the $15 million in the second quarter of 2012;

? Approximately 60,500 additional net acres in the Eagle Ford core area;

? The right to receive five percent of any net sales proceeds in excess of $1 billion and ten percent of any net sales proceeds in excess of $1.2 billion if Hess sells any of its retained working interest in the Cotulla Prospect Area by May 1, 2013; and

? A five percent overriding royalty interest ("ORRI") in certain of Hess's exploration licenses in the Paris Basin capped at $130 million.

As a result of consummation of the transactions set forth in the Hess Settlement Agreements, ZaZa's net acreage holdings in the Eagle Ford core increased from a total of 11,500 acres to approximately 72,000 acres. The acreage by area comprises approximately 1,970 acres in the Cotulla Prospect Area in the proved, productive region of southern Frio County, 23,120 acres in the Hackberry Prospect Area (Lavaca and Colorado Counties), 10,810 acres in the Moulton Prospect Area (Fayette, Gonzalez and Lavaca Counties) and 35,650 acres in the Sweet Home Prospect Area (DeWitt and Lavaca Counties). Following the receipt of the necessary governmental approvals, ZaZa transferred its 50% working interest in the Paris Basin exploration licenses as provided for in the

Investment Agreement between Hess France and ZEF retained a 5% ORRI in such licenses, in which the total proceeds relating thereto to ZaZa are capped at $130 million.

Pursuant to the Hess Agreements, Hess received the following:

? Approximately 4,490 net acres in LaSalle, Frio, Zavala, and Dimmit Counties (the "Cotulla Prospect Area");

? A two percent ORRI on the Moulton Prospect Area and a one percent ORRI in the Hackberry and Sweet Home Prospect Areas; and

All rights and title to the exploration permits and pending permits in France (ZaZa retains all current production in France from its operating concessions).

As described above, in connection with the entry into the Hess Agreements, ZaZa LLC and Hess terminated the Eagle Ford Agreements. Pursuant to the Eagle Ford Agreements, ZaZa LLC retained a 10% working interest in all acreage acquired on behalf of the joint venture in the Eagle Ford shale and also earned a cash bonus of 10% on all acreage acquired on behalf of the joint venture. Under the terms of the joint venture, Hess had a right to participate in all leases acquired by ZaZa LLC in the Eagle Ford shale. If Hess elected to participate in a lease, the lease became part of the joint venture and Hess paid all of the acquisition costs up to a cap, and paid all of the exploration and development costs for a specified number of approved wells on the leased acreage until production. ZaZa LLC also received a partial reimbursement of general and administrative expenses while it was the operator of wells under the joint venture. ZaZa LLC's 10% working interest in each well (subject to a cap) in the joint venture was "carried" by Hess pursuant to the Eagle Ford Agreements.

Pursuant to the Hess Agreements, Hess has assigned to ZaZa certain claims that the joint venture had against various leasing contractors and brokers who had been paid for acreage but had neither delivered the acreage nor refunded the payments. Hess is entitled to 50% of any cash proceeds received by ZaZa in its prosecution of these claims, however, ZaZa is entitled to all of the acreage delivered in kind by the leasing contractors/brokers. ZaZa LLC filed a lawsuit against certain lease brokers, consultants and law firms who were involved in the leasing of acreage for the company in DeWitt and Lavaca Counties, including Emerald Leasing LLC, FLMK Acquisition, LLC, John T. Lewis, Billy Marcum, Brad Massey, Max Smith, Randy Parsley, Timothy E. Malone, Heroux & Helton PLLC, and Whitaker Chalk Swindle & Schwartz PLLC.

In connection with the division of assets, Hess France and ZEF also agreed to terminate the French Agreements. The French Agreements provided the framework for a proof of concept program in the Paris Basin and the sharing on a 50-50 basis of the permits in certain areas in the Paris Basin. As a result of recent legislation in France banning hydraulic fracturing, ZaZa's plan to drill on the land had been adversely affected and the value of the French Agreements had declined. The French Agreements were terminated as of October 1, 2012, following the receipt of the necessary governmental approvals to the transfer and division of the French assets contemplated by the Hess Agreement.

The termination of agreements with Hess and the division of assets resulted in a gain of $197 million consisting of oil and gas property fair valued at $117 million, a write off of $4 million working capital and cash proceeds of $84 million. Property received consisted of producing wells and unproved acreage. All receivables and payables related to Hess were written off.

Note Amendments

On June 8, 2012, ZaZa entered into an amendment and waiver ("Amendment") to the Securities Purchase Agreement dated February 21, 2012 (the "SPA"), relating to our 8% senior secured notes due 2017 (the "Senior Secured Notes"). The Amendment No. 1:

? permitted certain intercompany loans;

? required the consent of the holders of a majority of the Senior Secured Notes to any amendment or termination of the Eagle Ford Agreements or the French Agreements and to dispositions of oil and gas properties (which consent was obtained in connection with the entry into the waiver and Amendment No. 2 to the SPA described below); and

? required certain further amendments to the SPA, which were provided for in the Waiver and Amendment No. 2 to the SPA described below; and

? waives all existing defaults arising under the SPA, including the Company's failure to timely provide financial statements with an unqualified opinion to the holders of the Senior Secured Notes.

The Amendment No.1 was subject to certain conditions, including providing December 31, 2011 annual and March 31, 2012 quarterly financial statements by August 31, 2012 and finalizing and executing definitive documentation related to the HoA by July 31, 2012. These conditions have been satisfied.

In addition, immediately following the closing of the transactions contemplated by the Hess Agreement, and as contemplated by Amendment No. 2, the Company paid down the outstanding principal amount of the Senior Secured Notes by $33.0 million and paid a $3.5 million associated fee. We also recorded a charge of $11.7 million due to the write off of issuance costs and discount amount. Total loss on the extinguishment of debt was $15.2 million.

The parties also entered into an Amended and Restated Subordination Agreement with Todd A. Brooks, a director and President and Chief Executive Officer of the Company, John Hearn, a director and Chief Operating Officer of the Company, Gaston Kearby, a director of the Company, Omega Energy, LLC, Blackstone Oil & Gas, LLC, and Lara Energy, Inc., entities controlled by Messrs. Brooks, Hearn and Kearby, specifying that payments may not be made by the Company under the relevant subordinated promissory notes until after the consummation of the transactions outlined in the HoA and the related $33.0 million pay down of the principal amount of the Senior Secured Notes, which conditions have now been satisfied.

On July 25, 2012, in connection with entry into the definitive documents with Hess contemplated under the HoA, we entered into a Waiver and Amendment No. 2 to the SPA ("Amendment No. 2). Under Amendment No. 2, we paid down the outstanding principal amount of the Senior Secured Notes by $33.0 million and paid a $3.5 million associated fee. Amendment No. 2 also provided waivers of certain technical defaults under the SPA. Amendment No. 2 also provides for:

(a) consent rights for the holders of a majority of the Senior Secured Notes on all sale or joint venture transactions involving oil and gas properties, with certain carveouts and requirements to apply a portion of net sales proceeds to pay down the Senior Secured Notes, until such time as the Senior Secured Notes have an outstanding principal amount of $25 million or less;

(b) a provision that if the Senior Secured Notes have not been paid down to $35 million by February 21, 2013, the interest rate will increase from 8% to 10% per annum;

. . .

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