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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: June 30, 2015

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)

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):

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 July 31, 2015, there were 13,761,084 shares of common stock, par value $0.01 per share, outstanding.

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ZAZA ENERGY CORPORATION

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PART I - FINANCIAL INFORMATION

ITEM 1 - FINANCIAL STATEMENTS

ZAZA ENERGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share data)

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

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ZAZA ENERGY CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

(In thousands, except per share data)

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

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ZAZA ENERGY CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ DEFICIT

(Unaudited)

(In thousands)

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

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ZAZA ENERGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

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

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ZAZA ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 - BASIS OF PRESENTATION

ZaZa Energy Corporation is an independent oil and gas company focused on the exploration and production of unconventional and conventional oil and gas assets.  We currently operate primarily through joint ventures in the Eagle Ford East trend in East Texas and the Eagle Ford trend in South Texas.  Our common stock is traded on the NASDAQ Capital Market under the trading symbol ZAZA.  In this Quarterly Report on Form 10-Q, unless the context provides otherwise, “we”, “our”, “us” and like references refer to ZaZa Energy Corporation and its subsidiaries.

During interim periods, ZaZa follows the same accounting policies disclosed in its Annual Report on Form 10-K for the year ended December 31, 2014 (“Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”). The interim financial statements should be read in conjunction with the notes to the consolidated financial statements and information presented in the Form 10-K. In management’s opinion, the accompanying interim consolidated financial statements contain all material adjustments, consisting only of normal recurring adjustments, necessary for a fair statement. The results for any interim period are not necessarily indicative of the expected results for the entire year.

All material intercompany accounts and transactions have been eliminated in consolidation.

April 2015 Financing

As part of our efforts to raise additional funds, on April 30, 2015, ZaZa closed the April 2015 Financing for $2.5 million in gross proceeds. Under the terms of the April 2015 Financing, ZaZa sold an aggregate of 2,500 shares of Series A 5% Convertible Preferred Stock (the “Preferred Stock”) at a stated price of $1,000 per share, and warrants to purchase an aggregate of 1,875,000 shares of common stock at an exercise price of $2.25 per share (the “April 2015 Warrants”). The Preferred Stock sold is convertible into an aggregate of 2,500,000 shares of common stock at a ratio equal to approximately 1,000 shares of the Company’s common stock for each share of Preferred Stock.  Net proceeds from the April 2015 Financing, following the payment of all expenses related thereto, were approximately $2.1 million. See further discussion at Note 7 – Preferred Stock and Warrants.

East Texas Joint Venture with EOG

On March 21, 2013, we entered into a Joint Exploration and Development Agreement (the “JEDA”) with EOG Resources, Inc. (“our counterparty” or “EOG”) for the joint development of certain of our East Texas properties located in Walker, Grimes, Madison, Trinity, and Montgomery Counties, Texas.  As of June 30, 2015, approximately 130,000 gross acres of the joint venture in East Texas were subject to this agreement and its subsequent amendments.  Our counterparty acts as the operator, has paid us certain cash amounts, has borne 100% of the drilling and completion costs of certain specified wells, and has paid a portion of our share of additional seismic or well costs in order to earn its interest in these properties per the JEDA terms.  Initially, ZaZa has retained a 25% working interest and our counterparty has earned a 75% working interest in the acreage.  This joint development was originally divided into several phases.  Please refer to our Annual Report on Form 10-K for the year ended December 31, 2014 for additional detail and discussion surrounding each individual phase.

In December 2014, EOG satisfied the last of its drilling obligations under the JEDA.  While selected JEDA provisions survive, the joint venture is now principally governed by the Joint Operating Agreement among EOG, ZaZa, and Quantum (the “Joint Operating Agreement”).  Pursuant to its terms, ZaZa now has the right to propose new development wells, workovers, and maintain its desired minimum drilling pace.

On July 28, 2015, we received a notice from our counterparty claiming that we were in default on joint interest billings for a total amount of $3,174,692 relating to operations conducted pursuant to the Joint Operating Agreement.  Our counterparty advised us in the notice that it will retain all revenues due to ZaZa and will apply those retained revenues against the amount owed.  Under the Joint Operating Agreement, if the default is not cured within thirty days, our counterparty may suspend all of our rights under the Joint Operating Agreement, including the right to receive proceeds and participate in future operations, until the default is cured, file suit for damages, deem that we have non-consented in any operation for which our portion of the costs remain unpaid or require advance payment of future joint interest billings.  Certain of these remedies, if exercised, could result in the temporary or permanent loss of all or a portion of our interest in our joint venture in East Texas.  In addition, our counterparty may be able to exercise remedies with respect to the customary security interest granted in each party’s interest in the assets covered by the Joint Operating Agreement to secure obligations owed under the Joint Operating Agreement.  Even if we are able to cure the default, if we are subsequently unable to raise a sufficient amount of cash to pay our portion of costs associated with the ongoing drilling program, we would be subject to customary non-consent penalties on an individual well by well basis with respect to any wells in which we are unable to participate, which would result in the loss of a significant portion of any future revenue derived from such non-consent wells.  Similarly, if the Company is unable to fund renewals of expiring leases, it could lose portions of its acreage.

East Texas Joint Venture with Quantum

On September 18, 2014, ZaZa and an affiliate of Quantum Energy Partners (“Quantum”) closed the Purchase and Sale Agreement originally entered into on August 21, 2014 (the “Quantum Purchase and Sale Agreement”). The Quantum Purchase and Sale Agreement was amended by Amendment No. 1 to Quantum Purchase and Sale Agreement, dated September 16, 2014 (“Quantum Amendment No.1”), to allow Quantum to assign its rights under the Purchase and Sale Agreement to a different affiliate and to address other technical matters. The Company also entered into an East Texas Development Agreement, dated September 18, 2014, by and between ZaZa and Quantum (the “Quantum Development Agreement”).  The Quantum Development Agreement establishes an area of mutual interest for future acreage acquisitions in Walker, Grimes, Madison, Trinity and Houston counties in Texas. The

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Quantum Purchase and Sale Agreement, Quantum Amendment No.1 and the Quantum Development Agreement are collectively referred to as the “Quantum Agreements.” Pursuant to the terms of the Quantum Agreements:

·                  ZaZa assigned to Quantum an approximately 4 percent working interest (6,000 of ZaZa’s net acres) in undeveloped leases within ZaZa’s East Texas joint venture.  ZaZa retained its interest in all existing wells in the East Texas joint venture and is reserving the right to participate with respect to Quantum’s working interest in the next 15 East Texas joint venture wells that are spudded, drilled and completed after the closing of the Quantum transaction, as long as those wells are spudded, drilled and completed on or before the second anniversary of the closing of the transaction (the “Reserved Wells”).

·                  ZaZa received $11 million in cash as initial consideration and the right to receive Quantum’s interest in certain of the Reserved Wells.

·                  ZaZa will receive ongoing G&A and cost reimbursements from Quantum for providing services related to their jointly owned assets in Walker, Grimes, Madison, Trinity, and Houston counties.

·                  Quantum has the right to cause ZaZa to purchase Quantum’s interest in the jointly owned assets on an all or nothing basis for a cash price based on Quantum’s initial consideration paid of $11 million plus any out-of-pocket cost of acquiring and renewing leases under the Quantum Agreements on September 17, 2016 (the “Quantum Put Option”).

Following the closing of these Quantum Agreements, ZaZa’s East Texas acreage holdings comprise two separate development areas, each with different operators and ownership structures:

·                  Madison, Walker, and Grimes Counties. The Madison-Walker-Grimes Development Area comprises approximately 130,000 gross acres of the East Texas joint venture and is operated by EOG. ZaZa holds an approximately 21% working interest, or approximately 31,000 net acres and Quantum holds and approximately 4% working interest, or 5,000 net acres in this area. During the next two years, ZaZa has the option to participate for both its and Quantum’s working interest—for a total of a 25% working interest to ZaZa—in the next 15 wells drilled within the Madison-Walker-Grimes Development Area. ZaZa also retained its full 25% working interest in all wells spudded prior to the closing of the Quantum Agreements.

·                  Houston, Trinity, and Leon Counties. The Houston-Trinity-Leon Development Areas comprises approximately 10,000 net acres and is operated and owned 100% by ZaZa. This acreage is not subject to the Quantum Agreements.

Working interests in 6,000 net acres were sold and assigned to Quantum on September 18, 2014.  U.S. generally accepted accounting principles (“U.S. GAAP”) prevents sale accounting due to the Quantum Put Option. Accordingly, the related oil and gas properties continue to be included in the consolidated balance sheet, and a liability was recorded for the Quantum Put Option in an amount equal to Quantum’s initial cash payment of $11 million. Quantum’s out of pocket costs that are incurred subsequent to the initial $11 million represent contingent liabilities and will be recorded as a liability when and if payment becomes probable. As of June 30, 2015, this contingent liability totaled approximately $0.1 million.  The Quantum transaction did not have any impact on revenue, income from continuing operations, net income, or income per share.

NOTE 2 — GOING CONCERN

Our independent registered public accounting firm for the year ended December 31, 2014 issued its report dated March 31, 2015, 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 working capital deficiency and inability to generate sufficient cash flows to fund operations and meet debt service requirements.

Pursuant to an agreement with the holders of our 10% Senior Secured Notes due 2017 (the “Senior Secured Notes”), the Company was required to repurchase on July 15, 2015 all of the Senior Secured Notes at a price equal to the $13.9 million in principal amount, plus any accrued and unpaid interest and fees (the “Senior Secured Notes Prepayment”).  The Company did not have sufficient cash or cash equivalents as of July 15, 2015 to complete the Senior Secured Notes Prepayment.  The Company’s inability to complete the Senior Secured Notes Prepayment was an “Event of Default” under the Senior Secured Notes Purchase Agreement.  Such “Event of Default” gives each holder of Senior Secured Notes the ability, with proper notice, to accelerate the debt represented by such holder’s Senior Secured Notes.  This “Event of Default” also creates a cross-default under the indenture (the “Convertible Senior Notes Indenture”) governing the Company’s 9.00% Convertible Senior Notes due 2017 (the “Convertible Senior Notes”) and gives the holders of the Convertible Senior Notes the ability, with proper notice, to accelerate the debt associated with the Convertible Senior Notes.  This cross-default under the Convertible Senior Notes Indenture creates another “Event of Default” under the Senior Secured Notes Purchase Agreement that gives the right to holders of a majority in principal amount of the Senior Secured Notes outstanding to accelerate the entirety of the debt represented by the Senior Secured Notes.  As of the time of filing of this Quarterly Report on Form 10-Q, the Company has not received notice of acceleration from any of the holders of the Senior Secured Notes or the holders of the Convertible Senior Notes.  If the acceleration of any of our debt were to occur, it is unlikely that we would be able to continue as a going concern and we may be forced to declare, or we may be forced into, bankruptcy.  The Company is continuing to work with the holders of the Senior Secured Notes and the Convertible Senior Notes to develop a solution to its liquidity challenges.  However, there can be no assurance that a mutually acceptable resolution will be agreed to.

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Even without considering the Senior Secured Notes Prepayment, the Company will need to access additional capital to continue as a going concern through the third quarter of 2015.  As of June 30, 2015, we had $0.5 million in cash and cash equivalents and working capital deficit of approximately $55 million (of which $13.9 million related to our Senior Secured Notes and $32.5 million related to our Convertible Senior Notes).  Over the next year, we anticipate monthly cash general and administrative expenses to average approximately $0.4 million per month.

Any action or transaction the Company undertakes to address its liquidity challenges may result in significant changes to the Company’s capital structure, the disposition of material assets, and adjustments to its balance sheet.  These changes may adversely affect the holders of ZaZa common stock through dilution or loss in value.

These matters raise substantial doubt about the Company’s ability to continue as a going concern.  Our only anticipated methods of fully funding our cash requirements are through changes to our debt arrangements, debt and equity financing activities, asset monetization or the curtailment of capital expenditures.  To date, we have not entered into any definitive documentation for any such transactions, and no such transactions have been consummated.  We will continue to search for possible transactions, but no assurances can be given that such transactions can be consummated on terms that are acceptable to the Company, or at all.

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 consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

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 this entity may be similarly affected by changes in economic or other conditions. The Company has incurred no losses related to these accounts.

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, which have historically been and currently continue to be immaterial, 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.

Successful Efforts Method of Accounting for Oil and Gas Activities

The Company accounts for its oil and gas 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 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 reserves are not discovered, such drilling costs are expensed. In some circumstances, it may be uncertain whether proved 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.

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The Company’s third party engineers estimate proved oil and gas reserves, which directly impact financial accounting estimates, including depreciation, depletion, and amortization and impairment considerations. 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.

Depreciation, depletion, and amortization of the cost of proved oil and gas properties are calculated using the unit-of-production method. The reserve base used to calculate depreciation, depletion, and amortization for leasehold acquisition costs is the sum of proved developed reserves and proved undeveloped reserves. With respect to lease and well equipment costs, which include development costs and successful exploration drilling costs, the reserve base includes only proved developed reserves. Estimated future dismantlement, restoration, and abandonment costs, net of salvage values are taken into account.

Unit-of-production rates are revised whenever there is an indication of a need, but at least annually. When circumstances indicate that an asset may be impaired, the Company compares expected undiscounted future cash flows at a producing field level to the net book value 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 net book value, 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.

Income (Loss) Per Common Share

Basic income (loss) per share is calculated by dividing net income (loss) available for common shareholders by the weighted average number of common shares outstanding for the period.

Diluted income (loss) per share reflects the potential dilutive effect of unvested share-based payments, warrants and debt instruments that can be converted into common stock. We use the treasury stock method to compute potential common shares from unvested share-based payments and warrants and the if-converted method to compute potential common shares from convertible notes. When a net loss occurs, potential common shares have an anti-dilutive effect on loss per share and are excluded from the diluted loss per share calculations.

Recent Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Updates (“ASU”) No. 2014-09, “Revenue from Contracts with Customers (Topic 606)”. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle of the guidance is that a company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. On July 9, 2015, the FASB announced that it had decided to delay the ASU’s effective date.  It is now expected this ASU will become effective beginning in fiscal year 2018 and can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption, with early adoption permitted at the Company’s election for fiscal year 2017. The Company is currently evaluating the effect that adopting this guidance will have on its financial position, results of operations or cash flows and has not yet determined the transition method it will use.

In June 2014, the FASB issued ASU No. 2014-12, “Compensation — Stock Compensation (Topic 718)”. This update amends current guidance for stock compensation tied to performance targets. The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition and apply existing guidance in Topic 718 as it relates to awards with performance conditions that affect vesting to account for such awards. ASU 2014-12 will be effective for interim and annual periods beginning after December 15, 2015 with early adoption permitted. The adoption of ASU 2014-12 is not expected to have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

In August 2014, the FASB issued ASU No. 2014-15, “Presentation of Financial Statements — Going Concern (Subtopic 205-40)”. This update defines management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. This ASU provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures in the financial statement footnotes. ASU 2014-15 will be effective for interim and annual periods beginning after December 15, 2016 with early adoption permitted. We are currently evaluating the provisions of this ASU and assessing the impact, if any, it may have on our financial statement footnotes.

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In November 2014, the FASB issued ASU No. 2014-16, “Derivatives and Hedging (Topic 815)”.  This update clarifies how current guidance should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share.  ASU 2014-16 will be effective for interim and annual periods beginning after December 15, 2015 with early adoption permitted.  The adoption of ASU 2014-16 is not expected to have an impact on the Company’s consolidated financial position, results of operations or cash flows.

In April 2015, the FASB issued ASU No. 2015-03, “Interest — Imputation of Interest (Subtopic 835-30)”.  This update requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability, consistent with debt discounts or premiums.  This accounting standards update is effective for public entities with financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years with early adoption of the amendment permitted.  We are currently evaluating the provisions of this ASU and assessing the impact, if any, it may have on our financial statements.

In April 2015, the FASB issued ASU No. 2015-05, “Internal-Use Software (Subtopic 350-40)”.  This update requires customers to determine whether a cloud computing arrangement includes a software license, utilizing the same guidance cloud service providers apply to determine whether they are selling a license to software or providing a service. This accounting standards update is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015 with early adoption of the amendment permitted.  We are currently evaluating the provisions of this ASU and assessing the impact, if any, it may have on our financial statements.

NOTE 4 — LOSS PER COMMON SHARE

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

For the three and six months ended June 30, 2015, the calculations of diluted loss per common share did not include the anti-dilutive effects attributable to the following: (a) 0.7 million unvested restricted stock, (b) 0.3 million options and 5.6 million warrants, and (c) 1.6 million common equivalent shares from the embedded convertible options associated with the Convertible Senior Notes.

For the three and six months ended June 30, 2014, the calculations of diluted loss per common share did not include the anti-dilutive effects attributable to the following: (d) 0.9 million unvested restricted stock, (e) 2.8 million warrants, and (f) 1.6 million common equivalent shares from the embedded convertible options associated with the Convertible Senior Notes.

NOTE 5 —INCOME TAXES

We are subject to income taxes primarily in the United States. 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. 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 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.

The following table reconciles income tax expense/(benefit) at the U.S. federal statutory rate to the expense/(benefit) for income taxes (in thousands):

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Income tax for the three months ended June 30, 2015 and 2014 was an expense of $0.3 million and a benefit of $5.3 million, respectively. The income tax expense for the three months ended June 30, 2015 of $0.3 million is different from the statutory tax benefit (at a rate of 35%) of $2.8 million due to increases in the valuation allowance. The income tax benefit for the three months ended June 30, 2014 of $5.3 million is different from the statutory tax benefit (at a rate of 35%) of $5.0 million due to permanent differences related to the gain on the warrants and a reduction in the valuation allowance.

Income tax for the six months ended June 30, 2015 and 2014 was an expense of $0.3 million and a benefit of $6.5 million, respectively.  The income tax expense for the six months ended June 30, 2015 of $0.3 million is different from the statutory tax benefit (at a rate of 35%) of $5.2 million due to increases in the valuation allowance.  The income tax benefit for the six months ended June 30, 2014 of $6.5 million is different from the statutory tax benefit (at a rate of 35%) of $5.9 million due to permanent differences related to the gain on warrants and a reduction in the valuation allowance.

We have approximately $107 million in gross net operating losses. As a result of the lack of positive evidence at the consolidated level, we recorded a valuation allowance to offset a portion of the deferred tax assets.

We have $16.4 million of uncertain tax positions.  As of June 30, 2015 and December 31, 2014, the Company has NOLs available for carryback that exceed the $16.4 million of unrecognized tax benefit.  As such, the unrecognized tax benefit is presented as a reduction of the NOLs, resulting in no liability on the consolidated balance sheet as of June 30, 2015 and December 31, 2014. We are not able to reasonably estimate the period in which settlement related to the $16.4 million of uncertain tax positions could occur, if at all.

NOTE 6 — FAIR VALUE MEASUREMENTS

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 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, embedded conversion options and debt. 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, and accounts payable approximate fair value, due to the short-term nature or maturity of the instruments.

The Senior Secured Notes and Subordinated Notes were valued under the income approach using discounted cash flows.  The Convertible Senior Notes and embedded conversion option were valued using a Binomial Lattice Model designed to capture incremental value attributed to the conversion options in addition to the value of the note. The warrants issued in association with the Senior Secured Notes (the “Senior Secured Notes Warrants”) and April 2015 Financing were valued as written call options using a Binomial Lattice Model.

Cash flows were discounted utilizing the U.S. Treasury rate and our credit spread to estimate the appropriate risk adjusted rate.  A Binomial Lattice Model was used to estimate our credit spread by solving for a premium to the U.S. Treasury rate that produces a value of the Convertible Senior Notes.  The fair value measurements are considered Level 3 measurements within the fair value hierarchy.

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The following tables summarize the valuation of our liabilities measured on a recurring basis at levels of fair value at June 30, 2015 and December 31, 2014 (in thousands):

The following is a reconciliation of changes in fair value of our liabilities classified as Level 3 during the six months ended June 30, 2015 and 2014 (in thousands):

On June 30, 2015, the Senior Secured Notes, which had a book value of $13.9 million, had a fair value of approximately $14.8 million.  An increase in the credit spread by 500 basis points results in $0.02 million decrease to the aggregate fair value of those notes.

On June 30, 2015, the Convertible Senior Notes, which had a book value of $32.5 million (net of unamortized discount of $7.5 million), had a fair value of approximately $33.3 million.  An increase in the credit spread by 500 basis points results in a $0.03 million decrease in the aggregate fair value of those notes.

On June 30, 2015, Subordinated Notes, which had a book value of $49.3 million, had a fair value of approximately $49.0 million.  An increase in the credit spread by 500 basis points results in a $0.08 million decrease in the aggregate fair value of those notes.

As of June 30, 2015, an increase in the volatility by 5% results in a $0.1 million and $0.04 million increase in the fair values of the warrants and embedded conversion options, respectively.

NOTE 7 — PREFERRED STOCK AND WARRANTS

As part of our efforts to raise additional funds, on April 30, 2015, ZaZa closed the April 2015 Financing for $2.5 million in gross proceeds. Under the terms of the April 2015 Financing, ZaZa sold an aggregate of 2,500 shares of Series A 5% Convertible Preferred Stock (the “Preferred Stock”) at a stated price of $1,000 per share, and warrants to purchase an aggregate of 1,875,000 shares of common stock at an exercise price of $2.25 per share (the “April 2015 Warrants”). The shares of Preferred Stock issued at closing were initially convertible into an aggregate of 2,500,000 shares of common stock at a ratio equal to approximately 1,000 shares of the Company’s common stock for each share of Preferred Stock.  Net proceeds from the April 2015 Financing, following the payment of all expenses related thereto, were approximately $2.1 million.

The April 2015 Warrants will first be exercisable on October 30, 2015 and will have a 5 year term, starting on the date that the warrants first become exercisable.  If the Company issues shares of common stock for certain purposes at any time prior to October 30, 2015, the exercise price of the April 2015 Warrants may be adjusted to maintain an aggregate value of $2,250,000, which is the agreed-upon Black Scholes value as of the issuance date, unless the exercise price of the warrants has been adjusted as a result of issuances for such purposes to a price that the holder of the warrants deems to be more favorable, in which case the holder may elect to retain the previously adjusted price.  Such purposes would include issuances of common stock to the holders of the

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Company’s 8.00% Subordinated Notes due 2017 or to the holders of the Company’s 9.00% Convertible Senior Notes due 2017 as part of a transaction to extinguish such debt or issuances of common stock by the Company to satisfy the Company’s obligations under those reimbursement agreements, dated September 11, 2012, by and between the Company and the parties thereto.

The terms of the April 2015 Warrants provide that if the Company effects a fundamental transaction, then upon any subsequent exercise of a warrant, the holder thereof will have the right to receive, for each share of common stock that would have been issuable upon such exercise immediately prior to the occurrence of such fundamental transaction, the number of shares of the successor’s or acquiring corporation’s common stock or of the Company’s common stock, if the Company is the surviving corporation, and any additional consideration receivable as a result of such fundamental transaction by a holder of the number of shares of common stock for which the warrant is exercisable immediately prior to such fundamental transaction.

The warrants also contain a call provision that grants the Company the ability to call for cancellation of all unexercised warrants for a price equal to $1.60 per share of the initial shares of common stock underlying each warrant, or an aggregate of $3 million for all warrants issued under the Purchase Agreement.  The Company may exercise this right only during the period that begins on the 181st day following the date of issuance and ends on the 270th day following the date of issuance, subject to certain additional conditions as set forth in the warrant (including possible extensions if certain other conditions are met).

The April 2015 Financing transaction required that we recognize both a derivative warrant liability and preferred equity at the time of issuance.  We assessed the value of the April 2015 Warrants at the time of issuance at $1.5 million and recorded a liability for this amount and allocated the remaining net proceeds of $0.6 million to the Preferred Stock.  Because the Preferred Stock can be redeemed upon the occurrence of certain redemption events not within our control, we are required to present the Preferred Stock as mezzanine equity in the consolidated balance sheet.   Furthermore, as the conversion of the Preferred Stock was in-the-money at the time of issuance, we were also required to recognize a beneficial conversion feature totaling approximately $1.0 million which was immediately accreted via a deemed dividend in the second quarter of 2015. 

During the second quarter of 2015, 550 Preferred Stock shares were converted into 550,000 shares of common stock.  As of June 30, 2015, 1,950 Series A 5% Convertible Preferred Stock shares remain outstanding.

NOTE 8 — 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 2015, non-producing leasehold costs in South Texas with carrying values of approximately $0.4 million were written down to their fair value of zero, resulting in pretax impairment charges of $0.4 million.  The decline in fair value of these non-producing leases is driven by the expiration of existing leases in South Texas.  There were no impairments in the first quarter of 2015.

In the second quarter of 2014, non-producing leasehold costs in South Texas with carrying values of $1.5 million were written down to their fair value of zero, resulting in pretax impairment charges of $1.5 million.  The decline in fair value of these non-producing leases is driven by the expiration of existing leases in South Texas.  In the first quarter of 2014, non-producing leasehold costs in South Texas with carrying values of $2.4 million were written down to their fair values of $0.8 million, resulting in pretax impairment charges of $1.6 million. The declines in fair value of these non-producing leases were driven by shorter remaining lease terms.

NOTE 9 — ASSET RETIREMENT OBLIGATIONS

The following table summarizes the changes in our asset retirement liability during the six months ended June 30, 2015 and 2014 (in thousands):

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NOTE 10 — LONG-TERM DEBT

As described in more detail in our 2014 Annual Report on Form 10-K, our long-term debt includes 10.00% Senior Secured Notes due 2017 (“Senior Secured Notes”), 9.00% Convertible Senior Notes due 2017 (“Convertible Senior Notes”), and 8.00% Subordinated Notes due 2017 (“Subordinated Notes”).

Our long-term debt consisted of the following (in thousands):

(1)                     The Senior Secured Notes issuance discount was fully amortized as of June 30, 2015.

(2)                     The Convertible Senior Notes issuance discount is amortized through maturity on August 1, 2017 using the effective interest rate method and a rate of 18.0%.

(3)                     We classified $13.9 million and $13.6 million of our Senior Secured Notes as current as of June 30, 2015 and December 31, 2014, respectively, consisting of principal of $13.9 million and discount of $0.0 million and $0.3 million, respectively, pursuant to the Senior Secured Notes Purchase Agreement described below, which gave the holders of the Senior Secured Notes the right to require us to purchase all or a portion of the Senior Secured Notes beginning July 15, 2015.  Additionally, because the default under the Senior Secured Notes was in excess of $10 million, a default under the indenture that governs our Convertible Senior Notes occurred at the same time. Furthermore, on August 1, 2015, ZaZa failed to make the required semiannual interest payment on our Convertible Senior Notes giving rise to defaulted interest equal to 2.0% per annum in excess of the currently applicable rate of 9.00% per annum.  If the interest payment is not made within 30 days, there will be an “Event of Default” under the Convertible Senior Notes Indenture causing the debt due there under to accelerate. Accordingly, we have also presented the Convertible Senior Notes as current as of June 30, 2015, consisting of principal of $40 million and discount of $7.5 million.

10.00% Senior Secured Notes due 2017 and Warrants

The Senior Secured Notes were issued under a Senior Secured Notes Purchase Agreement, dated February 21, 2012 (as amended, the “Senior Secured Notes Purchase Agreement”) and will mature on February 21, 2017 (subject to an early prepayment requirement as described below).  The Senior Secured Notes are guaranteed by all of our subsidiaries and secured by a first-priority lien on substantially all of our assets and of our domestic subsidiaries.

Pursuant to the Senior Secured Notes Purchase Agreement, the purchasers of our Senior Secured Notes were also issued warrants that were originally exercisable for 26,315,789 shares of our common stock at an exercise price of $3.15 per share (the “Senior Secured Warrants”). Due to various transactions in prior periods having triggered anti-dilution adjustments in the Senior Secured Notes Warrants and considering the impact of the reverse stock split, as of June 30, 2015, the number of outstanding shares of common stock represented by the Senior Secured Notes Warrants was 3,764,017 with an exercise price of $1.94 per share. The Senior Secured Notes Warrants expire on August 21, 2020.

Effective as of February 24, 2015, the Company entered into Amendment No. 7 to the Senior Secured Notes Purchase Agreement. Prior to Amendment No. 7, the Senior Secured Notes Purchase Agreement provided that each holder of Senior Secured Notes had the right, beginning on February 21, 2015, to give notice to the Company, requiring the Company to repurchase up to 100% of such Purchaser’s Senior Secured Notes at par plus accrued and unpaid interest (the “Senior Secured Notes Put Option”). The Company would have had 60 days after such notice to repurchase any such Senior Secured Notes.  Amendment No. 7 amended the Senior Secured Notes Purchase Agreement to delay the earliest date that any noteholder could exercise the Senior Secured Notes Put Option by 30 days (from February 21, 2015 to March 23, 2015).  Amendment No. 7 also contained a corresponding decrease from 60 days to 30 days of the time period afforded to the Company to complete the repurchase of the Senior Secured Notes of any holder that exercises its rights in accordance with the terms of Senior Secured Notes Put Option.

On April 6, 2015, the holders of the Senior Secured Notes began to exercise the Senior Secured Notes Put Option resulting in a requirement for the Company to repurchase on May 6, 2015 substantially all of the $13.9 million in principal amount of the Senior Secured Notes plus accrued and unpaid interest.

Effective April 21, 2015, the Company entered into Amendment No. 8 to the Senior Secured Notes Purchase Agreement (“Amendment No. 8”) that effectively substituted the Senior Secured Notes Put Option that was due on May 6, 2015 with a direct requirement for the Company to complete the Senior Secured Notes Prepayment on or before May 29, 2015, for an amount equal to the outstanding principal amount plus accrued and unpaid interest through the date of repurchase.  As consideration for this extension, the Company agreed to pay each holder, on the repayment date, an amendment fee in an amount equal to 3% of the aggregate outstanding principal amount of such holder’s Senior Secured Notes for a total of $0.4 million and the exercise price for the Senior Secured Notes Warrants was lowered from $15.96 per share to $2.50 per share.

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On April 23, 2015, the Company executed Amendment No. 9 to the Senior Secured Notes Purchase Agreement (“Amendment No. 9”) with the majority of the holders of the Senior Secured Notes in order to waive and consent to any breach by the Company resulting from the issuance of “Disqualified Stock” and any other restrictive covenants under the Senior Secured Notes Purchase Agreement in respect of the April 2015 Financing.

On May 29, 2015, the Company completed execution of a consent (the “May 2015 Consent”) with the holders of the Senior Secured Notes to extend the date of the Senior Secured Notes Prepayment from May 29, 2015 to June 30, 2015.  As consideration for the extension, the Company agreed to pay each of the holders a cash consent fee equal to an additional 3% of the aggregate outstanding principal amount of the Senior Secured Notes.

On June 30, 2015, the Company completed execution of a second consent (the “June 2015 Consent”) with the Purchasers to extend the date of the Senior Secured Notes Prepayment from June 30, 2015 to July 15, 2015.  The Company did not have sufficient cash or cash equivalents as of July 15, 2015 to complete its repurchase obligations to the holders of the Senior Secured Notes and this resulted in an “Event of Default” under the Senior Secured Notes Purchase Agreement.  Though an “Event of Default” has occurred, the holders of such debt have not yet accelerated the indebtedness nor demanded immediate payment via other legal remedies.  If the acceleration of any of our debt were to occur, it is unlikely that we would be able to continue as a going concern and we may be forced to declare, or we may be forced into, bankruptcy.  If there are any overdue interest payments or during periods in which an event of default under the Senior Secured Notes Purchase Agreement has occurred and is continuing, the annual rate of interest will increase to the greater of 3% per annum in excess of the non-default interest rate and 10.00% over the yield to maturity for 10-Year United States treasury securities. Thus, the interest rate on Senior Secured Notes increased on July 16, 2015 to 13.00% per annum.

Effective as of August 5, 2015, the Company entered into Amendment No. 10 to the Senior Secured Notes Purchase Agreement (“Amendment No. 10”), which permits the Company to issue additional Senior Secured Notes in an aggregate principal amount not to exceed $500,000. Amendment No. 10 required that any such additional note would be issued solely for cash in an amount equal to 100% of the principal amount of the notes. In accordance with Amendment No. 10, effective as of August 5, 2015, the Company issued an aggregate of $374,000 in principal amount of additional Senior Secured Notes (the “August 2015 Notes”) in equal amounts to Jubalee Ltd. (an affiliate of John E. Hearn, Jr., a director of the Company) and Todd A. Brooks, the Company’s Executive Director, President and Chief Executive Officer. Each of the purchasers of the August 2015 Notes also entered into a Supplement to Securities Purchase Agreement, each dated as of August 5, 2015, under which the note purchaser agreed to be bound by and to comply with the terms and provisions of the Senior Secured Notes Purchase Agreement in connection with the issuance of the August 2015 Notes. Mr. Brooks and Jubalee Ltd. also executed joinders to that Collateral Agency Agreement, dated as of February 21, 2012, among U.S. Bank, the Company, its domestic subsidiaries and the Purchasers.

The terms of the August 2015 Notes are identical to the terms of the currently outstanding Senior Secured Notes. Thus, the August 2015 Notes bear interest at a rate of 10.00% per annum (as adjusted for the Events of Default described below), mature on February 21, 2017, are guaranteed by all of our subsidiaries and are secured by a first-priority lien on substantially all of our assets and those of our domestic subsidiaries. To the extent such assets include stock of any foreign subsidiaries, only 65% of such foreign subsidiary stock is to be pledged as security for the August 2015 Notes. The August 2015 Notes (along with the Senior Secured Notes) rank senior to all of our other debt and obligations. We are subject to certain affirmative and negative covenants pursuant to the August 2015 Notes, including, without limitation, restrictions on our and our subsidiaries’ abilities to incur additional debt, pay dividends or make other distributions, redeem stock, make investments, incur liens, enter into transactions with affiliates, merge or consolidate and transfer or sell assets, in each case subject to certain baskets and carve-outs.

Because the Event of Default was still continuing as of the date of issuance of the August 2015 Notes, the interest rate on the August 2015 Notes as of the time of issuance immediately increased to 13.00% per annum. Shortly after the purchasers of the August 2015 Notes acquired those newly-issued notes from the Company, they also acquired all already-outstanding Senior Secured Notes that were then owned by Talara Master Fund Ltd. (“Talara”) and Blackwell Partners, LLC (“Blackwell”). Mr. Brooks acquired the approximately $174,000 in principal amount of the Senior Secured Notes held by Talara, and Jubalee Ltd. acquired the approximately $299,000 in in principal amount of the Senior Secured Notes held by Blackwell. The proceeds for those purchases of existing notes were paid to the noteholders, not to the Company.

9.00% Convertible Senior Notes due 2017

As of June 30, 2015, the Company had $39,981,000 aggregate principal amount of Convertible Senior Notes. The Convertible Senior 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 Senior Notes are convertible, at the option of the holder, at any time prior to the third trading 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 reverse stock split adjusted conversion rate is 40.0052 shares per $1,000 Convertible Senior Notes which equated to an initial conversion price of $25.00 per share.

In the first and second quarters of 2015, $19,000 of Convertible Senior Notes was exchanged for into 13,533 shares of common stock thereby reducing the aggregate principal amount of Convertible Senior Notes from $40,000,000 to $39,981,000 as of June 30, 2015. The Convertible Senior Notes were converted into common shares at a 20% discount to market and the Company recognized a loss on extinguishment of debt of $6 thousand.

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Because of the default with respect to the Senior Secured Notes, there is also an “Event of Default” under the indenture that governs our Convertible Senior Notes (the “Convertible Senior Notes Indenture”). Accordingly, we have presented the Convertible Senior Notes as current as of June 30, 2015.  The Event of Default under the Convertible Senior Notes Indenture gives the holders of the Convertible Senior Notes the ability, with proper notice, to accelerate the debt associated with the Convertible Senior Notes. As of the date of filing this Quarterly Report on Form 10-Q, we have not received any notice of acceleration of the debt associated with the Convertible Senior Notes.  If the acceleration of the Convertible Senior Notes were to occur, it is unlikely that we would be able to continue as a going concern and we may be forced to declare, or we may be forced into, bankruptcy.

At June 30, 2015 and December 31, 2014, the unamortized issuance discount related to Convertible Senior Notes was $7.5 million and $9.1 million, respectively.  At June 30, 2015 and December 31, 2014, the unamortized debt issuance costs related to the Convertible Senior Notes was $1.4 million and $1.6 million respectively.  The outstanding principal on the Convertible Senior Notes was $40 million at both June 30, 2015 and December 31, 2014.

8.00% Subordinated Notes due 2017

In February 2012, we issued Subordinated Notes in an aggregate amount of $47.3 million to Todd A. Brooks (President and Chief Executive Officer of the Company) and Blackstone Oil & Gas, LLC (an entity controlled by Mr. Brooks) (together, the “Brooks Note Holders”), (b) John E. Hearn, Jr. (a Director of the Company) and Lara Energy, Inc. (an entity controlled by Mr. Hearn) (together, the “Hearn Note Holders”) and (c) Gaston L. Kearby (a Director of the Company) and Omega Energy Corp. (an entity controlled by Mr. Kearby) (together, the “Kearby Note Holders,” and collectively with the Brooks Note Holders and the Hearn Note Holders, the “Subordinated Note Holders”). The Subordinated Notes accrue interest at a rate of 8% per annum payable monthly in cash, and mature on August 17, 2017.

On February 24, 2014, the Company entered into Exchange Agreements (the “Exchange Agreements”) to exchange an aggregate of $47.3 million in 8.00% Subordinated Notes due 2017 for a combination of shares of common stock of the Company and shares of a new series of preferred stock of the Company. The Exchange Agreements were amended and superseded by the Subordinated Note Modification Agreements with each of the Subordinated Note Holders (the “Modification Agreements”) on January 19, 2015. The Modification Agreements provide that, instead of exchanging the Subordinated Notes for common stock and preferred stock of the Company, all interest payments to the Subordinated Note Holders will be paid in kind.

Simultaneously with the execution of the Modification Agreements, each Subordinated Note Holder surrendered his or its Subordinated Note effective as of January 19, 2015 in exchange for a replacement subordinated note (each, a “First Amended and Restated Subordinated Note”). The First Amended and Restated Subordinated Notes provide that interest payments will be paid in kind as additional principal beginning with the first interest payment due with respect to interest that accrues beginning January 1, 2015, and the payment-in-kind interest will continue as long as those notes remain outstanding. Interest will continue to accrue at a rate of 8.00% per annum, and the maturity date will remain August 21, 2017.

Interest expense

For the three and six months ended June 30, 2015 and 2014, interest expense consisted of the following (in thousands):

NOTE 11 — STOCK-BASED COMPENSATION

Long Term Incentive Plan (the “Plan”)

As of June 30, 2015, we currently have 2.6 million shares authorized for issuance under the Plan adopted in March 2012.  At June 30, 2015, approximately 0.4 million shares were available for future grants under the Plan.  On July 6, 2015, at the Company’s annual meeting of stockholders, the Company’s stockholders approved an amendment to the Plan increasing the shares authorized for issuance by an additional 10 million shares with automatic subsequent increases equal to 15% of future common stock issuances.

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Stock-based compensation costs for the six months ended June 30, 2015 and 2014 were $1.2 million and $1.8 million, respectively.

The following table presents the changes in unvested stock awards pursuant to the Plan (in thousands except per share data):

The following table presents the changes in unvested stock options pursuant to the Plan (in thousands except per share data):

At June 30, 2015 we had $3.6 million of total unrecognized compensation costs related to unvested awards which are expected to be recognized over a weighted average period of 1.9 years.

NOTE 12 — COMMITMENTS AND CONTINGENCIES

From time to time, we are named as a defendant in 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.

See the description of the notice from our counterparty claiming that we were in default on joint interest billings for a total amount of $3,174,692.11 relating to operations conducted pursuant to the Joint Operating Agreement in Note 1 — Basis of Presentation - East Texas joint venture with EOG.

Under the Quantum Agreements, we could be required to repay Quantum for their proportionate interest in any additional interests and option acreage acquired outside the original $11 million investment between the date of the Quantum Agreements and two year anniversary. Quantum’s out of pocket costs that are incurred for additional interests and option acreage are contingent liabilities and only recorded as a liability when and if payment becomes probable. The Quantum Put Option cannot be enacted until the period beginning on the second anniversary of the Quantum Agreements and the 90th day following the second anniversary. As of June 30, 2015, this contingent liability totaled approximately $0.1 million.

NOTE 13 — SUBSEQUENT EVENTS

See the description of the notice from our counterparty claiming that we were in default on joint interest billings for a total amount of $3,174,692.11 relating to operations conducted pursuant to the Joint Operating Agreement in Note 1 — Basis of Presentation - East Texas joint venture with EOG.

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See description of Amendment No. 10 to the Senior Secured Notes Purchase Agreement in Note 10 — Long Term Debt.

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 Quarterly Report on Form 10-Q may contain “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  All statements, other than statements of historical fact, including without limitation, statements and projections regarding the Company’s future financial position, operations, performance, business strategy, returns, budgets, reserves, levels of production and costs, statements regarding future commodity prices and statements regarding the plans and objectives of the Company’s management for future operations, are forward-looking statements.  The Company’s forward looking statements are typically preceded by, followed by or include words such as “will,” “may,” “could,” “would,” “should,” “likely,” “believe,” “expect,” “anticipate,” “plan,” “estimate,” “target,” “goal,” “project,” “plan,” “intend” and similar words or expressions.  The Company’s forward-looking statements are not guarantees of future performance and are only predictions and statements of the Company’s beliefs based on assumptions that may prove to be inaccurate.  Forward-looking statements involve known, unknown or currently unforeseen risks and uncertainties that may be outside of the Company’s control and may cause the Company’s actual results and future developments to differ materially from those projected in, and contemplated by, such forward-looking statements.  Risks, uncertainties and other factors that could cause the Company’s actual results to materially differ from the expectations reflected in the Company’s forward-looking statements include, without limitation, the following:

·                  our registered public accounting firm for the year ended December 31, 2014 expressing doubt about our ability to maintain sufficient liquidity to continue as a going concern;

·                  requirements to repurchase our 10.00% Senior Secured Notes due 2017 or our 9.00% Convertible Senior Notes due 2017;

·                  our substantial level of indebtedness;

·                  the impact of our current financial condition on our business operations and prospects;

·                  fluctuations in the prices for, and demand for, oil, natural gas and natural gas liquids;

·                  our ability to raise necessary capital in the future;

·                  problems with our joint ventures or joint venture partners;

·                  exploratory risks associated with new or emerging oil and gas formations;

·                  risks associated with drilling and operating wells;

·                  inaccuracies and limitations inherent in estimates of oil and gas reserves;

·                  our ability to replace oil and gas reserves;

·                  our concentration in a single geographic area;

·                  uninsured losses from oil and gas operating risks;

·                  legislation and governmental regulations, including federal or state regulation of hydraulic fracturing;

·                  our dependency upon third-party gathering, transportation and processing facilities;

·                  our size relative to our peers;

·                  our ability to use net operating loss carryforwards;

·                  failures in our acquisition strategy or integration of our acquisitions;

·                  hurricanes and natural disasters;

·                  access to water to conduct hydraulic fracturing;

·                  payments for hedging activities, if undertaken, that are not offset by production sales; and

·                  our ability to assume a greater operational role with respect to our assets in the future.

In addition to these factors, important factors that could cause actual results to differ materially from our expectations, and specific risks involved with investing in our common stock, are disclosed under “Risk Factors” included under Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014 and Item 1A of Part II of this Quarterly Report on Form 10-Q and are incorporated by reference herein.

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