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                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                   FORM 10-K
 
           [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
 
                                      OR
 
         [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
                        SECURITIES EXCHANGE ACT OF 1934
 
            FOR THE TRANSITION PERIOD FROM            TO
 
                        COMMISSION FILE NUMBER: 0-22076
 
                              ZYDECO ENERGY, INC.
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
                                   DELAWARE
        (STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)
 
                                  76-0404904
                     (I.R.S. EMPLOYER IDENTIFICATION NO.)
 
                   1710 TWO ALLEN CENTER, 1200 SMITH STREET
                                HOUSTON, TEXAS
                   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
 
                                     77002
                                  (ZIP CODE)
 
                                (713) 659-2222
             (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
 
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: None
 
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
 
                         Common Stock, $.001 par value
                Warrants to Purchase One Share of Common Stock
        Units Consisting of One Share of Common Stock and Two Warrants
                               (TITLE OF CLASS)
 
  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes  [X] No  [_]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K ((S) 229.405 under the Securities Exchange Act of 1934)
is not contained herein, and will not be contained, to the best of
registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K.  [_]
 
  As of March 2, 1998, there were 10,357,096 shares of Zydeco Energy, Inc.
Common Stock, $.001 par value, issued and outstanding, 6,736,806 of which,
having an aggregate market value of approximately $16,842,015 were held by
non-affiliates of the registrant (affiliates being, for these purposes only,
directors, executive officers, and holders of more than 5% of the registrant's
Common Stock).
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
  Part III, Items 10 through 13 are incorporated from the registrant's
definitive Proxy Statement to be filed in connection with its Annual Meeting
of Stockholders to be held on June 11, 1998.
 
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                               TABLE OF CONTENTS
 
<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
 
                                     Part I
 
 <C>      <S>                                                               <C>
 Item 1.  Business.......................................................     2
            The Company..................................................     2
            Seismic Technology...........................................     2
            Geologic and Geophysical Expertise...........................     3
            Louisiana Transition Zone....................................     4
            West Cameron Seismic Project.................................     4
            Fortune Project..............................................     5
            Proprietary Rights and Licenses..............................     6
            Competition and Markets......................................     6
            Governmental Regulation......................................     7
            Risk Factors.................................................    10
            Facilities...................................................    12
            Employees....................................................    12
 Item 2.  Properties.....................................................    12
            Potential Prospects and Leases...............................    12
            Drilling Activities..........................................    13
            Oil and Gas Reserves.........................................    13
            Statistical Information--Oil and Gas Properties..............    14
 Item 3.  Legal Proceedings..............................................    15
 Item 4.  Submission of Matters to a Vote of Security Holders............    15
 
                                    Part II
 
 Item 5.  Market for Registrant's Common Equity and Related Stockholder 
            Matters......................................................    16
            Dividend Policy..............................................    16
            Sales of Unregistered Securities.............................    16
 Item 6.  Selected Financial Data........................................    17
 Item 7.  Management's Discussion and Analysis of Financial Condition and
            Results of Operations........................................    17
            Overview.....................................................    17
            Results of Operations........................................    18
            Year Ended December 31, 1997 Compared to Year Ended December
             31, 1996....................................................    18
            Year Ended December 31, 1996 Compared to Year Ended December
             31, 1995....................................................    19
            Liquidity and Capital Resources..............................    20
            Year 2000 Compliance.........................................    21
 Item 8.  Financial Statements and Supplementary Data....................    21
 Item 9.  Changes in and Disagreements with Accountants on Accounting and
            Financial Disclosure.........................................    22
 
                                    Part III
 
 Item 10. Directors and Executive Officers of the Registrant.............    22
 Item 11. Executive Compensation.........................................    22
 Item 12. Security Ownership of Certain Beneficial Owners and Management.    22
 Item 13. Certain Relationships and Related Transactions.................    22
 
                                    Part IV
 
 Item 14. Exhibits, Financial Statement Schedules and Reports on Form 
            8-K..........................................................    22
          Signature Page.................................................    23
          Index to Consolidated Financial Statements.....................   F-1
          Exhibit Index..................................................   E-1
</TABLE>
 
                                       i
<PAGE>
 
                                    PART I
 
  When used in this document, the words "anticipate," "believe," "expect,"
"estimate," "project," and similar expressions are intended to identify
forward-looking statements. Such statements are subject to certain risks,
uncertainties, and assumptions. Should one or more of these risks or
uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those anticipated, believed, expected,
estimated, or projected. For additional discussion of such risks,
uncertainties, and assumptions, see "Item 1. Business--Risk Factors" included
elsewhere in this report.
 
ITEM 1. BUSINESS
 
THE COMPANY
 
  Zydeco Energy, Inc. ("Zydeco") is an independent energy company engaged in
the exploration for oil and gas utilizing advanced three-dimensional ("3D")
seismic and computer-aided exploration ("CAEX") techniques. The Company has
developed comprehensive in-house technology and software and expertise
enabling it to use the most recent advances in such 3D seismic and CAEX
technology. Such technology includes the Company's "Wavefield Imaging
Technology", a patented data processing technique designed to substantially
reduce the cost of 3D seismic data acquisition for certain surveys without
significantly sacrificing the quality of the 3D subsurface image.
 
  The Company's primary business objective is to discover and develop oil and
gas reserves and, therefore, increase revenues, net income and cash flows. In
pursuing this strategy the Company intends to (i) focus its efforts in
geologic areas that it believes are underexplored with 3D seismic techniques
and have potential for substantial oil and gas reserves, (ii) maintain its
state-of-the-art 3D seismic capabilities through selective hardware and
software acquisitions and exploitation of proprietary technology, and (iii)
continue to pursue exploration and development alliances with industry
participants in order to spread funding requirements and exploration risks.
 
  The Company pursues its business strategy in phases. First, the Company
identifies areas with high oil and gas potential that are underexplored with
advanced 3D seismic techniques. Second, the Company secures seismic rights and
implements a 3D seismic acquisition program using third party contractors or
obtains access to third party seismic data for in-house processing and
analysis. Third, through the use of its advanced 3D seismic processing
techniques and the integration of geological and other data, the Company's
staff of geophysicists and geologists identifies and ranks potential drilling
prospects. Fourth, the Company seeks to secure lease positions or other
drilling rights for its identified potential prospects through private
landowner negotiations, state and federal public lease sales or negotiations
with industry participants holding lease positions or drilling rights. Upon
securing drilling rights, the potential prospects may then be drilled with
industry participants. The Company intends to pursue relationships with
industry participants who are experienced operators in the prospect area.
Generally, the Company intends to pursue retaining nonoperating interests in
its drilling prospects through "farmout" arrangements and prospect sales with
retained interests, while permitting a more experienced operator to manage the
drilling and production activities.
 
  Present efforts of the Company are focused primarily in the Louisiana
Transition Zone, the area of shoreline, marshland, near shore and shallow
coastal and bay waters where the combination of marine and land seismic data
acquisition and processing techniques are difficult and expensive. The largest
project of the Company to date is its West Cameron Seismic Project, an
extensive exploration program in part of the Louisiana Transition Zone in
western Cameron Parish, Louisiana.
 
SEISMIC TECHNOLOGY
 
  Traditionally, seismic analysis involved the acquisition, processing and
interpretation of seismic data collected along a single line of seismic
detectors and sources. Processing of the resulting data created a two
dimensional cross-section of the earth's subsurface beneath this line ("2D
seismic"). The advent of high speed,
 
                                       2
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large storage capacity computers and advanced geophysical software development
has permitted the acquisition, processing and interpretation of seismic data
collected in an areal array, usually from a multiple relatively closely spaced
grid of seismic detectors and sources. Processing of the resulting data
creates a three dimensional image of the earth's subsurface ("3D seismic"). 3D
seismic provides a substantially improved image for interpretation and
analysis than the cross section created by 2D seismic. As a result of the
adoption of 3D seismic technology, the industry's success rate with respect to
the drilling of prospects has risen.
 
  Basic 3D seismic imaging and analysis are now routinely used by a majority
of the companies involved in oil and gas exploration. The goal of 3D seismic
processing is to image a cube of the subsurface for detailed structural and
stratigraphic interpretation. Three common processes used in 3D seismic
processing are Dip-Moveout ("DMO"), Common Depth Point stacking ("CDP") and
post-stack migration, which adjust the collected seismic data to more
accurately image the subsurface. Continuing improvements in computing speed
and capacity resulted in the development of more advanced 3D processing
techniques such as pre-stack migration which the Company can perform with its
staff and in-house processing capabilities. This processing technique
generally improves the imaging of the subsurface. Many independent oil and gas
exploration companies do not have in-house capabilities for performing pre-
stack migration processing or other advanced 3D seismic processing techniques.
 
  Wavefield Imaging Technology represents a further advancement of 3D seismic
survey design, processing and analysis. Wavefield Imaging Technology permits
the Company to use more broadly spaced seismic receivers in its surveys
thereby reducing the cost of data acquisition for certain surveys. In its West
Cameron Seismic Project seismic survey, the Company estimates that it acquired
the survey for approximately one half the cost of a conventional transition
zone survey. Under the survey configuration used by the Company in its West
Cameron Seismic Survey, the Wavefield Imaging Technology is limited to
analysis of seismic objectives below 8,000 feet. The technology may also be
applied in the analysis of shallower objectives by increasing receiver and
sound source densities, although with diminishing cost advantages.
 
  On July 1, 1997, the Company acquired all of the outstanding capital stock
of Wavefield Image, Inc. ("Wavefield"), the owner of the Wavefield Imaging
Technology. As a result of this acquisition, the Company owns the Wavefield
Imaging Technology and a related United States patent subject to licenses
granted previously by Wavefield. Prior to its acquisition, Wavefield granted
partial or restricted licenses for the Wavefield Imaging Technology to one
major oil company and one foreign company and offered a license to another
foreign company. In addition, Dr. Norman S. Neidell, a principal shareholder
of Wavefield and inventor of the Wavefield Imaging Technology, entered into a
four year employment agreement with the Company and was appointed Vice
President-Innovations of the Company. Under Dr. Neidell's agreement, Dr.
Neidell retained an option to obtain a limited, nontransferable license to the
Wavefield Imaging Technology under certain conditions. The Company also
granted him stock options, vesting over four years, to purchase 150,000 shares
of the Company's Common Stock. Currently, the Company is not aware of any
other company, including the licensees, employing Wavefield Imaging Technology
in the design of its seismic surveys and processing of its seismic data. The
Company and Dr. Neidell have also agreed to negotiate in good faith to form an
agreement between them to own and exploit any non-seismic applications of the
Wavefield Imaging Technology. The acquisition of Wavefield also gives the
Company new employees with expertise in stratigraphic sequencing analysis,
which involves using seismic processing and interpretive techniques to
determine stratigraphy and hydrocarbon potential.
 
GEOLOGIC AND GEOPHYSICAL EXPERTISE
 
  The Company has employed a group of talented and experienced geophysicists
and geologists. The Company currently employs 7 geophysicists and 3
geologists. These experts have an average of approximately 25 years of
experience in the industry. As discussed above, the Company believes this in-
house expertise is a critical factor in enabling the Company to effectively
and efficiently use the most recent developments in 3D seismic imaging and
interpretation.
 
  The Company believes it is one of the few independent oil and gas
exploration companies to perform both 3D seismic data processing and seismic
interpretation in-house. Most independent exploration companies use
 
                                       3
<PAGE>
 
outside contractors to process their 3D data. The Company believes processes
such as pre-stack migration analysis can be most effectively and efficiently
accomplished by integrating seismic survey design, data processing and
interpretation in-house. The Company has selected and acquired the computers
and software necessary to perform advanced 3D seismic imaging and analysis.
This equipment is specifically designed to handle the scale and complexity of
large scale seismic projects such as the Company's West Cameron Seismic
Project. The Company has also assembled a team of geophysicists and geologists
with expertise in these advanced 3D processes.
 
LOUISIANA TRANSITION ZONE
 
  The Company has identified and is evaluating numerous potential prospects
onshore and offshore in the Louisiana Transition Zone, the Company's current
principal area of concentration.
 
  The Louisiana Transition Zone is a narrow trend paralleling the coastline of
Louisiana. It is approximately six miles wide (three miles on either side of
the beach) and extends approximately 300 miles from the Sabine River eastward
to the Mississippi River. Water depths in the Louisiana Transition Zone extend
to approximately 40 feet. The Louisiana Transition Zone contains the Miocene
Trend which has produced many of the largest oil and gas fields developed in
the continental United States and its territorial waters. Productive zones
within the Miocene Trend have excellent reservoir characteristics and have
historically exhibited multiple pay zones, which allow a single strategically
placed well bore to drain multiple reservoirs. The western portion of the
Louisiana Transition Zone contains the gas prolific Planulina sands.
 
  The Louisiana Transition Zone is populated with salt domes with numerous
radial and tangential faults surrounding the salt domes. The use of advanced
3D seismic technology is essential to the exploration of such salt features
and fault blocks. Until the last two years, there have been relatively few 3D
seismic surveys conducted in the Louisiana Transition Zone because of the
relatively high cost of such surveys compared to land or deepwater surveys.
The high cost is a result of the problems associated with seismic surveys in
coastal transition zones as discussed under "The Company" above. Activities in
this area are controlled by sophisticated land owners onshore and the State of
Louisiana within three miles of the beach offshore. Permits for 3D acquisition
require the consent of all landholders and all leaseholders. Such consents are
not required in Federal waters. Thus, seismic contractors have been reluctant
to conduct speculative 3D surveys due to the difficulty of permitting acreage
in the Louisiana Transition Zone. Due to these limitations, this zone was
considered a "seismically blind" area and was thus reflected on virtually
every onshore and offshore 2D seismic coverage map for the State of Louisiana
as an area of "no seismic coverage." Given the past sparcity of high quality
3D seismic surveys which span both onshore and offshore areas, the Company
believes that this zone has the potential for containing substantial
undeveloped oil and gas reserves. Many of these prospective areas in the
Louisiana Transition Zone are located in shallow waters near existing pipeline
infrastructure. As a result, reserves underlying these areas are generally
less costly to develop and connect to pipeline infrastructure than reserves in
deeper water areas.
 
WEST CAMERON SEISMIC PROJECT
 
  The West Cameron Seismic Project encompasses approximately 230 square miles.
At the core of the West Cameron Seismic Project is 51,000 non-leased acres in
state waters. The exclusive seismic permit covering this area was obtained by
the Company from the State of Louisiana. In August 1996, the Company commenced
the West Cameron Seismic Project, an extensive 3D seismic exploration program
in a part of the Louisiana Transition Zone in western Cameron Parish,
Louisiana.
 
  Options, Permits and Leases. In connection with the West Cameron Seismic
Project, the Company negotiated seismic options covering approximately 36,718
gross acres (33,225 net acres) and secured seismic permits covering
approximately 119,557 gross acres (119,075 net acres). In connection with the
exclusive seismic permit, for eighteen months, commencing February 1996, the
Company had the exclusive right to acquire seismic data on the State's acreage
and nominate any of the acreage for competitive lease bids. On
 
                                       4
<PAGE>
 
August 11, 1997, the Company paid $391,877 to the State of Louisiana to extend
the deadline for delivery of the survey to February 18, 1998. Prior to the
February 18, 1998 deadline, the Company nominated certain properties for bid.
In Louisiana, a public auction of leases is held approximately 120 days after
the property is nominated for bid and the auction is generally announced
approximately 45 days prior to the auction date. A bidder at the auction may
bid on all or only a portion of the property nominated for bid. Under the
Company's seismic permit, the State of Louisiana is required to keep the
information obtained from the survey confidential for a period of ten years.
The Company timely delivered seismic data to the State of Louisiana in January
1998 in compliance with the terms of the exclusive seismic permit.
 
  Data Acquisition and Analysis. Advanced seismic processing techniques,
including pre-stack migration, amplitude variation with offset (AVO) and
seismic inversion were applied to the data by year-end 1997. The data is
currently being interpreted by the Company's exploration staff to identify
potential drilling prospects. While some initial prospects have been
identified, the Company intends to further process the data with additional
advanced 3D processing techniques, such as pre-stack depth migration over
potential drilling prospects during 1998. The Company is presently in the
process of obtaining oil and gas leases and other drilling rights with respect
to several prospect areas identified with the West Cameron Seismic Project.
 
  Cheniere Exploration Agreement. In April 1996, the Company executed the
Cheniere Exploration Agreement with Cheniere Energy Operating Co., Inc.
("Cheniere"), formerly known as FX Energy, Inc., covering the West Cameron
Seismic Project. See "Item 7 Management's Discussion and Analysis of Financial
Condition and Results of Operations." The Cheniere Exploration Agreement
provides for aggregate payments to Zydeco of at least $13.5 million to fund
the costs of seismic acquisition, including the purchase of seismic rights or
lease options on the related onshore acreage of the West Cameron Seismic
Project, and to complete data acquisition and processing of a 3D seismic
survey of the onshore and offshore areas. Costs incurred under this agreement
that exceed $13.5 million are to be shared equally by Cheniere and Zydeco. The
Cheniere Exploration Agreement provides that Cheniere may receive up to a 50%
interest in the West Cameron Seismic Project and in any leases acquired as a
result thereof through May 2001, based on Cheniere completing its funding
obligations under the Cheniere Agreement, including its share of lease
acquisition costs. The costs covered by the Cheniere Agreement include the
costs of 3D seismic acquisition, including the purchase of seismic rights or
lease options on the related onshore acreage of the West Cameron Seismic
Project, the purchase of other 3D seismic data, and processing of seismic data
over such project area, but excludes such costs as associated with Zydeco
personnel utilized on the project. The Cheniere Exploration Agreement provides
that Cheniere may discontinue funding under certain circumstances, in which
case its interest would then be reduced pro rata, based on the West Cameron
Seismic Project's total cost. At December 31, 1997, Cheniere had funded all of
its share of project costs for which it had been invoiced through such date.
Seismic data acquisition operations, which commenced in August 1996, were
completed in July 1997. At December 31, 1997, pursuant to the terms of the
Cheniere Exploration Agreement, the Company had incurred third party and
processing costs of approximately $19,653,932 in connection with the West
Cameron Seismic Project, net of interest earned of $49,095 on the unused
project funds and $46,000 for the sale of seismic data. At December 31, 1997,
Cheniere's share of these costs was $16,529,524 and Zydeco's share was
$3,124,408 under the Cheniere Agreement. During the term of the Cheniere
Exploration Agreement, the Company and Cheniere have executed eight agreement
amendments of which six amendments have granted Cheniere extensions of time in
which to pay invoices due under such agreement.
 
  Cheniere has the right to farm out a portion or all of its interest in each
prospect identified in the project to Zydeco under a put arrangement in the
Cheniere Exploration Agreement. In the event of such a farmout, Cheniere would
retain a 1% overriding royalty interest, as to its interest in the project,
convertible into a 10% working interest as to its interest in the project,
after Zydeco, or its participants, has recouped the cost of drilling,
completion, and hook-up of completed wells. Should Cheniere farm out a smaller
working interest to Zydeco, the overriding royalty and after-payout working
interests would be proportionately reduced. Zydeco has similar farmout rights
under the Cheniere Exploration Agreement.
 
FORTUNE PROJECT
 
  In February 1995, Zydeco entered into the Fortune Exploration Agreement with
a predecessor of Fortune Petroleum Corporation ("Fortune"). Pursuant to the
Fortune Exploration Agreement, Fortune advanced to
 
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Zydeco $4.8 million and agreed to advance 50% of any additional funds
necessary for the acquisition and processing of seismic data and acquisition
of leases on 17 potential prospects in exchange for Fortune's right to
maintain up to a 50% interest in such prospects. From the inception of the
Fortune Exploration Agreement until June 1997, Zydeco spent approximately $2.7
million of the Fortune $4.8 million advance to acquire and/or maintain leases
and to purchase and process seismic data. In June 1997, Fortune exercised its
right under the Fortune Exploration Agreement to have returned to it the $2.2
million of unexpended funds, including earned interest. Substantially all the
cost of lease acquisition and seismic data acquisition had been incurred at
the time of Fortune's election. By the end of 1997, evaluation of the
potential prospects was nearly completed and leases on five of the potential
prospects were sold to third parties by the Company and Fortune. Additionally,
the Company elected to sell its interest in three areas in which Fortune
elected to maintain its interest. The terms of each sale included a cash
consideration and retained revenue interest for the Company. The balance of
the potential prospects will be evaluated annually based on additional
industry activity.
 
PROPRIETARY RIGHTS AND LICENSES
 
  The Company believes that its success depends primarily on the innovative
skills, technical competence, and sales and marketing abilities of its
personnel. The Company has obtained licenses to use all software currently
used in its business. On December 2, 1997, the Company was issued a patent on
the Wavefield Imaging Technology by the United States Patent and Trademark
Office. As discussed above, prior to the Wavefield acquisition, the Company
acquired a non-exclusive license to use the Wavefield Imaging Technology
throughout the world and an exclusive license to use it in the Louisiana
Transition Zone. See "--Seismic Technology."
 
COMPETITION AND MARKETS
 
  Competition for the acquisition of proved undeveloped acreage, as well as
producing properties, is intense. The Company competes with many other
entities including major integrated oil and gas companies as well as numerous
independent oil and gas companies and other producers of energy sources and
fuels. A substantial portion of prospect acreage in the West Cameron Seismic
Project is subject to competitive closed bidding at federal and state lease
sales. Many of the Company's competitors have financial resources and other
competitive advantages that are substantially greater than those of the
Company, and therefore may be better able to compete and bid for leases,
particularly in regions other than the Gulf Coast.
 
  The availability of a ready market for and the price of any hydrocarbons
produced will depend on many factors beyond the control of the Company,
including the extent of domestic production and imports of foreign oil, the
marketing of competitive fuels, the proximity and capacity of natural gas
pipelines, the availability of transportation and other market facilities, the
demand for hydrocarbons, the political conditions in the Middle East, the
effect of federal and state regulation of allowable rates of production,
taxation and the conduct of drilling operations, and federal regulation of
natural gas. In the past, as a result of excess deliverability of natural gas,
many pipeline companies curtailed the amount of natural gas taken from
producing wells, shut-in some producing wells, significantly reduced gas taken
under existing contracts, refused to make payments under applicable "take-or-
pay" provisions, and refused to contract for gas available from some newly
completed wells. The Company can give no assurance that such problems will not
affect these markets again. In addition, the ongoing restructuring of the
natural gas pipeline industry will eliminate the gas purchasing activity of
traditional interstate gas transmission pipeline buyers. See "--Governmental
Regulation" and "Risk Factors--Competitive Industry."
 
  Producers of natural gas, therefore, will be required to develop new markets
among gas marketing companies, end users of natural gas, and local
distribution companies. All of these factors, together with economic factors
in the marketing area, generally may affect the supply and/or demand for oil
and gas and thus the prices available for sales of oil and gas.
 
                                       6
<PAGE>
 
GOVERNMENTAL REGULATION
 
  The Company's oil and gas exploration, development, production, and related
operations are subject to extensive rules and regulations promulgated by
Federal and state agencies. Failure to comply with such rules and regulations
can result in substantial penalties. The regulatory burden on the oil and gas
industry increases the Company's cost of doing business and affects its
profitability. Because such rules and regulations are frequently amended or
reinterpreted, the Company is unable to predict the future cost or impact of
complying with such rules and regulations.
 
  Production. In most, if not all, areas where the Company may conduct
activities, there may be statutory provisions regulating the production of oil
and natural gas under which administrative agencies may promulgate rules in
connection with the operation and production of both oil and gas wells,
determine the reasonable market demand for oil and gas, and establish
allowable rates of production. Such regulations may restrict the rate at which
the Company's wells produce oil or gas below the rate at which such wells
would be produced in the absence of such regulations, with the result that the
amount or timing of the Company's revenues could be adversely affected.
 
  Louisiana State Regulation. The State of Louisiana requires permits for
seismic or drilling operations, drilling bonds, and reports concerning
operations and imposes other requirements relating to the exploration and
production of oil and gas. The State of Louisiana also has statutes or
regulations addressing conservation matters, including provisions for the
unitization or pooling of oil and gas properties, the establishment of maximum
rates of production from wells, and the U.S. Department of Interior Minerals
Management Service's, ("MMS") regulations of spacing, plugging, and
abandonment of such wells.
 
  Offshore Leasing. The Company has acquired and plans to acquire additional
oil and gas leases in the Gulf of Mexico, which will be granted by the Federal
government and administered by the MMS. Such leases are issued through
competitive bidding, contain relatively standardized terms, and require
compliance with detailed MMS regulations and orders pursuant to the Outer
Continental Shelf Lands Act ("OCSLA") (which are subject to change by the
MMS). For offshore operations, lessees must obtain MMS approval for
exploration plans and development and production plans prior to the
commencement of such operations. In addition to permits required from other
agencies such as the Coast Guard, the Army Corps of Engineers, and the
Environmental Protection Agency (the "EPA"), lessees must obtain a permit from
the MMS prior to the commencement of drilling. The MMS has promulgated
regulations requiring offshore production facilities located on the Outer
Continental Shelf to meet stringent engineering and construction
specifications. Similarly, the MMS has promulgated other regulations governing
the plugging and abandoning of wells located offshore and the removal of all
production facilities. With respect to any Company operations conducted on
offshore federal leases, liability may generally be imposed under the OCSLA
for the costs of clean-up and damages caused by pollution resulting from such
operations, other than damages caused by acts of war or the negligence of
third parties. Under certain circumstances, including but not limited to,
conditions deemed a threat or harm to the environment, the MMS may also
require any Company operations on federal leases to be suspended or terminated
in the affected area.
 
  Under the OCSLA, all oil and natural gas pipelines operating on the Outer
Continental Shelf must provide "open and non-discriminatory" access to both
owner and non-owner shippers. Consequently, the Company's gathering and
transportation facilities located on the Outer Continental Shelf must be made
available to third parties.
 
  Bonding and Financial Responsibility Requirements. The Company is required
to obtain bonding, or otherwise demonstrate financial responsibility, at
varying levels by governmental agencies in connection with obtaining state or
federal leases or acting as operator on such leases. These bonds may cover
such obligations as plugging and abandonment of nonproductive wells, removal
of related production facilities, and pollution liabilities on federal and
state leases. A substantially larger bond than the current $300,000 bond
currently issued on behalf of the Company is required in order to act as
operator on federal offshore leases. The Company will have to satisfy these
increased bonding requirements in the event that it elects to operate any
wells on federal
 
                                       7
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leases. The Company expects to be able to enter into participation
arrangements on its prospects with industry participants who are qualified to
act as operators on Federal leases. In addition, the State of Louisiana
recently adopted financial responsibility requirements with respect to
plugging and abandonment liabilities on Louisiana leases.
 
  Natural Gas Marketing and Transportation. The Federal Energy Regulatory
Commission ("FERC") regulates the transportation and sale or resale of natural
gas in interstate commerce pursuant to the Natural Gas Act of 1938 ("NGA") and
the Natural Gas Policy Act of 1978 ("NGPA"). In the past, the Federal
government has regulated the prices at which oil and gas could be sold.
Deregulation of wellhead sales in the natural gas industry began with the
enactment of the NGPA in 1978. In 1989, Congress enacted the Natural Gas
Wellhead Decontrol Act (the "Decontrol Act"). The Decontrol Act removed all
NGA and NGPA price and nonprice controls affecting wellhead sales of natural
gas effective January 1, 1993. While sales by producers of natural gas can
currently be made at uncontrolled market prices, Congress could reenact price
controls in the future.
 
  On April 8, 1992, the FERC issued Order No. 636, as amended by Order No.
636-A (issued in August 1992) and Order No. 636-B (issued in November 1992) as
a continuation of its efforts to improve the competitive structure of the
interstate natural gas pipeline industry and maximize the consumer benefits of
a competitive wellhead gas market. The FERC proposed to generally require
interstate pipelines to "unbundle," or separate their traditional merchant
sales services from their transportation and storage services and to provide
comparable transportation and storage services with respect to all gas
supplies whether purchased from the pipeline or from other merchants such as
marketers or producers. The pipelines must now separately state the applicable
rates for each unbundled service (e.g., for natural gas transportation and for
storage). This unbundling process has been implemented through negotiated
settlement in individual pipeline services restructuring proceedings.
 
  On July 16, 1996, the Court of Appeals for the District of Columbia Circuit
("D.C. Circuit") issued its opinion on review of Order No. 636. The opinion
upheld most elements of Order No. 636 including the unbundling of sales and
transportation services, curtailment of pipeline capacity, implementation of
the capacity release program and the mandatory imposition of straight-fixed-
variable ("SFV") rate design for interstate pipeline companies. The D.C.
Circuit did remand certain aspects of Order No. 636 to the FERC for further
explanation including, inter alia, the FERC's decision to exempt pipelines
from sharing in gas supply realignment ("GSR") costs caused by restructuring;
the FERC's selection of a twenty-year term matching cap for the right-of-
first-refusal mechanism; the FERC's restriction on the entitlement of no-
notice transportation service to only those customers receiving bundled sales
service at the time of restructuring; and the FERC's determination that
pipelines should focus on individual customers, rather than customer classes,
in mitigating the effects of SFV rate design. On February 27, 1997, the FERC
issued its order on remand. The order reaffirmed the holding of Order No. 636
that pipelines should be entitled to recover 100 percent of their prudently
incurred GSR costs. Moreover, since Order No. 636, few, if any, pipeline
customers have been willing, or required, to commit to twenty-year contracts
for existing capacity. Thus, the FERC reduced the contract-matching cap for
the right-of-first-refusal mechanism to five years. In light of the varied
post-restructuring experience with no-notice service, the FERC also decided to
no longer limit a pipeline's no-notice service to its bundled sales customers
at the time of restructuring. Finally, the FERC reaffirmed that pipelines
should focus on individual customers, rather than customer classes, in
mitigating the effects of SFV rate design. Four petitions were filed with the
Supreme Court on January 27, 1997 for writ of certiorari to review those
portions of the D.C. Circuit's opinion which affirmed the capacity release and
right-of-first-refusal provisions adopted in Order No. 636. Those petitions
are still pending before the Court.
 
  Although the Company is unable to predict the consequences of Order No. 636,
the Company believes that Order No. 636 could have a significant effect on all
segments of the natural gas industry. While Order No. 636 will not directly
regulate the production and sale of gas that may be produced from the
Company's properties, the FERC has stated that the order was intended
primarily to foster increased competition in the natural gas industry and to
allow for the transmission of more accurate price signals. Thus, the order
could affect the market conditions in which the gas is sold and the
availability of transportation services to deliver the gas to market.
 
 
                                       8
<PAGE>
 
  Oil Sales and Transportation Rates. The FERC regulates the transportation of
oil in interstate commerce pursuant to the Interstate Commerce Act. Sales of
crude oil, condensate, and gas liquids by the Company are not regulated and
are made at market prices. However, the price a company receives from the sale
of these products is affected by the cost of transporting the products to
market. Effective as of January 1, 1995, the FERC implemented regulations
establishing an indexing system for transportation rates for oil pipelines,
which would generally index such rates to inflation, subject to certain
conditions and limitations. Under the new regulations, petroleum pipelines are
able to change their rates within prescribed ceiling levels that are tied to
the Producer Price Index for Finished Goods, minus one percent. Rate increases
made pursuant to the index will be subject to protest, but such protests must
show that the portion of the rate increase resulting from application of the
index is substantially in excess of the pipeline's increase in costs. The new
indexing methodology can be applied to any existing rate, even if the rate is
under investigation. If such rate is subsequently adjusted, the ceiling level
established under the index must be likewise adjusted.
 
  In the order adopting the new regulations, the FERC said that as a general
rule pipelines must utilize the indexing methodology to change their rates.
The FERC indicated, however, that it was retaining cost-of-service ratemaking,
market-based rates, and settlements as alternatives to the indexing approach.
A cost-of-service proceeding will be instituted to determine just and
reasonable initial rates for new services. A pipeline can also follow a cost-
of-service approach when seeking to increase its rates above index levels for
uncontrollable circumstances. A pipeline can seek to charge market-based rates
if it can establish that it lacks market power. Finally, a pipeline can
establish rates pursuant to settlement if agreed upon by all current shippers.
 
  On May 10, 1996, the D.C. Circuit affirmed the new regulations. The Court
held that by establishing a general indexing methodology along with limited
exceptions to indexed rates, the FERC had reasonably balanced its dual
responsibilities of ensuring just and reasonable rates and streamlining
ratemaking through generally applicable procedures. Because of the novelty and
uncertainty surrounding the indexing methodology, as well as the possibility
of the use of cost-of-service ratemaking and market-based rates, the Company
is not able to predict with certainty what effect, if any, these regulations
will have on it. However, other factors being equal, the regulations may tend
to increase transportation costs or reduce wellhead prices for such
commodities.
 
  Environmental. The Company's operations are subject to numerous laws and
regulations governing the discharge of materials into the environment or
otherwise relating to environmental protection. These laws and regulations may
require the acquisition of a permit before drilling commences, restrict the
types, quantities, and concentration of various substances that can be
released into the environment in connection with drilling and production
activities, limit or prohibit drilling activities on certain lands lying
within wilderness, wetlands, and other protected areas, and impose substantial
liabilities for pollution resulting from the Company's operations. Moreover,
the recent trend toward stricter standards in environmental legislation and
regulation is likely to continue. For instance, legislation has been proposed
in Congress from time to time that would reclassify certain oil and gas
exploration and production wastes as "hazardous wastes" which would make the
reclassified wastes subject to much more stringent handling, disposal, and
clean-up requirements. If such legislation were to be enacted, it could have a
significant impact on the operating costs of the Company, as well as the oil
and gas industry in general. State initiatives to further regulate the
disposal of oil and gas wastes are also pending in certain states, and these
various initiatives could have a similar impact on the Company.
 
  The Comprehensive Environmental Response, Compensation, and Liability Act
("CERCLA"), also known as the "Superfund" law, imposes liability, without
regard to fault or the legality of the original conduct, on certain classes of
persons that are considered to have contributed to the release of a "hazardous
substance" into the environment. These persons include the owner or operator
of the disposal site or sites where the release occurred and companies that
disposed of or arranged for the disposal of the hazardous substances found at
the site. Persons who are or were responsible for releases of hazardous
substances under CERCLA may be subject to joint and several liability for the
costs of cleaning up the hazardous substances that have been released into the
environment and for damages to natural resources. It is not uncommon for
neighboring landowners and other third parties to file claims for personal
injury and property damage.
 
                                       9
<PAGE>
 
RISK FACTORS
 
  High Dependence on 3D seismic and Exploratory Drilling Activities. The
Company's producing activities to date have been limited. Such activities
presently consist of a working interest in one well and an overriding royalty
interest in another well. Both wells are located in offshore Louisiana. No oil
and gas reserves have been assigned by the Company at December 31, 1997 to the
well in which it has a working interest. Currently, the Company's focus is
directed to increasing its reserves, and therefore, its revenues, net income
and cash flow, by relying on certain 3D seismic methods to identify potential
hydrocarbon accumulations which will then require the successful drilling of
such prospects. There is no assurance that those 3D seismic methods will
identify potential hydrocarbon accumulations or that drilling will
successfully test these prospects. The use of 3D seismic involves numerous
risks in the acquisition, processing and interpretive phases including, but
are not necessarily limited to, acquiring seismic shooting rights over a
prospective area, availability of trained seismic crews, subsurface conditions
which may affect the quality of the acquisition of data, surface conditions,
and availability of data from any nearby previously drilled wells. Drilling
involves numerous risks, including the risk that no commercially productive
oil or gas reservoirs will be encountered. The cost of drilling, completing,
and operating wells is often uncertain and drilling operations may be
curtailed, delayed, or abandoned as a result of a variety of factors,
including unexpected drilling conditions, excessive pressure or irregularities
in formations, equipment failures or accidents, weather conditions, and
shortages or delays in the delivery of equipment.
 
  Lack of Diversification; Oil and Gas Industry Conditions; and Volatility of
Prices for Oil and Gas. As an independent energy company, the Company's
revenues and profits will be substantially dependent on the oil and gas
industry in general and the prevailing prices for oil and gas in particular.
Historically, the markets for oil and gas have been volatile and are likely to
continue to be volatile in the future. Prices for oil and gas are subject to
wide fluctuations in response to relatively minor changes in supply of and
demand for oil and gas, market uncertainty, and a variety of additional
factors that are beyond the control of the Company. These factors include
political conditions in the Middle East, the domestic and foreign supply of
oil and gas, the price of foreign imports, the level of consumer demand,
weather conditions, domestic and foreign government regulations, the price and
availability of alternative fuels, and overall economic conditions.
Accordingly, it is impossible to predict future oil and gas price movements
with any certainty. Declines in oil and gas prices would adversely affect the
company's cash flow, liquidity, and profitability, and reduce the amount of
the Company's oil and gas reserves that can be economically produced. In
addition, various factors, including the availability and capacity of gas
gathering systems and pipelines, the effect of federal regulations on
production and transportation, general economic conditions, and changes in
supply and demand, may adversely affect the Company's ability to market its
oil and gas production.
 
  High Dependence upon Lease Acquisition Activities. Both the United States
Department of Interior and the State of Louisiana award oil and gas leases on
a competitive bidding basis. It is expected that other major and independent
oil and gas companies having financial resources significantly greater than
those of the Company will bid against the Company for the purchase of oil and
gas leases. Recent sales of federal and state leases have indicated that the
competition for lease acreage may be substantially greater than in past sales
and, accordingly, the Company may face a substantial increase in lease costs.
Accordingly, there can be no assurance that the Company will be successful in
acquiring any leases on which it bids.
 
  Limited Operating Revenues; Need for Additional Financing. The Company
presently has limited operating revenues and does not expect to generate
substantial operating revenues in the immediate future. It is expected the
Company will need substantial additional capital in order to sustain
operations and to acquire additional oil and gas leases, producing properties,
or to drill wells on the potential prospects. Additional capital may be
secured from a combination of funding sources that may include borrowings from
financial institutions, vendor financings, production payment financings, debt
offerings, additional offerings of the Company's stock and alliances with
other industry participants. The Company's ability to access additional
capital will depend on its success in acquiring and developing high reserve
potential oil and gas leases and the status of various capital markets at the
time such additional capital is sought. Accordingly, there can be no
assurances that capital will be available to the Company from any source, at
the time required or that, if available, it will be on terms acceptable to the
Company. Should sufficient financing not be available because costs are higher
than estimated or
 
                                      10
<PAGE>
 
otherwise, the development and exploration of any Prospect acquired by the
Company would be delayed and, accordingly, the implementation of the Company's
business strategy could be adversely affected. However, the Company believes
it has sufficient capital to sustain operations in the immediate future.
 
  Competitive Industry. The Company operates in a highly competitive industry.
The Company competes with major and independent oil and gas companies for the
acquisition of oil and gas leases as well as for the equipment and labor
required to explore, develop and operate such properties. Many of these
competitors have financial, technical, human, and other resources greater than
those of the Company.
 
  Operating Risks. The Company's oil and gas operations are subject to all of
the risks and hazards typically associated with the exploration for, and the
development and production of, oil and gas in the Gulf of Mexico and any other
areas in which the Company may, in the future, conduct such activities. Risks
in drilling operations include blowouts, oil spills, fires, and offshore risks
such as capsizing, collision, hurricanes, and other adverse weather and sea
conditions. Such risks can result in personal injury and loss of life and
substantial damage to or destruction of oil and gas wells, platforms,
production facilities, or other property, suspension of operations, and
liabilities to third parties, any and all of which could adversely affect the
Company. In addition, the Company's operations could also result in liability
for oil spills, discharge of hazardous materials, and other environmental
damages.
 
  In accordance with customary industry practices, the Company maintains
insurance against some, but not all, of such risks and some, but not all, of
such losses. There can be no assurance, however, that any insurance the
Company intends to carry will be available to the Company when applied for or,
if available and carried, will be adequate to cover the Company's liability in
all circumstances. The occurrence of an event not fully covered by insurance
could have a material and adverse effect on the financial position and results
of operations of the Company. In addition, the Company may be liable for
environmental damages caused by previous owners of any property which may be
purchased by the Company, which liabilities would not be covered by insurance.
 
  Most of the oil and gas leases the Company has acquired or expects to
acquire are or will be located offshore in water depths of less than 130 feet.
Drilling operations offshore in such water depths are by their nature more
remote, exposed, and, consequently, more difficult than typical drilling
operations conducted on land, and, as a result, could result in significantly
higher drilling, completion, and connection costs.
 
  Risks of Turnkey Contracts. The Company intends to have other industry
participants operate its wells and will attempt to obtain, wherever possible
and desirable, turnkey contracts, subject to availability, for the drilling of
wells on any of its potential prospects. In the event a turnkey contract is
not economically beneficial to the Company or is otherwise unobtainable from
proven industry participants, the Company may contract for drilling operations
on either a footage or day rate basis. The recent increase in exploration
activity in the Gulf Coast region may result in the inability to negotiate
turnkey contracts. In this instance, the Company may be liable for significant
cost overruns attributable to downhole drilling problems that otherwise would
have been covered by a turnkey contract had one been negotiated.
 
  Dependence on Key Personnel. The Company believes that its success will be
highly dependent upon its continued ability to attract and retain skilled
managers and employees. In the event that the Company loses the services of
any of its key personnel, there could be a material adverse effect on the
Company's business and prospects.
 
  Governmental Regulations. The Company's business will be regulated by
certain federal, state, and local laws and regulations relating to the
development, production, marketing, and transportation of oil, gas, and
related products as well as certain environmental and safety matters. These
laws may be changed from time to time in response to economic or political
conditions. Matters subject to regulation include permits for drilling
operations, drilling and abandonment bonds, reports concerning operations, the
spacing of wells, unitization and pooling of properties, and taxation. From
time to time, regulatory agencies have imposed price controls and limitations
on production by restricting the rate of flow of oil and gas wells below
actual production capacity in
 
                                      11
<PAGE>
 
order to conserve supplies of oil and gas. In addition, the production,
handling, storage, transportation, and disposal of oil and gas, by-products
therefrom, and other substances and materials produced or used in connection
with oil and gas operations are subject to regulation under federal, state,
and local laws and regulations primarily relating to protection of human
health and the environment. These laws and regulations have continually
imposed increasingly strict requirements for water and air pollution control
and solid waste management. The Company believes the trend of more expansive
and stricter environmental legislation and regulations will continue and such
legislation may result in costs to the Company in the future. Amendments to
laws regulating the disposal of oil and gas exploration and production wastes
have been considered by Congress and may be adopted. Moreover, new and
additional taxes have been proposed on energy consumption in the form of a BTU
tax or a gasoline tax. Such legislation or taxes, if enacted, could have a
significant adverse impact on the Company's operating costs.
 
FACILITIES
 
  The Company leases approximately 19,600 square feet of office space in
Houston, Texas under two leases expiring in 1999.
 
EMPLOYEES
 
  As of December 31, 1997, the Company had 22 full-time employees, including 7
geophysicists, 3 geologists and 3 landmen. None of the Company's employees are
employed pursuant to a collective bargaining agreement, and the Company has
not experienced any work stoppages. The Company considers its relations with
its employees to be good. Two employees of the Company have employment
agreements with the Company, while another employee of the Company who
terminated in September 1997 had an employment agreement with the Company.
 
ITEM 2. PROPERTIES
 
POTENTIAL PROSPECTS AND LEASES
 
  Undeveloped Properties. At the beginning of 1997, the Company had identified
and was evaluating a number of potential prospects outside the West Cameron
Seismic Project under oil and gas leases in which the Company has an interest.
These leases are located primarily in the Miocene Trend of southern Louisiana.
The potential prospects have generally been identified by shooting or
purchasing certain 2D and 3D seismic data, processing or reprocessing thereof,
and correlating the seismic data with subsurface well control and historical
production data from similar properties. During 1997, the Company completed
evaluation and had sold or farmed out its interest in twelve areas for a
consideration of cash, a retained overriding royalty and, in some cases,
additional future contingent cash payments. Of the remaining ten potential
prospects, the Company owns 100% interest in one of the areas and owns 50%
interest in eight potential prospects in which Fortune owns the remaining 50%
interest. The Company owns 53.75% interest in the tenth potential prospect.
These areas will be monitored for new industry activity and will be evaluated
annually on the basis of such activity's impact on their value. As of December
31, 1997, the Company had licensed 3D seismic data covering approximately
88,320 acres offshore Louisiana within which the Company owned leases on
10,234 gross acres covering all or portions of the potential prospects. In
addition, during 1997, the Company licensed 3D seismic data covering
approximately 103,000 acres over federal and state waters adjacent to the
Company's West Cameron Seismic Project. The Company does not have any leases
in the area covered by the recently acquired data.
 
  In 1997, the Company acquired Fortune's interest in a 116 acre potential
prospect in the area of the West Cameron Seismic Project to eliminate any
conflict between the areas of mutual interest "AMIs" for the West Cameron
Seismic Project and the Fortune project. The Company is in the process of
identifying potential prospects in the West Cameron Seismic Project and, in
the first quarter of 1998, commenced lease acquisitions in such project.
 
  Lease Terms. Most of the leases currently held by the Company are Federal or
State of Louisiana offshore leases. The Company's leases have expiration dates
ranging from 1998 to 2003. Federal offshore leases generally
 
                                      12
<PAGE>
 
provide for a minimum royalty of 16.67%, have a primary lease term of five
years, comprise an approximate 5,000 acre lease block, and are administered by
the MMS. Annual rentals on Federal leases are $5.00 per acre. In general, the
Company's federal leases consist of portions of 5,000 acre lease blocks. If
production is not established or an extension is not obtained during the
primary term, the lease terminates. Louisiana state leases are administered by
the State Mineral Board of the State of Louisiana and generally provide for:
(i) a minimum royalty of 20%; (ii) a five year primary term; and (iii) annual
rentals in an amount equal to 50% of the original lease acquisition cost.
Generally, title to state and federal leases is merchantable in all respects
and operations thereon are not normally subject to litigation resulting from
the legal doctrine of adverse possession or any other similar challenge to
title. The Company intends to evaluate its participation in federal and state
competitive bid lease sales during 1998.
 
DRILLING ACTIVITIES
 
  The Company had no drilling activities in 1997 and currently only
anticipates drilling in the 1998 second half possibly as a result of leases it
may be able to acquire in connection with potential prospects in the West
Cameron Seismic Project.
 
OIL AND GAS RESERVES
 
  The Company engaged Ryder Scott Company, Petroleum Engineers ("Ryder Scott")
to estimate the proved oil and gas reserves of the Company's properties for
the year ended December 31, 1997. Ryder Scott is an independent oil and gas
reserve engineering firm. This firm was also asked to estimate the future net
revenues to be derived from such properties. Prior to 1995, the Company had no
proved oil and gas reserves. In preparing their report, Ryder Scott reviewed
and examined such geological, economic, engineering, and other data provided
by the Company as considered necessary under the circumstances, and examined
the reasonableness of certain economic assumptions regarding estimated
operating and development costs and recovery rates in light of economic
circumstances as of December 31, 1997. As of December 31, 1997, the proved oil
reserves were estimated to be 2,614 Bbls and the proved gas reserves were
estimated to be 104,000 Mcf.
 
  There are numerous uncertainties inherent in estimating quantities of
reserves and in projecting future rates of production and timing of
development expenditures, including many factors beyond the control of the
producer. The reserve data set forth in this Annual Report on Form 10-K
represent only estimates. Reserve engineering is a subjective process of
estimating underground accumulations of oil and gas that cannot be measured in
an exact way, and the accuracy of any reserve estimate is a function of the
quality and quantity of available data and of engineering and geological
interpretation and judgment. As a result, estimates of different engineers
often vary. In addition, results of drilling, testing, and production
subsequent to the date of an estimate may justify revision of such estimate.
Accordingly, reserve estimates at a specific point in time are often different
from the quantities of oil and gas that are ultimately recovered, which
differences may be significant. Additionally, the estimates of future net
revenues from proved reserves of the Company and the present value of future
net revenues are based upon certain assumptions about future production
levels, prices, and costs that may not prove correct over time. The
meaningfulness of such estimates is highly dependent upon the accuracy of the
assumptions upon which they were based.
 
                                      13
<PAGE>
 
STATISTICAL INFORMATION--OIL AND GAS PROPERTIES
 
  Production. The Company had no oil and gas reserves or production prior to
1995. The following table summarizes the sales volumes of the Company's net
oil and gas production in the United States in barrels of oil and thousands of
cubic feet of natural gas for each of the three years ended December 31, 1997,
1996, and 1995, respectively:
 
<TABLE>
<CAPTION>
                                                           YEAR ENDED DECEMBER
                                                                   31,
                                                          ----------------------
                                                           1997    1996    1995
                                                          ------- ------- ------
      <S>                                                 <C>     <C>     <C>
      Crude Oil and Natural Gas Liquids (Bbls)...........   9,377  20,186  1,118
      Natural Gas (Mcf).................................. 336,730 372,678 84,546
</TABLE>
 
  The sales volumes in the table represent sales of "net production", i.e.,
production which is net to the Company and produced to its interest after
deducting royalty and other similar interests.
 
  Average Prices and Production Costs. For each of the last three years,
average unit prices and unit production costs are set forth below with respect
to the Company's net share of production of oil and gas in the United States:
 
<TABLE>
<CAPTION>
                                               AVERAGE SALES  AVERAGE OPERATING
                                                   PRICE      COSTS PER NBOE(1)
                                              --------------- ------------------
                                              PER BBL PER MCF PRODUCTION
                                                OIL     GAS   (LIFTING)  DD&A(2)
                                              ------- ------- ---------- -------
      <S>                                     <C>     <C>     <C>        <C>
      1997................................... $20.69   $2.59    $0.31     $1.20
      1996................................... $22.39   $2.60    $0.27     $1.73
      1995................................... $18.37   $1.76    $1.81     $7.50
</TABLE>
--------
(1) Net barrels of oil equivalent (NBOE) assuming natural gas converted at six
    Mcf per equivalent barrel.
(2) Excludes depreciation on seismic computer hardware and software of
    $575,706, $488,521 and $278,297 for the years ended December 31, 1997,
    1996 and 1995, respectively.
 
  Acreage and Well Summary. The information presented below relates to
properties in the United States in which the Company has "working interests"
which bear the cost of operations. The Company's total gross and net interests
in productive wells and in developed and undeveloped acres at December 31,
1997, are summarized as follows:
 
<TABLE>
<CAPTION>
                                                                  GROSS    NET
                                                                 ------- -------
                                                                 OIL GAS OIL GAS
                                                                 --- --- --- ---
      <S>                                                        <C> <C> <C> <C>
      Productive Wells(1).......................................  --   1  -- .08
      Developed Acres(2)........................................   349     28
      Undeveloped Acres(3)...................................... 11,817   5,729
</TABLE>
--------
(1) "Productive Wells" are producing wells and wells capable of production,
    and include gas wells awaiting pipeline connections or necessary
    governmental certifications to commence deliveries and oil wells to be
    connected to production facilities. No oil and gas reserves have been
    assigned by the Company at December 31, 1997 to the well in which it has a
    working interest.
(2) "Developed Acres" include all acreage (on a leasehold basis in the United
    States) as to which proved reserves are attributed, whether or not
    currently producing, but exclude all producing acreage as to which the
    Company's interest is limited to royalty, overriding royalty, and other
    similar interests.
(3) "Undeveloped Acres" are considered to be those lease acres on which wells
    have not been drilled or completed to a point that would permit the
    production of commercial quantities of oil or gas regardless of whether
    such acreage contains proved reserves.
 
                                      14
<PAGE>
 
  Drilling and Present Activities. The following table summarizes the oil and
gas drilling activities of the Company in the United States for each of the
three years ended December 31, 1997, 1996, and 1995, respectively:
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                                                -------------------------------
                                                  1997       1996       1995
                                                --------- ---------- ----------
                                                GROSS NET GROSS NET  GROSS NET
                                                ----- --- ----- ---- ----- ----
      <S>                                       <C>   <C> <C>   <C>  <C>   <C>
      Development Wells Drilled(1)(2):
        Productive.............................   --   --   --    --   --    --
        Dry....................................   --   --   --    --   --    --
      Exploratory Wells Drilled(1)(2):
        Productive.............................   --   --   --    --   --    --
        Dry....................................   --   --  1.0  .375  1.0  .125
                                                 ---  ---  ---  ----  ---  ----
          Total................................   --   --  1.0  .375  1.0  .125
                                                 ===  ===  ===  ====  ===  ====
</TABLE>
--------
(1) "Wells Drilled" refers to the number of wells completed at any time during
    the fiscal year, regardless of when drilling was initiated. The term
    "completed" refers to the installation of permanent equipment for the
    production of oil or gas, or, in the case of a dry hole, to the reporting
    of abandonment to the appropriate agency.
(2) A dry well is an exploratory or a development well found to be incapable
    of producing either oil or gas in sufficient quantities to justify
    completion as an oil or gas well. A productive well is an exploratory or a
    development well that is not a dry well.
 
  At December 31, 1997, the Company was not participating in any drilling
wells.
 
ITEM 3. LEGAL PROCEEDINGS
 
  There are no legal proceedings currently pending against the Company.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  No matters were submitted to a vote of the stockholders of the Company
during the fourth quarter of 1997.
 
                                      15
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
  The Common Stock and the Warrants have traded on The Nasdaq National Market
since August 19, 1997, and on the Nasdaq SmallCap Market since December 23,
1995 under the symbols "ZNRG" and "ZNRGW"; prior to that date they were quoted
on the OTC Bulletin Board under the symbols "TNER" and "TNERW", respectively.
Prior to December 23, 1995, the Units were quoted on the OTC Bulletin Board
under the symbol "TNERU"; the Units are no longer quoted on the OTC Bulletin
Board. There is very limited trading of the Units and pricing information is
not readily available. The high and low sales prices of the Common Stock, the
Warrants, and the Units during each quarter are presented in the table below.
The quotes represent "inter-dealer" prices without retail markups, markdown,
or commissions and may not necessarily represent actual transactions.
 
<TABLE>
<CAPTION>
                                COMMON STOCK          WARRANTS           UNITS(1)
                               -----------------   ---------------    --------------
                               HIGH($)    LOW($)   HIGH($)  LOW($)    HIGH($) LOW($)
                               -------    ------   -------  ------    ------- ------
<S>                            <C>        <C>      <C>      <C>       <C>     <C>
Three Months Ended
  March 31, 1996..............     7        5 1/8     2 3/8   1 5/16    N/A    N/A
  June 30, 1996...............     8        5 3/4     3 1/8   1 7/16    N/A    N/A
  September 30, 1996..........    7 1/4     4 1/2     3 1/8   1 3/8     N/A    N/A
  December 31, 1996...........    6 7/8     4 3/8     2 1/8   1 3/16    N/A    N/A
Three Months Ended
  March 31, 1997..............    7 7/8     6 1/8      3      1 5/8     N/A    N/A
  June 30, 1997...............    6 3/4     4 1/2     2 1/4    1        N/A    N/A
  September 30, 1997..........    5 3/4     4 1/8     2 1/8   0 7/8     N/A    N/A
  December 31, 1997...........    4 33/64    2        1 5/8   0 5/8     N/A    N/A
</TABLE>
--------
(1) The Units have not been quoted after December 23, 1995.
 
  As of March 2, 1998, there were 10,357,096 shares of the Company's Common
Stock outstanding held by approximately 74 holders of record. The Company
believes there are approximately 1,400 beneficial owners of the Common Stock.
 
DIVIDEND POLICY
 
  The Company has never paid a cash dividend on its Preferred Stock (prior to
its conversion) or its Common Stock. The Company currently intends to retain
its existing working capital and potential future earnings to finance the
growth and development of its business and does not anticipate paying any cash
dividends on the Common Stock in the foreseeable future. Any future change in
the Company's dividend policy will be made at the discretion of the Company's
Board of Directors in light of the financial condition, capital requirements,
earnings, and prospects of the Company and any restrictions under any credit
agreements, as well as other factors the Board of Directors may deem relevant.
 
SALES OF UNREGISTERED SECURITIES
 
  On December 2, 1997, the Company issued 150,000 shares of Common Stock to
the former shareholders of Wavefield Image, Inc. The merger agreement pursuant
to which the Company acquired Wavefield in July 1997 obligated the Company to
issue such shares upon the issuance of a U.S. patent claiming certain aspects
of the Wavefield Imaging Technology. Such a patent was issued on December 2,
1997. The shares were issued to 4 individuals, all former shareholders of
Wavefield, in reliance on Section 4(2) of the Securities Act of 1933, as
amended.
 
                                      16
<PAGE>
 
ITEM 6. SELECTED FINANCIAL DATA
 
  The selected financial data set forth below are derived from the
Consolidated Financial Statements of the Company that have been audited by
Arthur Andersen LLP, independent public accountants, for the periods
indicated. The financial data should be read in conjunction with the
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Company's Consolidated Financial Statements and Notes
thereto included elsewhere in this report.
 
<TABLE>
<CAPTION>
                                                                    PERIOD FROM
                                                                     INCEPTION
                                YEAR ENDED DECEMBER 31,          (MARCH 17, 1994)
                          -------------------------------------       THROUGH
                             1997         1996         1995      DECEMBER 31, 1994
                          -----------  -----------  -----------  -----------------
<S>                       <C>          <C>          <C>          <C>
SUMMARY OPERATIONS DATA:
  Operating Revenues....  $   958,304  $ 1,470,046  $   586,752      $      --
  Operating Costs and
   Expenses.............   (7,433,982)  (3,577,385)  (1,736,584)      (110,242)
                          -----------  -----------  -----------      ---------
  Operating Loss........   (6,475,678)  (2,107,339)  (1,149,832)      (110,242)
  Other Income
   (Expense), Net.......      323,551      249,207      (23,814)       (22,639)
                          -----------  -----------  -----------      ---------
  Net Loss..............  $(6,152,127) $(1,858,132) $(1,173,646)     $(132,881)
                          ===========  ===========  ===========      =========
  Weighted Average
   Shares of Common
   Stock Outstanding
   (Basic and Diluted)..    7,951,438    6,168,798    3,906,706      4,468,777
                          ===========  ===========  ===========      =========
  Loss Per Share of
   Common Stock
   Oustanding (Basic and
   Diluted).............  $     (0.77) $     (0.30) $     (0.30)     $   (0.03)
                          ===========  ===========  ===========      =========
<CAPTION>
                                     DECEMBER 31,
                          -------------------------------------
                             1997         1996         1995
                          -----------  -----------  -----------
<S>                       <C>          <C>          <C>          <C>
SUMMARY BALANCE SHEET
 DATA:
  Cash and Cash
   Equivalents..........  $12,200,306  $ 6,906,650  $   517,781
  Marketable Securities.           --      845,852   10,938,674
  Properties, Equipment,
   and Software--Net....      949,690    1,371,235      699,279
  Total Assets..........   15,676,450    9,911,602   12,582,405
  Total Stockholders'
   Equity...............   15,186,968    6,339,407    8,188,618
</TABLE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
OVERVIEW
 
  The Company (formerly "TN Energy Services Acquisition Corp.") was
incorporated in June 1993. Other than raising capital and reviewing
acquisition candidates, the Company did not engage in any significant business
activities prior to December 1995. Zydeco Exploration, the Company's wholly
owned subsidiary, was incorporated as an independently owned corporation in
March 1994. Zydeco Exploration immediately commenced exploration activities in
the Louisiana Transition Zone. On December 20, 1995, the Company acquired all
the outstanding common stock and preferred stock of Zydeco Exploration
pursuant to a merger (the "Merger") and changed its name to Zydeco Energy,
Inc. For accounting purposes, the Merger has been treated as a
recapitalization of Zydeco Exploration with Zydeco Exploration as the acquiror
(a reverse acquisition). Accordingly, the historical financial statements
prior to December 20, 1995, are those of Zydeco Exploration. No pro forma
information giving earlier effect to the transaction has been presented since
the transaction was accounted for as a recapitalization.
 
  In February 1996, the Company obtained an exclusive seismic permit covering
approximately 51,000 acres of state waters in western Cameron Parish,
Louisiana from the State of Louisiana for $783,754. The permit was initially
set to expire on August 18, 1997, and in August 1997, the Company extended the
permit period to February 18, 1998, by payment of an additional fee of
$391,877. During such period, the Company had the
 
                                      17
<PAGE>
 
exclusive right to nominate parcels of such area for competitive bidding for
drilling rights. Under the permit, the State of Louisiana is required to keep
the information obtained from the survey confidential for a period of ten
years. The Company has nominated approximately 55,000 net acres for bid at
State of Louisiana sales currently set for April and June 1998. The Company
intends to evaluate its participation in federal and state competitive bid
lease sales during 1998.
 
  In April 1996, the Company executed the Cheniere Exploration Agreement with
Cheniere Energy Operating Co., Inc. ("Cheniere"), formerly known as FX Energy,
Inc., for the West Cameron Seismic Project, covering an area of land and
waters in western Cameron Parish, Louisiana, including the area covered by the
seismic permit described above. Cheniere holds an interest of 50% in the West
Cameron Seismic Project. In exchange for such interest, Cheniere agreed to
fund the costs of seismic acquisition up to $13.5 million and 50% of such
costs in excess of $13.5 million. Such costs include the purchase of seismic
rights, the cost of lease options on the related onshore acreage of the West
Cameron Seismic Project, the purchase of other 3D seismic data, and data
acquisition and processing of a 3D seismic survey of the onshore and offshore
areas. Cheniere may elect to discontinue funding of the West Cameron Seismic
Project under certain circumstances, in which case its interest would be
reduced pro rata in relation to total project costs. At December 31, 1997
Cheniere had funded all of its share of this project's costs for which it had
been invoiced through such date. At December 31, 1997, pursuant to the terms
of the Cheniere Exploration Agreement, the Company had incurred third party
and processing costs in connection with the West Cameron Seismic Project
aggregating approximately $19,653,932, net of interest earned of $49,095 on
the unused project funds and $46,000 for the sale of seismic data. Through
December 31, 1997, Cheniere's share of these costs was $16,529,524 and
Zydeco's share was $3,124,408 under the Cheniere Exploration Agreement. During
the term of the Cheniere Exploration Agreement, the Company and Cheniere have
executed eight agreement amendments of which six amendments have granted
Cheniere extensions of time in which to pay invoices due under such agreement.
 
  On July 1, 1997, the Company acquired Wavefield Image, Inc., the owner and
licensor of the rights to the Wavefield Imaging Technology. A patent in
respect of the Wavefield Imaging Technology was issued by the United States
Patent and Trademark Office on December 2, 1997, see "Business--Seismic
Technology".
 
  In connection with the West Cameron Seismic Project, the Company began
onshore leasing and permitting in February 1996. On July 6, 1997, the seismic
data acquisition phase of the West Cameron Seismic Project, covering
approximately 230 square miles, was completed. The Company timely delivered
seismic data to the State of Louisiana in January 1998 in compliance with the
terms of the exclusive seismic permit.
 
  On August 26, 1997, the Company completed an offering of 3,680,000 shares of
Common Stock and warrants to purchase 320,000 shares of Common Stock (the
"Offering"). Proceeds from the Offering were approximately $14.1 million, net
of Offering expenses of approximately $1.6 million.
 
  The Company accounts for its oil and gas exploration and production
activities using the successful efforts method of accounting. Under this
method, acquisition costs for proved and unproved properties are capitalized
when incurred. Exploration costs, including geological and geophysical costs
and the costs of carrying and retaining unproved properties, are expensed.
Exploratory drilling costs are initially capitalized, but charged to expense
if and when the well is determined not to have found proved reserves. Costs of
productive wells, developmental dry holes, and productive leases are
capitalized and amortized on a property-by-property basis using the units-of-
production method. The estimated costs of future plugging, abandonment,
restoration, and dismantlement are considered as a component of the
calculation of depreciation, depletion, and amortization. Unproved properties
with significant acquisition costs are assessed periodically on a property-by-
property basis and any impairment in value is charged to expense.
 
RESULTS OF OPERATIONS
 
 YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
 
  The Company recorded a loss of $6,152,127, or $.77 per share, in the year
ended December 31, 1997 compared to a loss of $1,858,132 or $.30 per share, in
the year ended December 31, 1996. The increase in the loss is primarily due to
a $3,402,930 increase in exploration expenses in 1997 over 1996. However, also
 
                                      18
<PAGE>
 
contributing to the increase in the loss from 1996 to 1997 were a drop of
$355,538 in oil and gas revenues and increases of $304,372 in general and
administrative expenses and $128,010 in research and development expense.
 
  The increase in exploration expenses was primarily due to the Company's
participation under the Cheniere Exploration Agreement governing activities on
the West Cameron Seismic Project. The Company's 50% share of costs directly
attributable to this project amounted to $3,124,408 in 1997. The Company had
no comparable exploration expense in 1996 because, pursuant to the terms of
such agreement, Cheniere paid nearly all of this project's 1996 costs. The
remainder of the exploration expenses increase is principally due to other
geological and geophysical expenses which are mostly composed of salaries and
related payroll burdens of the Company's exploration department staff. Other
geological and geophysical expenses increased approximately $278,522 in 1997
over 1996 primarily due to an increase of the exploration staff from four
individuals in late 1996 to ten individuals by mid 1997. General and
administrative expenses also increased because of additional personnel costs
and increased rent due to a move to a larger office space in mid 1996. In
addition, the Company commenced a research and development program in mid
1997. The Company had no comparable research and development expense in 1996.
The Company expects that its current level of exploration, general and
administrative, and research and development expenses will continue into the
near future. However, because the Company utilizes the successful efforts
method of accounting, exploration expenses typically vary materially from
period to period based upon exploration program activities, the Company's cost
participation and other factors.
 
  Total revenues decreased $511,742 in 1997 from 1996 due to a combination of
decreased oil and gas sales and a loss on the sale of the Company's interest
in the Bay Marchand prospect area. Oil and gas sales dropped from $1,422,227
in 1996 to $1,066,689 in 1997 primarily due to sales volumes of oil and gas
declining 54% and 10%, respectively. The decline in such sales volumes is
attributable to natural production declines of the two wells in which the
Company has interests. Although it expects that the production rates of these
wells will continue to decline during the near term, the Company cannot
ascertain whether the rates experienced in 1997 will continue throughout 1998.
The Company has not assigned any oil and gas reserves at December 31, 1997 to
one of these wells. Compared to a $16,319 gain on sales of properties in 1996,
the Company recorded a $108,385 loss on sales of properties in 1997. Because
the Company will continue to develop and then sell some portion or all of its
interest in prospects to other industry participants, the Company will
continue to record gains or losses for these transactions. However, the timing
of such sales and the extent of their gain or loss are due to a number of
factors such as, but not limited to, the timing and cost of lease
acquisitions, the availability of leaseholds in particular prospect areas and
market conditions, both generally and in the oil and gas industry, at the time
of sale.
 
  The increase in the net loss per share from $.30 in 1996 to $.77 in 1997 was
also affected by an increase in the weighted average number of the Company's
Common Shares (basic and diluted) due to the issuance of 3,680,000 shares in
the Offering in August 1997.
 
 YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
 
  Compared to a loss of $1,173,646, or $.30 per share in 1995, the Company
posted a loss of $1,858,132, or $.30 per share in 1996. The $684,486 increase
in the net loss is mostly attributable to the Company's increased exploration
efforts. Partly offsetting those expenses and as a result of those efforts,
oil and gas sales increased by $1,252,992, or 740%, to $1,422,227 for the year
ended December 31, 1996, from $169,235 for the year ended December 31, 1995.
Of this increase, $856,961 was attributable to an increase in production
volumes and $396,031 was due to increases in the average prices for oil and
gas. Of the increase in oil and gas sales, such sales from one well, which
commenced production in December 1995, aggregated $1,007,613. Partly
offsetting this rise in oil and gas sales, seismic services and gains on sales
of properties declined $268,500 and $101,198, respectively. The drop in
seismic services is mostly attributable to the substantial completion of two
contracts in 1995. The Company did not have a comparable source of revenues in
1996.
 
  Exploration expenses increased $1,006,964, or 152%, to $1,667,523 for the
year ended December 31, 1996, from $660,559 for the year ended December 31,
1995. The increase was due to dry hole costs of $647,355
 
                                      19
<PAGE>
 
incurred on one well abandoned in September 1996 and increased exploration
expense of $569,354 related to increased personnel costs associated with the
Company's two exploration projects. Depreciation, depletion, and amortization
("DD&A") expense increased $238,478, or 61%, to $630,865 in 1996 from $392,387
in 1995. DD&A expense on oil and gas properties was $142,344 in 1996 compared
to $114,090 in 1995. Depreciation and amortization expense of equipment and
software increased $210,224, or 76%, to $488,521 in 1996 from $278,297 in 1995
principally as a result of additions aggregating $818,497 in computer
equipment and geophysical software. General and administrative expenses
increased $800,343, or 175%, to $1,256,489 in 1996 from $456,146 in 1995
principally due to increases in the costs associated with payroll and related
burdens of additional personnel amounting to $262,587 and estimated additional
costs of public company reporting and related costs of $172,549.
 
  Other income increased $273,021 for the year ended December 31, 1996,
compared to other expense of $23,814, for the year ended December 31, 1995,
principally due to increased interest income resulting from the investment of
cash equivalents and marketable securities acquired in the merger with TN
Energy in December 1995.
 
  For the years ended December 31, 1996 and 1995, the net loss per share
amounted to $.30 per share despite an increase in the net loss to $1,858,132
from $1,173,646 in those respective years. The net loss per share computation
was affected by the issuance of shares in connection with the Merger in
December 1995 and the conversion of all outstanding preferred stock to common
stock in mid 1996.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  The Company has generated funds from public and private equity offerings,
cash flow from the Company's operations, and cash payments made to it under
the Fortune Exploration Agreement and the Cheniere Exploration Agreement. The
Company may use its cash for any general corporate purposes except for the
funds advanced under such agreements, which are committed to the project
operations for which they were intended. Sources of funds include
approximately $24.1 million from the sale of securities in 1993, 1994, 1995
and 1997, $4.8 million in advances in 1995 under the Fortune Exploration
Agreement, and $16.4 million, as of December 31, 1997, provided under the
Cheniere Exploration Agreement. The Company does not currently hold any funds
advanced under either the Fortune Exploration Agreement or the Cheniere
Exploration Agreement.
 
  The Company expects that capital needs for 1998 will be satisfied through
cash on hand of approximately $12.2 million at December 31, 1997, and cash
expected to be made available under the Cheniere Exploration Agreement.
However, the total amount of expenditures is unknown at this time due to
factors such as, but not limited to, leasehold availability, lease terms of
potential leaseholds which may yet be negotiated or bid on in lease sales,
future potential operations proposed under the terms of operating or other
agreements to which the Company is a participant or may become a participant
and the timing of expenditures related to the performance of these activities.
The Company's ability to access additional capital will also depend on a
number of factors including its success in acquiring oil and gas leaseholds,
attracting industry participants to participate in the exploration of and
sharing of costs of such leaseholds and finding commercially productive
hydrocarbon deposits. The Company does not presently maintain any credit
facilities.
 
  The Company expects to use its available cash to acquire leases and develop
potential prospects in the West Cameron Seismic Project area and for other
general corporate purposes. The Company's share of the budgeted costs could
increase if Cheniere discontinues its share of funding of the West Cameron
Seismic Project costs or elects not to participate in any or all of the
potential prospects. There is no assurance that Cheniere will continue to fund
its full share of costs under the Cheniere Exploration Agreement. Such
additional costs and other capital needs may be funded from available cash of
the Company, the issuance of additional equity securities, including the
exercise of outstanding warrants and options of the Company, securing
additional industry participants, or the sale of prospects, if any, identified
in the Company's projects. The Company anticipates that it may sell an
interest in the West Cameron Seismic Project as a whole for the exploration
and development of potential prospects, or may seek to develop its potential
prospects, if any, in the West Cameron Seismic Project by selling
 
                                      20
<PAGE>
 
interests in individual prospects or groups of prospects. In the future, in
the event the Company increases oil and gas production through the successful
completion of oil and gas wells, the Company may consider obtaining a credit
facility. There can be no assurance that the Company will be successful in
securing additional participants, additional project financing or credit
financing.
 
  The Company's current 1998 budgeted capital expenditures are approximately
$7.9 million, including $5.5 million related to the acquisition of oil and gas
leases and $1.5 million for drilling on these leases. Should the Company sell
interests in the West Cameron Seismic Project and/or prospects generated from
such project, the estimated capital expenditures may be reduced by proceeds
from such sales and/or reduced expenditures attributed to reduced working
interest share of expenditures. The Company may also engage in the drilling of
other prospects identified by the Company, the acquisition of interests in
producing wells, and other oil and gas exploration and production related
investment opportunities determined by management and the Board of Directors
to be in the interest of the Company. The amount and timing of these
expenditures will be dependent upon numerous factors including the
availability of capital to the Company, availability of seismic data, the
number and type of drilling prospects, if any, identified as a result of the
Company's 3D seismic analysis, the terms under which industry participants may
participate in the Company's prospects, and the cost of drilling and
completing wells in the Louisiana Transition Zone.
 
  The Company has incurred net losses and negative cash flows from operations
since its inception in 1994. The Company does not expect to generate operating
cash flow or net income in 1998 unless it sells substantial interests in
prospects generated from the West Cameron Seismic Project or interests in such
project. The Company contemplates that the sale of such interests would
include prospect development commitments and financing provided by the
purchasers coupled with retained interests and back-in rights to the Company,
and additional cash consideration to the Company for recoupment of costs
incurred in identifying such prospective interests. As generally required by
the successful efforts method of accounting, the Company has expensed all of
its costs in the West Cameron Seismic Project as of December 31, 1997, and
accordingly, payments for the recoupment of non-capitalized costs would be
treated as income to the Company. There can be no assurance that the Company
will be successful in the selling of significant interests or in receiving
payments for the recoupment of the Company's costs incurred to date on this
project.
 
  The Company currently maintains a $300,000 bond required to hold its present
federal oil and gas leases. This bond is collateralized by a United States
Treasury Note. In the event that the Company would act as operator on a
federal offshore lease or is otherwise required to increase its bonding by
federal or state authorities, significant amounts of capital may be required
for additional collateral to satisfy bonding requirements.
 
  The Company is unaware of any possible exposure from actual or potential
claims or lawsuits involving environmental matters. As such, no liability is
accrued at December 31, 1997.
 
YEAR 2000 COMPLIANCE
 
  The Company does not expect to incur any material cost to modify and replace
its information technology infrastructure to be Year 2000 compliant. The
Company does not anticipate any material disruption in its operations as a
result of any failure by the Company to be in compliance. The Company does not
currently have any information concerning the Year 2000 compliance status of
its suppliers and customers. In the event that any of the Company's
significant suppliers or customers do not successfully and timely achieve Year
2000 compliance, the Company's business or operations could be adversely
affected. The Company has not incurred significant costs related to Year 2000
compliance prior to December 31, 1997, other than immaterial internal costs to
evaluate the extent of compliance.
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
  The financial statements required by this Item are incorporated under Item
14 in Part IV of this report.
 
                                      21
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
 
  The information required by this item has been previously reported in
accordance with the rules and regulations under the Securities Exchange Act of
1934.
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT*
 
ITEM 11. EXECUTIVE COMPENSATION*
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT*
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS*
 
--------
*  Items 10, 11, 12, and 13 are incorporated by reference to the registrant's
   Definitive Proxy Statement to be filed with the Commission pursuant to
   Regulation 14A under the Securities Exchange Act of 1934 within 120 days
   after the close of the registrant's fiscal year.
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
(a)(1) FINANCIAL STATEMENTS
 
  See "Index to Consolidated Financial Statements" set forth on page F-1.
 
(a)(2) FINANCIAL STATEMENT SCHEDULES
 
  Not applicable.
 
(a)(3) EXHIBITS
 
  See pages E-1 through E-2 for a listing of exhibits.
 
  The exhibits to this report have been included only with the copies of this
report filed with the Securities and Exchange Commission. Copies of individual
exhibits will be furnished to stockholders upon written request to Chief
Accounting Officer, Zydeco Energy, Inc., 1710 Two Allen Center, 1200 Smith
Street, Houston, Texas 77002 with payment of a reasonable fee.
 
(B) REPORTS ON FORM 8-K
 
  The Company filed a Current Report on Form 8-K on November 17, 1997,
announcing its results of operation for the three months and nine months ended
September 30, 1997. In addition, the Company issued its Report to Shareholders
describing several important events that occurred during the quarter ended
September 30, 1997.
 
                                      22
<PAGE>
 
                                  SIGNATURES
 
  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF
HOUSTON, STATE OF TEXAS.
 
                                          ZYDECO ENERGY, INC.
                                           (Registrant)
 
Date: March 27, 1998                      By:     /s/ Sam B. Myers, Jr.
                                             ----------------------------------
 
                                                    SAM B. MYERS, JR.
                                                CHAIRMAN OF THE BOARD AND
                                                 CHIEF EXECUTIVE OFFICER
 
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
 
<TABLE>
<S>  <C>
</TABLE>
              SIGNATURE                      TITLE                   DATE
 
    /s/ Sam B. Myers, Jr.            Chairman of the           March 27, 1998
-----------------------------------   Board and Chief
      SAM B. MYERS, JR.               Executive Officer
                                      (Principal
                                      Executive Officer)
 
    /s/ Edward R. Prince, Jr.        Director and Vice         March 27, 1998
-----------------------------------   Chairman of the
      EDWARD R. PRINCE, JR.           Board
 
    /s/ John O. Smith                Director, President,      March 27, 1998
-----------------------------------   and Chief Operating
      JOHN O. SMITH                   Officer
 
    /s/ John Misitigh                Chief Accounting          March 27, 1998
-----------------------------------   Officer and
      JOHN MISITIGH                   Controller
                                      (Principal
                                      Accounting Officer)
 
    /s/ Philip A. Tuttle             Director                  March 27, 1998
-----------------------------------
      PHILIP A. TUTTLE
 
    /s/ Harry C. Johnson             Director                  March 27, 1998
-----------------------------------
      HARRY C. JOHNSON
 
    /s/ Charles E. Bradley, Sr.      Director                  March 27, 1998
-----------------------------------
      CHARLES E. BRADLEY, SR.
 
                                      23
<PAGE>
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
<TABLE>
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS.................................. F-2
CONSOLIDATED FINANCIAL STATEMENTS
  Consolidated Balance Sheets as of December 31, 1997 and 1996............ F-3
  Consolidated Statements of Operations for the Three Years Ended December
   31, 1997............................................................... F-4
  Consolidated Statements of Stockholders' Equity for the Three Years
   Ended December 31, 1997................................................ F-5
  Consolidated Statements of Cash Flows for the Three Years Ended December
   31, 1997............................................................... F-6
  Notes to Consolidated Financial Statements.............................. F-7
</TABLE>
 
                                      F-1
<PAGE>
 
                   REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
 
TO THE STOCKHOLDERS AND THE BOARD OF DIRECTORS OF ZYDECO ENERGY, INC.:
 
  We have audited the accompanying consolidated balance sheets of Zydeco
Energy, Inc. (a Delaware corporation) and subsidiaries as of December 31,
1997, and 1996, and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 1997. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Zydeco Energy, Inc. and
subsidiaries as of December 31, 1997, and 1996, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
 
                                          ARTHUR ANDERSEN LLP
 
Houston, Texas
March 4, 1998
 
                                      F-2
<PAGE>
 
                      ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
                          CONSOLIDATED BALANCE SHEETS
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                       -----------------------
                        ASSETS                            1997         1996
                        ------                         -----------  ----------
<S>                                                    <C>          <C>
CURRENT ASSETS
  Cash and Cash Equivalents........................... $12,200,306  $6,906,650
  Marketable Securities...............................          --     845,852
  Oil and Gas Revenue Receivables.....................     151,957     327,975
  Exploration Receivable..............................     102,524          --
  Prepaid Expenses....................................     974,139     130,495
  Other Current Assets................................      54,376      21,244
                                                       -----------  ----------
    Total Current Assets..............................  13,483,302   8,232,216

Oil & Gas Properties, Using Successful Efforts Method
 of Accounting
  Proved Properties...................................     334,972     300,784
  Unproved Properties.................................      27,600     488,290
Equipment and Software, at Cost.......................   2,254,139   1,608,207
                                                       -----------  ----------
                                                         2,616,711   2,397,281
Less: Accumulated Depreciation, Depletion, and
 Amortization.........................................  (1,667,021) (1,026,046)
                                                       -----------  ----------
                                                           949,690   1,371,235
Investment in Wavefield Imaging Technology............     933,409          --
Operating Bond and Other Assets.......................     310,049     308,151
                                                       -----------  ----------
TOTAL ASSETS.......................................... $15,676,450  $9,911,602
                                                       ===========  ==========
<CAPTION>
         LIABILITIES AND STOCKHOLDERS' EQUITY
         ------------------------------------
<S>                                                    <C>          <C>
CURRENT LIABILITIES
  Accounts Payable.................................... $   436,941  $  692,188
  Accrued Liabilities.................................      52,541     232,738
  Exploration Obligations.............................          --   2,489,732
  Capital Lease Obligation............................          --     157,537
                                                       -----------  ----------
    Total Current Liabilities.........................     489,482   3,572,195

Commitments and Contingencies (Note 10)

STOCKHOLDERS' EQUITY
  Common Stock, Par Value $.001 Per Share; 50,000,000
   Shares Authorized; 11,318,351 and 7,374,905 Shares
   Issued; 10,537,096 and 6,593,650 Shares
   Outstanding, Respectively..........................      11,318       7,375
  Additional Paid-In Capital..........................  24,499,688   9,503,943
  Accumulated Deficit.................................  (9,316,786) (3,164,659)
  Less Treasury Stock, at Cost; 781,255 Shares........      (7,252)     (7,252)
                                                       -----------  ----------
    Total Stockholders' Equity........................  15,186,968   6,339,407
                                                       -----------  ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY             $15,676,450  $9,911,602
                                                       ===========  ==========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-3
<PAGE>
 
                      ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 
<TABLE>
<CAPTION>
                                              YEARS ENDED DECEMBER 31,
                                         -------------------------------------
                                            1997         1996         1995
                                         -----------  -----------  -----------
<S>                                      <C>          <C>          <C>
REVENUES
  Oil and Gas Sales..................... $ 1,066,689  $ 1,422,227  $   169,235
  Gain/(Loss) on Sales of Properties....    (108,385)      16,319      117,517
  Seismic Services......................          --       31,500      300,000
                                         -----------  -----------  -----------
                                             958,304    1,470,046      586,752
EXPENSES
  Exploration Expenses
    Geological and Geophysical..........   4,958,060      967,957      398,603
    Dry Hole and Other Costs............     112,393      699,566      261,956
  Production Costs......................      20,413       22,508       27,492
  Seismic Services Costs................          --           --      200,000
  Research and Development Costs........     128,010           --           --
  Depreciation, Depletion, and
   Amortization.........................     654,245      630,865      392,387
  General and Administrative............   1,560,861    1,256,489      456,146
                                         -----------  -----------  -----------
                                           7,433,982    3,577,385    1,736,584
OPERATING LOSS..........................  (6,475,678)  (2,107,339)  (1,149,832)

OTHER INCOME (EXPENSE)
  Interest Income.......................     336,513      293,414       46,555
  Interest Expense......................     (12,962)     (44,207)     (70,369)
                                         -----------  -----------  -----------
                                             323,551      249,207      (23,814)
NET LOSS................................ $(6,152,127) $(1,858,132) $(1,173,646)
                                         ===========  ===========  ===========
PER COMMON SHARE--
  WEIGHTED AVERAGE NUMBER OF COMMON
   SHARES OUTSTANDING (BASIC AND
   DILUTED).............................   7,951,438    6,168,798    3,906,706
                                         ===========  ===========  ===========
NET LOSS PER COMMON SHARE
  (BASIC AND DILUTED)................... $     (0.77) $     (0.30) $     (0.30)
                                         ===========  ===========  ===========
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-4
<PAGE>
 
                      ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
 
<TABLE>
<CAPTION>
                            CONVERTIBLE
                          PREFERRED STOCK      COMMON STOCK     ADDITIONAL                              TOTAL
                          ----------------  -------------------   PAID-IN    ACCUMULATED  TREASURY  STOCKHOLDERS'
                           SHARES   AMOUNT    SHARES    AMOUNT    CAPITAL      DEFICIT     STOCK       EQUITY
                          --------  ------  ----------  ------- -----------  -----------  --------  -------------
<S>                       <C>       <C>     <C>         <C>     <C>          <C>          <C>       <C>
BALANCE AT DECEMBER 31,
 1994...................   781,255  $ 781    4,468,777  $ 4,469 $ 2,195,278  $  (132,881) $    --    $ 2,067,647
Net Loss................        --     --           --       --          --   (1,173,646)      --     (1,173,646)
Issuance of Common Stock
 Prior to Merger........        --     --      218,753      219        (175)          --       --             44
Acquisition of Treasury
 Stock..................        --     --     (781,255)      --          --           --   (7,252)        (7,252)
Issuance of Common Stock
 to Acquire TN Energy...        --     --    1,875,000    1,875   7,969,650           --       --      7,971,525
Costs of the Merger.....        --     --           --       --    (669,700)          --       --       (669,700)
                          --------  -----   ----------  ------- -----------  -----------  -------    -----------
BALANCE AT DECEMBER 31,
 1995...................   781,255    781    5,781,275    6,563   9,495,053   (1,306,527)  (7,252)     8,188,618
Net Loss................        --     --           --       --          --   (1,858,132)      --     (1,858,132)
Options & Warrants
 Exercised for Common
 Stock..................        --     --       31,154       31       8,890           --       --          8,921
Adjustment for
 Fractional Shares Paid
 in Cash................        --     --          (34)      --          --           --       --             --
Conversion of Preferred
 Stock to Common Stock..  (781,255)  (781)     781,255      781          --           --       --             --
                          --------  -----   ----------  ------- -----------  -----------  -------    -----------
BALANCE AT DECEMBER 31,
 1996...................        --     --    6,593,650    7,375   9,503,943   (3,164,659)  (7,252)     6,339,407
Net Loss................        --     --           --       --          --   (6,152,127)      --     (6,152,127)
Options & Warrants
 Exercised for Common
 Stock..................        --     --       13,450       13      18,486           --       --         18,499
Issuance of Common Stock
 Related to the
 Wavefield Image, Inc.
 Acquisition............        --     --      250,000      250     924,750           --       --        925,000
Issuance of Common Stock
 Related to the Public
 Offering...............        --     --    3,680,000    3,680  15,636,420           --       --     15,640,100
Costs of the Offering...        --     --           --       --  (1,583,911)          --       --     (1,583,911)
Adjustment for
 Fractional Shares Paid
 in Cash................        --     --           (4)      --          --           --       --             --
                          --------  -----   ----------  ------- -----------  -----------  -------    -----------
BALANCE AT DECEMBER 31,
 1997...................        --  $  --   10,537,096  $11,318 $24,499,688  $(9,316,786) $(7,252)   $15,186,968
                          ========  =====   ==========  ======= ===========  ===========  =======    ===========
</TABLE>
 
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-5
<PAGE>
 
                      ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 
<TABLE>
<CAPTION>
                                              YEARS ENDED DECEMBER 31,
                                         -------------------------------------
                                            1997         1996         1995
                                         -----------  -----------  -----------
<S>                                      <C>          <C>          <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Loss...............................  $(6,152,127) $(1,858,132) $(1,173,646)
Adjustments to Reconcile Net Loss to
 Net Cash Used in Operating Activities:
  Depreciation, Depletion, and
   Amortization........................      654,245      630,865      392,387
  Impairment/Abandonment of Unproved
   Leases..............................        6,570       28,005           --
  (Gain)/Loss on Sales of Properties...      108,385      (16,319)    (117,517)
  Exploration and Dry Hole Costs.......    5,063,884    1,639,519      660,559
  Changes in Operating Assets and
   Liabilities
    (Increase) Decrease in Oil & Gas
     Revenue Receivables...............      176,018     (260,951)     (67,024)
    (Increase) Decrease in Other
     Current Assets....................       33,104     (105,193)     (34,638)
    Increase (Decrease) in Accounts
     Payable...........................      (18,763)    (185,288)     183,070
    Decrease in Accrued Liabilities....      (72,276)    (123,095)    (145,487)
    Other..............................       (6,085)          --        3,040
                                         -----------  -----------  -----------
  Net Cash Used in Operating
   Activities..........................     (207,045)    (250,589)    (299,256)
CASH FLOWS FROM INVESTING ACTIVITIES:
  Additions to Oil and Gas Properties..  $   (37,347) $  (507,377) $   (77,573)
  Exploration and Dry Hole Costs.......   (5,044,471)  (1,639,519)    (660,559)
  Proceeds from the Sale of Properties.      373,335       16,319      100,000
  Cost Recovery on Exploration
   Agreement...........................           --           --      628,547
  Net Change in Exploration Obligation.   (1,051,461)      90,214    3,210,477
  Distributions to Exploration
   Participant.........................   (2,114,638)    (217,704)          --
  Increase In Prepaid Computer Lease...     (909,880)          --           --
  Purchases of Equipment and Software..     (320,205)    (818,497)    (140,352)
  Investment in Wavefield Imaging
   Technology..........................      (25,272)          --           --
  Proceeds from the Sale of (Investment
   in) Marketable Securities, Net......      845,852   10,092,822  (10,938,674)
                                         -----------  -----------  -----------
  Net Cash Provided by (Used in)
   Investing Activities................   (8,284,087)   7,016,258   (7,878,134)
CASH FLOWS FROM FINANCING ACTIVITIES:
  Common Stock Issued in Reverse
   Acquisition of TN Energy............  $        --  $        --  $ 8,196,553
  Costs of Acquisition of TN Energy....           --           --     (168,380)
  Principal Payments of Capital Lease
   Obligations.........................     (157,537)    (160,693)    (208,973)
  Repayments of Short-Term Debt........           --     (225,028)          --
  Proceeds from Options and Warrants
   Exercised...........................       18,499        8,921           --
  Proceeds from Common Stock Issuances,
   Net.................................   13,923,826           --           44
                                         -----------  -----------  -----------
Net Cash Provided by (Used in)
 Financing Activities..................   13,784,788     (376,800)   7,819,244
                                         -----------  -----------  -----------
Net Increase (Decrease) in Cash and
 Cash Equivalents......................  $ 5,293,656  $ 6,388,869  $  (358,146)
Cash and Cash Equivalents at Beginning
 of Year...............................    6,906,650      517,781      875,927
                                         -----------  -----------  -----------
Cash and Cash Equivalents at End of
 Year..................................  $12,200,306  $ 6,906,650  $   517,781
                                         ===========  ===========  ===========
Cash Paid during the Year for:
  Interest.............................  $    12,962  $    46,296  $    70,369
  Income Taxes.........................  $        --  $        --  $        --
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-6
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
 
  Organization. Zydeco Energy, Inc. was incorporated in Delaware in June 1993,
as a "special purpose acquisition corporation" under the name TN Energy
Services Acquisition Corp. ("TN Energy"), for the purpose of raising funds and
acquiring an operating business engaged in the energy services industry. Other
than its efforts to acquire an energy services business, TN Energy did not
engage in any business activities prior to December 1995. On December 20,
1995, TN Energy acquired all the outstanding common stock and preferred stock
of Zydeco Exploration, Inc. ("Zydeco") pursuant to a merger (the "TN
Acquisition") and changed its name to Zydeco Energy, Inc. As used herein,
unless the context indicates otherwise, the term "Company" refers to Zydeco
Energy, Inc., and its wholly-owned subsidiaries, Zydeco Exploration, Inc., and
Wavefield Image, Inc.
 
  The Company is engaged in identifying drilling prospects, acquiring leases,
drilling, and producing reserves from those properties utilizing focused
geologic concepts and advanced 3D seismic technology. The Company's current
focus is to explore for oil and gas in the Louisiana Transition Zone, the
region of land and shallow waters within a few miles of the shoreline. The
Company's future operations are dependent upon a variety of factors,
including, but not limited to, successful application of 3D seismic evaluation
and interpretation expertise in developing oil and gas prospects, future
generation of 3D seismic analysis fees, profitable exploitation of future
prospects, and the Company's ability to access capital sources necessary for
continued growth.
 
SIGNIFICANT ACCOUNTING POLICIES
 
  Basis of Presentation. For accounting purposes, the TN Acquisition has been
treated as a recapitalization of Zydeco with Zydeco as the acquiror (reverse
acquisition). Accordingly, the historical financial statements prior to
December 20, 1995, are those of Zydeco. The consolidated financial statements
include the accounts of the Company, and its wholly-owned subsidiaries, Zydeco
Exploration, Inc., and, since July 1, 1997, Wavefield Image, Inc. (see "Note
3--Acquisitions"). All significant intercompany transactions have been
eliminated in consolidation.
 
  In connection with the Company's two exploration agreements (See "Note 2--
Exploration Agreements"), advances to the Company are treated as exploration
obligations and expenditures made by the Company pursuant to the exploration
agreements are charged against the related exploration obligation. No costs or
expenses incurred pursuant to the exploration agreements are recognized by the
Company until the Company, pursuant to the terms of the exploration
agreements, begins sharing in such costs.
 
  Cash and Cash Equivalents. The Company considers all highly liquid
investments purchased with original maturities of three months or less to be
cash equivalents.
 
  Marketable Securities. The Company's investments in marketable securities at
December 31, 1996 primarily consisted of short-term U.S. Treasury bills. As
the Company's investments in marketable securities are all short-term in
nature, their carrying value at December 31, 1996 approximated fair value.
 
  Oil and Gas Properties. The Company accounts for its oil and gas exploration
and production activities using the successful efforts method of accounting.
Under this method, acquisition costs for proved and unproved properties are
capitalized when incurred. Exploration costs, including geological and
geophysical costs and the costs of carrying and retaining unproved properties,
are expensed. Exploratory drilling costs are initially capitalized, but
charged to expense if and when the well is determined not to have found proved
reserves. Costs of productive wells, developmental dry holes and productive
leases are capitalized and amortized on a property-by-property basis using the
units-of-production method. The estimated costs of future plugging,
abandonment, restoration and dismantlement are considered as a component of
the calculation of depreciation, depletion, and
 
                                      F-7
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

amortization. Unproved properties with significant acquisition costs are
assessed periodically, as conditions warrant, on a property-by-property basis
and any impairment in value is charged to expense.
 
  Equipment. Hardware and software associated with the 3D seismic technology
equipment, office furniture, and leasehold improvements are recorded at cost,
and the related depreciation is calculated on a straight-line basis over the
estimated useful lives of the assets, which range from 2 to 7 years.
 
  Impairment of Long-Lived Assets. In accordance with the provisions of
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of", management reviews its long-lived assets (i.e., oil and gas properties
and equipment) whenever events or changes in circumstances indicate that the
carrying amounts of such assets may not be recoverable. If the carrying
amounts of any of the Company's oil and gas properties or equipment are
greater than their projected undiscounted future cash flows, an impairment
loss to adjust the properties or equipment to fair value is recognized. This
determination of future cash flows from proved properties is based on current
proved oil and gas reserve estimates and current oil and gas prices and costs.
Management's estimates of fair value also reflect a discount factor on future
cash flows consistent with the rate used by the Company in other fair-value
determinations. Through December 31, 1997, no such provision for impairment
was necessary.
 
  Income Taxes. The Company follows SFAS No. 109 which requires the asset and
liability approach to accounting for income taxes. Under this approach,
deferred income taxes are determined based upon differences between the
financial statement and tax bases of the Company's assets and liabilities and
operating loss carryforwards using enacted tax rates in effect for the years
in which the differences are expected to reverse. Deferred tax assets are
recognized if it is more likely than not that the future tax benefit will be
realized.
 
  Oil and Gas Revenues. Oil and gas revenues are recorded using the
entitlements method of accounting, whereby the Company recognizes oil and gas
revenues as its entitled share is produced. Individually and in the aggregate,
the Company has no material gas imbalances as of December 31, 1997.
 
  Seismic Service Revenues. Seismic service revenues are recognized as
services are performed.
 
  Earnings Per Share. In February 1997, the Financial Accounting Standards
Board issued SFAS No. 128, "Earnings Per Share", which established new
standards for computing and presenting earnings per share. The provisions of
the statement are effective for fiscal years ending after December 15, 1997,
and requires that all prior periods be restated, and accordingly have been
adopted in the accompanying financial statements. Basic and diluted earnings
per share, as reported, are the same as the earnings per share as calculated
in accordance with Accounting Principles Board ("APB") Opinion No. 15, the
previous earnings per share standard. Basic earnings per common share is based
on the weighted average number of shares of common stock outstanding during
the period. The Company's common stock options, common stock warrants, and
convertible preferred stock are potential common shares but were anti-dilutive
in all periods presented.
 
  Treasury Stock. Treasury stock is recorded at cost and represents the value
of 781,255 common shares purchased in January 1995 from an officer of the
Company in consideration for an overriding royalty interest in certain
properties in which the Company had an interest at the time of the treasury
stock purchase. The Company had no proved reserves at the time of the
transaction. The cost of treasury stock of $7,252 was determined on the basis
of a pro-rata allocation of the Company's accumulated cost in unproved
properties at the time of the transaction in comparison to the net revenue
interest transferred.
 
  Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the
 
                                      F-8
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Significant estimates with regard
to these financial statements include the estimate of proved oil and gas
reserve volumes and the related discounted future net cash flows therefrom.
See "Note 13--Oil and Gas Producing Activities".
 
  Reclassifications. Certain reclassifications of prior period amounts have
been made to conform with current year presentation.
 
2. EXPLORATION AGREEMENTS.
 
  Fortune Exploration Agreement. In February 1995, Zydeco entered into an
Exploration Agreement (the "Fortune Agreement") with a predecessor of Fortune
Petroleum Corporation ("Fortune"). Under the Fortune Agreement, Fortune
advanced $4.8 million in a series of payments to purchase a 50% interest in
certain potential prospects ("Prospects") owned by the Company and to fund the
initial development of the potential Prospects. Pursuant to the Fortune
Agreement, $628,547 represented a reimbursement of certain of the costs
previously incurred by the Company on the potential Prospects. The remaining
funds were designated for all third-party costs of preparing the potential
Prospects for evaluation, including lease acquisition, lease maintenance, and
the acquisition, processing and interpretation of seismic data. Thereafter,
the Fortune Agreement provided that the parties shall bear any additional
costs equally. At December 31, 1996, and 1995, the portion not yet expended
was recorded as an exploration obligation and classified as a current
liability. At December 31, 1997, inception-to-date expenditures under the
Fortune Agreement aggregated approximately $2,256,823, net of interest earned
of $209,731 and revenue from the farmout and sale of interests of $277,154.
 
  Pursuant to the terms of the Fortune Agreement, in June 1997, at the request
of Fortune, the Company returned $2,153,645 to Fortune, representing the
unexpended funds previously advanced to the Company under the Fortune
Agreement. The Company will retain its undivided working interest in each of
the existing properties acquired under the Fortune Agreement. Substantially
all the cost of lease acquisition and seismic data acquisition had been
incurred at the time of Fortune's election. The Company is continuing to
evaluate certain of the prospects that could merit further evaluation or
development. The Company does not expect to incur any significant additional
expenditures pursuant to the terms of such agreement.
 
  Cheniere Exploration Agreement. In April 1996, the Company executed an
Exploration Agreement (the "Cheniere Agreement") with Cheniere Energy
Operating Co., Inc. ("Cheniere"), formerly known as FX Energy, Inc., covering
an area of land and waters in western Cameron Parish, Louisiana ("West Cameron
Seismic Project"). The Cheniere Agreement, as amended, provided for Cheniere
to fund the first $13.5 million of costs plus 50% of costs in excess of $13.5
million of the West Cameron Seismic Project. The costs covered by the Cheniere
Agreement include the costs of 3D seismic acquisition, including the purchase
of seismic rights or lease options on the related onshore acreage of the West
Cameron Seismic Project, the purchase of other 3D seismic data, and processing
of seismic data over the West Cameron Seismic Project Area. The Cheniere
Agreement provides that Cheniere may receive up to a 50% interest in the West
Cameron Seismic Project and in any leases acquired as a result thereof through
May 2001, based on Cheniere completing its funding obligations under the
Cheniere Agreement, including its share of lease acquisition costs. The
Cheniere Agreement provides that Cheniere may discontinue funding at any time,
in which case its interest would then be reduced pro rata, based on the West
Cameron Seismic Project's total cost. At December 31, 1997, Cheniere had
funded all of its share of project costs for which it had been invoiced
through such date. Seismic shooting operations which commenced in August 1996
were completed in July 1997, and the processing of such data is in progress.
At December 31, 1997, inception to date expenditures in connection with the
West Cameron Seismic Project aggregated approximately $19,653,932, net of
interest earned of $49,095 on the unused project funds and $46,000 from the
sale of seismic data. Through December 31, 1997, Cheniere's share of these
costs was $16,529,524 and Zydeco's share was $3,124,408 under the Cheniere
Agreement.
 
                                      F-9
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
  Each of the above exploration agreements contains provisions whereby either
party to the agreement has the right to "farmout" a portion or all of its
interest in a prospect under a put arrangement. In the event of such a
farmout, the farmor would retain a two percent of eight eighths overriding
royalty interest in the project, convertible into a 20% of eight eighths
working interest after the other party recouped its drilling, completion, and
hook-up costs of the well from production. Should either party farmout a
smaller working interest, the overriding royalty and after-payout working
interests would be proportionately reduced.
 
3. ACQUISITIONS.
 
  On December 20, 1995, the shareholders of TN Energy approved a merger with
Zydeco (the "Merger"). Pursuant to the Merger Agreement, each outstanding
share of common stock of Zydeco, par value $.000333 per share, was converted
into the right to receive 1.56251 shares of Common Stock of TN Energy, par
value $.001 per share; each share of convertible preferred stock of Zydeco,
par value $5.00 per share, was converted into the right to receive 1.56251
shares of Convertible Preferred Stock of TN Energy, par value $.001 per share,
and any fractional shares settled in cash.
 
  In addition, TN Energy assumed Zydeco's existing stock options issued in
connection with Zydeco's 1995 Employee Stock Option Plan (the "Plan"),
substituting shares of Common Stock of TN Energy as the shares subject to
purchase under the Plan. Further, TN Energy assumed each existing common stock
warrant issued by Zydeco, substituting Common Stock of TN Energy as the shares
subject to purchase under the warrants. The number of shares subject to
purchase under option and warrant agreements was adjusted by multiplying the
number of Zydeco option or warrant shares by the exchange ratio of 1.56251
shares. The exercise prices for Zydeco options and warrants were adjusted by
dividing the stated exercise price by the exchange ratio. After completion of
the Merger, TN Energy changed its name to Zydeco Energy, Inc. At the
conclusion of the Merger on December 21, 1995, Zydeco Energy, Inc. had
5,781,275 shares of Common Stock outstanding and 781,255 shares of Convertible
Preferred Stock outstanding.
 
  The Merger was treated as a reverse acquisition for accounting purposes with
Zydeco as the acquiror and TN Energy as the acquiree based upon Zydeco's then
current officers and directors assuming management control of the resulting
entity and the value and ownership interest being received by current Zydeco
stockholders exceeding that received by TN Energy stockholders. The Merger,
for accounting purposes, was treated as if Zydeco issued additional capital
stock to TN Energy shareholders for cash. The net assets of TN Energy on the
date of the Merger were $7,971,525 and, accordingly, the shares of common
stock of TN Energy on such date were recorded as an increase in common stock
and additional paid-in capital. The costs incurred in connection with the
Merger of approximately $669,700 were charged to additional paid-in capital at
December 31, 1995.
 
  On July 1, 1997, the Company acquired all of the outstanding capital stock
of Wavefield Image, Inc. ("Wavefield"), a privately held company that develops
and licenses a seismic data processing technique known as Wavefield Imaging
Technology. The Company is utilizing Wavefield Imaging Technology in its West
Cameron Seismic Project pursuant to a license agreement entered in May 1996.
Pursuant to the terms of the acquisition agreement between the Company and the
shareholders of Wavefield, the Company issued 100,000 shares of the Company's
common stock at closing to the shareholders of Wavefield and an additional
150,000 shares of such stock to the former Wavefield shareholders in
connection with the issuance of a patent on the Wavefield Imaging Technology
by the United States Patent and Trademark Office. In connection with the
issuances of Common Stock, the Company recorded an investment in the Wavefield
Imaging Technology of $950,068 based on the prices of the Company's Common
Stock on July 1, 1997, and December 2, 1997, the date of the patent issuance.
The Company is amortizing this investment over approximately 19 years (the
life of the patent received). Amortization for 1997 was $16,659. The
historical operations of Wavefield were not significant to the Company's
financial position or results of operations. The acquisition through the
issuance of
 
                                     F-10
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

Common Stock was a non-cash investing activity and accordingly, has been
excluded from the Consolidated Statements of Cash Flows.
 
4. INCOME TAXES.
 
  Significant components of the Company's deferred tax liabilities and assets
are as follows:
 
<TABLE>
<CAPTION>
                                                           DECEMBER 31,
                                                      ------------------------
                                                         1997         1996
                                                      -----------  -----------
     <S>                                              <C>          <C>
     Deferred Tax Liability.......................... $        --  $        --
                                                      ===========  ===========
     Deferred Tax Assets
       Carryforwards................................. $ 2,052,298  $   845,499
       Book/Tax Differences in Bases of Oil and Gas
        Assets.......................................   1,163,414      211,457
       Less Valuation Allowance......................  (3,215,712)  (1,056,956)
                                                      -----------  -----------
     Total Deferred Tax Assets....................... $        --  $        --
                                                      ===========  ===========
     Net Deferred Tax Liability...................... $        --  $        --
                                                      ===========  ===========
</TABLE>
 
  As of December 31, 1997, the Company had a net operating loss carryforward
for federal income tax purposes of approximately $5,753,724, which will be
available to reduce future taxable income. The full realization of the tax
benefit associated with the carryforward depends predominantly upon the
Company's ability to generate taxable income during the carryforward period.
Because of the current uncertainty of realizing such tax asset in the future,
a valuation allowance has been recorded equal to the amount of the net
deferred tax asset, which caused the Company's effective tax rate to differ
from the statutory income tax rate. The net operating loss carryforward, if
not utilized, will begin to expire in the year 2009. In addition, the company
has available $282,446 of statutory depletion as carryforward to apply against
future taxable income.
 
5. INDEBTEDNESS.
 
  Capital Lease--Computer Hardware. In 1997, the Company completed its
payments under a capital lease for certain computer hardware assumed from an
affiliate of Mr. Sam B. Myers, Jr. in 1994. Amortization expense, calculated
on a three-year, straight-line basis, aggregated $474,284 as of December 31,
1997. This lease had a stated interest rate of 19.45%. The lease was
collateralized by the computer equipment utilized under the lease.
 
  Operating Leases. The Company incurred rental expense of $151,006, $125,734,
and $37,465 in 1997, 1996 and 1995, respectively, in connection with its
office leases. See "Note 7--Related-Party Transactions". In addition, on
December 1, 1997, the Company prepaid $1,091,856 for a 12-month operating
lease, commencing on November 1, 1997, on a Hewlett-Packard SPP2000
supercomputer used in its 3D seismic processing. At December 31, 1997, future
minimum lease payments for leases having initial or remaining noncancelable
lease terms in excess of one year are presented below:
 
<TABLE>
<CAPTION>
      YEAR                                                               AMOUNT
      ----                                                              --------
      <S>                                                               <C>
      1998............................................................. $198,419
      1999............................................................. $ 73,698
      2000............................................................. $  3,054
      2001............................................................. $     --
      2002 and thereafter.............................................. $     --
</TABLE>
 
                                     F-11
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
6. COMMON STOCK, CONVERTIBLE PREFERRED STOCK, AND WARRANTS.
 
  Common Stock Offering. On August 26, 1997, the Company completed an offering
of 3,680,000 shares of Common Stock and warrants to purchase 320,000 shares of
Common Stock (the "Offering"). Proceeds from the Offering were $14,056,189,
net of Offering expenses of $1,583,911.
 
  In connection with the Offering, the Company sold to the Underwriters, for
nominal consideration, warrants to purchase 320,000 shares of Common Stock
from the Company ("1997 Underwriter Warrants"). The 1997 Underwriter Warrants
are exercisable, in whole or in part, at an exercise price of $5.10 (120% of
the Offering price) at any time during the four-year period commencing August
26, 1998. The warrant agreement pursuant to which the 1997 Underwriter
Warrants were issued contains provisions providing for adjustment of the
exercise price and the number and type of securities issuable upon exercise of
the 1997 Underwriter Warrants should any one or more of certain specified
events occur. The 1997 Underwriter Warrants grant to the holders thereof
demand and piggy-back registration rights for the securities issuable upon
exercise of the 1997 Underwriter Warrants.
 
  Conversion of Preferred Stock. Shares of Convertible Preferred Stock, par
value $.001, issued in December 1994 were subject to conversion at a rate of
one share of Common Stock for each share of Convertible Preferred Stock upon
either (i) the occurrence of a successful public offering or (ii) in the event
the closing price for the Common Stock equaled or exceeded $6.50 for a period
of 30 consecutive trading days. The price of the Common Stock exceeded the
minimum price for the required period in June 1996, and, accordingly, the
Company exercised its office option to convert all shares of Convertible
Preferred Stock to Common Stock effective July 15, 1996.
 
  Placement Warrants. In connection with a 1994 Private Placement in December
1994, Zydeco issued 72,268 Common Stock purchase warrants ("Placement
Warrants") to the participating placement agents, each of which entitles the
holder to purchase one share of Common Stock at an exercise price of $1.60 per
share at any time prior to their expiration on December 2, 1999. These
warrants are subject to a cashless exercise provision (i.e., the exercise
price may be satisfied by canceling a number of unexercised warrants valued by
the difference between the exercise price and the market value of the shares).
The initial value of such warrants issued in connection with the private
placement was immaterial. No Placement Warrants had been exercised prior to
1996. In 1997 and 1996, Placement Warrants were exercised for 1,888 and 29,592
shares of Common Stock, respectively, net of 573 and 9,575 warrant shares,
respectively, tendered in satisfaction of the exercise price. At December 31,
1997, there were 30,640 unexercised Placement Warrants outstanding.
 
  Redeemable Warrants. On December 26, 1993, the Company sold 1,500,000 units
("Units") in its initial public offering ("IPO"). Each Unit consists of one
share of the Company's Common Stock, $.001 par value, and two redeemable
Common Stock Purchase Warrants ("Redeemable Warrants"). Each Redeemable
Warrant entitles the holder to purchase from the Company one share of Common
Stock at an exercise price of $5.50, during the period commencing on the later
of the consummation by the Company of a Business Combination or one year from
the effective date of the IPO, or December 20, 1995, and ending seven years
from the effective date of the IPO, or December 13, 2000. The Merger
constituted a business combination under the terms of the Redeemable Warrants.
The Redeemable Warrants will be redeemable at a price of $.01 per warrant upon
30 days' notice at any time, only in the event that the last sale price of the
Common Stock is at least $10.00 per share for 20 consecutive trading days
ending on the third day prior to the date on which notice of redemption is
given.
 
  The Company also issued, in connection with the IPO, an aggregate of
$150,000 of promissory notes to certain accredited investors. These notes bore
interest at the rate of 10% per annum and were repaid on the consummation of
the Public Offering with accrued interest thereon. In addition, the investors
were issued
 
                                     F-12
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

300,000 Redeemable Warrants valued at a nominal amount. At December 31, 1997,
no Redeemable Warrants had been exercised.
 
  Unit Purchase Options. Also on December 21, 1993, the Company sold to the
underwriters in the IPO and their designees, for nominal consideration, the
right to purchase up to 195,652 units ("Unit Purchase Options") as adjusted
for the Offering completed on August 26, 1997. Each Unit Purchase Option
consists of one share of Common Stock and two Common Stock Purchase Warrants.
Each Common Stock Purchase Warrant entitles the holder to purchase one share
of Common Stock under terms similar to the terms of the Redeemable Warrants
except that the Common Stock Purchase Warrants are not redeemable. The Unit
Purchase Options are exercisable at $5.06 per unit ("Option Exercise Price"),
as adjusted, until December 13, 1998, when they expire. In addition, the
Common Stock Purchase Warrants are exercisable at $5.50 per warrant, and
expire on the same date as the Unit Purchase Options. The Unit Purchase
Options contain anti-dilution provisions providing for adjustment of the
Option Exercise Price upon the occurrence of certain events, including the
issuance of shares of Common Stock or other securities convertible into or
exercisable for shares of Common Stock at a price per share less than the
Option Exercise Price or the market price of the Common Stock, or in the event
of any recapitalization, reclassification, stock dividend, stock split, stock
combination, or similar transaction. The Unit Purchase Options grant to the
holders thereof certain "piggyback" and demand registration rights for periods
of seven and five years, respectively, from the date of the IPO. The
underwriters' units issuable upon the exercise of the Unit Purchase Options
are identical to the Units discussed above, except that the warrants contained
therein expire five years from the effective date of the IPO, or December 13,
1998, and cannot be redeemed. At December 31, 1997, no Unit Purchase Options
had been exercised.
 
  Non-Redeemable Bridge Warrants. In December 1995, in connection with
arranging the Bridge Financing, the Company issued to the Bridge Lenders
warrants to purchase 225,028 shares of Common Stock ("Non-Redeemable Bridge
Warrants"), at an exercise price of $5.33 per share. The terms of the Non-
Redeemable Bridge Warrants are identical to the terms of the Redeemable
Warrants, except that they are not redeemable and are subject to a cashless
exercise provision. At December 31, 1997, no Non-Redeemable Bridge Warrants
had been exercised.
 
7. RELATED-PARTY TRANSACTIONS.
 
  In connection with the acquisition of Wavefield, the Company agreed to
assume the remaining office lease obligation of a shareholder of Wavefield who
became an officer of the Company. The offices were used by Wavefield and the
Wavefield shareholders. The remaining term of the lease at December 31, 1997
was 22 months requiring the payment of monthly rentals of $5,585. The Company
expensed $33,510 during the year ended December 31, 1997, related to the
lease.
 
  In June 1996, the Company, with the approval of the Board of Directors (Mr.
Sam B. Myers, Jr. abstaining), purchased all the working interest in certain
unproved properties consisting of five non-producing offshore oil and gas
leases from entities beneficially owned or controlled by affiliates (the
"Myers Affiliates") of the Company's Chief Executive Officer, Mr. Sam B.
Myers, Jr. The Company paid $302,464 (represented by the Myers Affiliates as
their accumulated cost in the property interests) for the leases which are
located in state waters offshore Louisiana. The leases are subject to 7.5%
back-in after payout by the Myers Affiliates. The Myers Affiliates also own an
aggregate of between 4.5% and 7.5% overriding royalty interest in these
leases, which interests were owned by the Myers Affiliates prior to this
transaction with the Company. In addition, two former Vice Presidents and an
employee of the Company (formerly officers of certain Myers Affiliates) owned
overriding royalty interests under the leases and one former Vice President
received an additional 1% overriding royalty interest pursuant to an
employment contract. In addition, at the time of purchase of the property
interests, the two former Vice Presidents also received an aggregate one-half
percent overriding royalty interest in the
 
                                     F-13
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

properties directly from the Myers Affiliate. In May 1996, the Company
purchased certain proprietary geologic and geophysical data and computer
equipment which was being utilized by the Company from a Myers Affiliate for
$145,490.
 
  In August 1996, the Company, with the approval of the Board of Directors
(Mr. Sam B. Myers, Jr. abstaining), purchased non-producing leasehold
interests owned by a Myers Affiliate and agreed to participate in the drilling
of an exploratory well located in Timbalier Bay in state waters offshore
Louisiana. The Company paid $187,500 for a 37.5% working interest in the
drilling prospect. The Myers Affiliate owns an aggregate of between 33.1% and
37.25% net revenue interest in the prospect leases and Mr. Myers owns an
approximate 1.6% net revenue interest under portions of the leases. The Myers
Affiliates participated in the well with a working interest of 41.2% and paid
their proportionate share of the estimated cost of drilling and completion of
the well. The Myers Affiliates can also back-in for 25% of the well after
payout. In addition, an affiliate of a director of the Company also purchased
a 5% working interest in the properties on the same basis as the terms of the
Company's participation. The two former Vice Presidents also owned net revenue
interests in the prospect leases, one of whom also purchased an additional 1%
working interest participation in the property at the same time and on the
same basis as the terms of the Company's participation. Drilling of the well
commenced in August 1996 and was abandoned in September 1996 for mechanical
reasons without testing the well's primary objectives. The Company charged
$647,355 to exploration expense in 1996 in connection with the drilling and
abandonment of the well and sold its interests in such prospect to an
unaffiliated entity in 1997.
 
  In 1996, the Company licensed software and purchased related software
maintenance services aggregating $325,768 from an unaffiliated vendor.
Subsequently, in October 1996, an officer and director of the Company became a
director of the vendor. Software and services provided by the vendor
aggregated $262,380 for the year ended December 31, 1997.
 
  The Company engaged the services of a law firm, including the services of a
partner in the firm who is a relative of an officer and director of the
Company. The Company incurred costs of approximately $220,343, $109,902 and
$118,970 to this firm during the years ended December 31, 1997, 1996, and
1995, respectively.
 
  Zydeco entered into an exchange agreement, dated January 1, 1995, with an
entity beneficially owned by certain Myers Affiliates where certain officers
and/or directors are officers and/or directors of the Company, and agreed to
provide 3D seismic analysis services in exchange for a license to such data.
The value of this exchange was determined by the parties to be $200,000. As
this exchange agreement represents an exchange of dissimilar goods, income and
expense reflects the gross value of seismic service revenues and related data
costs associated with this transaction for 1995.
 
  Effective January 1, 1995, Zydeco assumed an obligation for office
facilities under an operating lease agreement expiring in March 1997, from a
Myers Affiliate where certain officers of the Company were, at the time, also
officers and/or directors of the Myers Affiliate. The lease agreement required
base monthly payments of $3,122. In connection with the relocation of the
Company's offices in June 1996, the Company bought out the remaining nine
month term under this lease for $24,615. Rental expense related to this lease
was $44,887 and $37,340 which is included in general and administrative
expenses for the years ended December 31, 1996, and 1995, respectively.
 
8. STOCK OPTION PLANS.
 
  At December 31, 1997, the Company had three stock-based compensation plans,
which are described below. Each plan provides for the granting of options
generally at not less than the per share market price on the date of grant.
The Company applies APB Opinion 25 and related Interpretations in accounting
for its plans. Accordingly,
 
                                     F-14
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)

no compensation cost has been recognized for its fixed stock option plans. Had
compensation cost for the Company's three stock-based compensation plans been
determined based on the fair value at the grant dates for awards under those
plans consistent with the method of SFAS No. 123 "Accounting for Stock-Based
Compensation", the Company's net loss and net loss per common share would have
been increased to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                             1997         1996         1995
                                          -----------  -----------  -----------
     <S>                      <C>         <C>          <C>          <C>
     Net Loss................ As Reported $(6,152,127) $(1,858,132) $(1,173,646)
                              Pro Forma   $(6,854,165) $(2,296,904) $(1,291,163)
     Net Loss Per Common
      Share.................. As Reported $     (0.77) $     (0.30) $     (0.30)
      (Basic and Diluted).... Pro Forma   $     (0.86) $     (0.37) $     (0.33)
</TABLE>
 
  For purposes of the above proforma disclosure, the fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted average assumptions used for grants in 1997,
1996, and 1995, respectively: no dividend yield for each of the three years,
expected volatility of .51, .52, and .10, respectively, risk-free interest
rates of 6.5%, 5.2% and 5.2%, respectively, and expected lives of 10 years for
all options. In connection with the above assumptions, the estimated weighted
average fair value of options granted in 1997, 1996, and 1995 is $3.85, $4.07,
and $.56 per share, respectively.
 
  In February 1995, Zydeco's board of directors approved the 1995 Employee
Stock Option Plan (the "Zydeco Plan") for certain employees of the Company and
any subsequently incorporated subsidiaries of the Company. Options to purchase
1,006,256 shares of stock at a price of $1.60 per share, as adjusted pursuant
to the TN Acquisition, were granted in March 1995. Such options are non-
compensatory, vest over a four-year period and terminate no later than March
2005.
 
  On January 4, 1996, the Board of Directors approved and adopted the Zydeco
Energy, Inc. 1996 Incentive Equity Plan (the "1996 Incentive Plan") and
amended such plan on March 3, 1997. The 1996 Incentive Plan authorizes the
grant of various stock and stock-related awards to key management and other
personnel on the basis of individual and corporate performance. The 1996
Incentive Plan, as amended, provides for the granting of stock options to
purchase an aggregate of 950,000 shares of Common Stock, which are reserved
for such purpose. Options under the 1996 Incentive Plan are non-compensatory,
vest over a four-year period and terminate no later than ten years after the
date of grant unless otherwise determined by the Compensation Committee.
 
  Also on January 4, 1996, the Board of Directors adopted the 1996 Non-
employee Director Stock Option Plan (the "1996 Director Plan") and authorized
and granted an aggregate of 45,000 shares of Common Stock to three non-
employee directors. The options vest one third on April 1, 1997, 1998, and
1999, and have an exercise price of $6.69 per share. The options terminate no
later than ten years after the date of grant. Both the 1996 Incentive Plan and
the 1996 Director Plan were approved by the Company's shareholders at the
Annual Meeting on July 9, 1996. The amended 1996 Incentive Plan was approved
by the Company's shareholders at the Annual Meeting on May 15, 1997.
 
                                     F-15
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
  Information about the Company's stock option plans for each of the three
years in the period ended December 31, 1997, is set forth below:
<TABLE>
<CAPTION>
                                 1997                   1996                      1995
                         ---------------------- ------------------------- ---------------------
                                      AVERAGE                   AVERAGE               AVERAGE
                          SHARES    GRANT PRICE  SHARES       GRANT PRICE  SHARES   GRANT PRICE
                         ---------  ----------- ---------     ----------- --------- -----------
<S>                      <C>        <C>         <C>           <C>         <C>       <C>
Outstanding at January
 1...................... 1,444,694     $2.91    1,006,256        $1.60           --    $  --
  Granted...............   504,000      5.55      540,000         6.06    1,006,256     1.60
  Exercised.............   (11,562)     1.60       (1,562)        1.60           --       --
  Forfeited.............  (168,500)     6.55     (100,000)        6.69           --       --
                         ---------              ---------                 ---------
Outstanding at December
 31..................... 1,768,632      3.33    1,444,694         2.91    1,006,256     1.60
                         =========              =========                 =========
Shares Exercisable at
 December 31............   855,317      2.18      501,565         1.60      251,564     1.60
                         =========              =========                 =========
Shares Available for
 Future Grant...........   219,500                555,000 (1)                    --
                         =========              =========                 =========
Average Fair Value of
 Shares Granted During
 Year................... $    3.85              $    4.07                 $     .56
                         =========              =========                 =========
</TABLE>
 
<TABLE>
<CAPTION>
                                                                SHARES
                              SHARES OUTSTANDING              EXERCISABLE
                        ---------------------------------  -------------------
                                    WEIGHTED    WEIGHTED             WEIGHTED
                                     AVERAGE    AVERAGE              AVERAGE
    RANGE OF GRANT                  REMAINING    GRANT                GRANT
        PRICES           SHARES       LIFE       PRICE     SHARES     PRICE
   -------------------- ---------   ---------   --------   -------   --------
   <S>         <C>      <C>         <C>         <C>        <C>       <C>
    $1.00 to    $3.00   1,050,132    7 years     $1.65     741,567    $1.60
     3.00 to     5.00      16,000    9 years      4.94          --       --
     5.00 to     7.00     702,500    9 years      5.79     113,750     5.94
                        ---------                          -------
     1.00 to     7.00   1,768,632    8 years      3.33     855,317     2.18
                        =========                          =======
</TABLE>
--------
(1) Includes shares approved by the Company's shareholders at the May 15, 1997
    Annual Meeting of Shareholders.
 
                                     F-16
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
9. SEGMENT INFORMATION.
 
 The Company operates principally in one industry segment--oil and gas
exploration and production ("E&P"). In 1995, the Company also had operations
in one other reportable segment: 3D seismic analysis services. The assets
reported in the 3D seismic analysis services segment in 1995 were used in both
segments and are included in the Oil and Gas E&P segment after 1995. During
1994, the Company had limited operations and no revenue, other than interest
income. The following table sets forth key operating information for each
business segment:
 
<TABLE>
<CAPTION>
                                              YEAR ENDED DECEMBER 31,
                                        -------------------------------------
                                           1997         1996         1995
                                        -----------  -----------  -----------
<S>                                     <C>          <C>          <C>
Operating Revenues
  Oil and Gas E&P...................... $   958,304  $ 1,470,046  $   286,752
  3D Seismic Analysis Services.........          --           --      300,000
                                        -----------  -----------  -----------
    Consolidated Total................. $   958,304  $ 1,470,046  $   586,752
                                        ===========  ===========  ===========
Operating (Loss)
  Oil and Gas E&P...................... $(4,698,833) $  (812,981) $  (555,009)
  3D Seismic Analysis Services.........          --           --     (108,716)
  Corporate and Other..................  (1,776,845)  (1,294,358)    (486,107)
                                        -----------  -----------  -----------
    Consolidated Total................. $(6,475,678) $(2,107,339) $(1,149,832)
                                        ===========  ===========  ===========
Capital Expenditures
  Oil and Gas E&P...................... $   626,951  $ 1,077,350  $   226,770
  3D Seismic Analysis Services.........          --           --           --
  Corporate and Other..................      72,989      248,524           --
                                        -----------  -----------  -----------
    Consolidated Total................. $   699,940  $ 1,325,874  $   226,770
                                        ===========  ===========  ===========
Depreciation, Depletion and
 Amortization
  Oil and Gas E&P...................... $   566,271  $   592,996  $   153,710
  3D Seismic Analysis Services.........          --           --      208,716
  Corporate and Other..................      87,974       37,869       29,961
                                        -----------  -----------  -----------
    Consolidated Total................. $   654,245  $   630,865  $   392,387
                                        ===========  ===========  ===========
<CAPTION>
                                                  AT DECEMBER 31,
                                        -------------------------------------
                                           1997         1996         1995
                                        -----------  -----------  -----------
<S>                                     <C>          <C>          <C>
Identifiable Assets
  Oil and Gas E&P(1)................... $ 2,333,055  $ 5,048,109  $ 3,501,290
  3D Seismic Analysis Services.........          --           --      364,770
  Corporate and Other..................  13,343,395    4,863,493    8,716,345
                                        -----------  -----------  -----------
    Consolidated Total................. $15,676,450  $ 9,911,602  $12,582,405
                                        ===========  ===========  ===========
</TABLE>
--------
(1) Identifiable assets of the Oil and Gas E&P segment include $189,612,
    $3,172,378 and $3,210,477 at December 31, 1997, and 1996, and 1995,
    respectively, related to the Exploration Agreements. See "Note 2--
    Exploration Agreements".
 
  Major Customers. Oil and gas sales to two customers of $829,732 and $236,957
in 1997, to two customers of $1,030,424 and $391,803 in 1996, and $133,589 to
one customer in 1995, each constituted more than 10% of consolidated revenue
for such years. In addition, 3D seismic services revenue of $100,000 in 1995,
from one customer represented more than 10% of consolidated revenue for 1995.
 
                                     F-17
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
10. COMMITMENTS AND CONTINGENCIES.
 
  In February 1996, the Company purchased an exclusive seismic option permit
from the State of Louisiana covering approximately 51,000 acres of state
waters in western Cameron Parish, Louisiana. The Company initially paid
$783,754 for the permit and in August 1997, paid $391,877 for a six-month
extension of the permit. Under the agreement with the state of Louisiana, the
Company was obligated to deliver within 24 months a 3D seismic survey over the
state acreage, which was delivered by the Company in January 1998. The State
of Louisiana is required to keep the information obtained from the survey
confidential for a period of ten years.
 
  In May 1996, the Company entered into a license agreement to use a
proprietary 3D seismic processing known as the Wavefield Imaging Technology,
which required the payment of annual royalties. In July 1997, the Company
acquired 100% of the outstanding capital stock of Wavefield Image, Inc., the
owner of this technology (See "Note 3 Acquisitions")
 
11. SUBSEQUENT EVENT.
 
  On January 15, 1998, the Company executed a termination agreement with a
former employee of the Company. The termination agreement provided that the
Company would purchase 200,000 shares of the Company's common stock at the
then current market price of $2.125 per share from a trust established for the
benefit of the former employee's descendants and assign to the former employee
a 1/2% of 8/8ths overriding royalty interest in certain Company-owned non-
productive leases. No such overriding royalty interest was assigned to leases
obtained in connection with the Company's West Cameron Seismic Project.
 
12. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED).
 
  Results of operations by quarter for the years ended December 31, 1997, and
1996, are set forth in the following table.
 
<TABLE>
<CAPTION>
                                              QUARTER ENDED
                              -------------------------------------------------
                              MARCH 31     JUNE 30    SEPTEMBER 30  DECEMBER 31
                              ---------  -----------  ------------  -----------
<S>                           <C>        <C>          <C>           <C>
1997
  Operating Revenues......... $ 373,994  $   257,329  $   437,877   $  (110,896)
  Operating Loss.............  (617,148)  (1,746,203)  (2,040,287)   (2,072,040)
  Net Loss...................  (565,617)  (1,701,400)  (1,956,578)   (1,928,532)
  Net Loss Per Common Share
   (Basis and Diluted)....... $   (0.09) $     (0.26) $     (0.24)  $     (0.18)
1996
  Operating Revenues......... $ 251,535  $   353,030  $   461,038   $   404,443
  Operating Loss.............  (461,377)    (274,574)    (943,334)     (428,054)
  Net Loss...................  (388,566)    (203,947)    (894,665)     (370,954)
  Net Loss Per Common Share
   (Basic and Diluted)....... $   (0.07) $     (0.04) $     (0.14)  $     (0.06)
</TABLE>
 
                                     F-18
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
13. OIL AND GAS PRODUCING ACTIVITIES.
 
 Results of Operations from Oil and Gas Producing Activities
 
  The results of operations for oil and gas producing activities for the years
indicated are presented below:
 
<TABLE>
<CAPTION>
                                                YEAR ENDED DECEMBER 31,
                                            ----------------------------------
                                               1997         1996       1995
                                            -----------  ----------  ---------
<S>                                         <C>          <C>         <C>
Oil and Gas Sales.......................... $ 1,066,689  $1,422,227  $ 169,235
Production (Lifting) Costs.................     (20,413)    (22,508)   (27,492)
Dry Hole and Other Costs...................    (112,393)   (699,566)  (261,956)
Geological and Geophysical Expenses........  (4,958,060)   (967,957)  (398,603)
Depreciation, Depletion, and Amortization..    (566,271)   (592,996)  (153,710)
Income Tax Benefit (Provision).............          --          --         --
                                            -----------  ----------  ---------
Results of Operations from Oil and Gas
 Producing Activities...................... $(4,590,448) $ (860,800) $(672,526)
                                            ===========  ==========  =========
</TABLE>
 
 Capitalized Costs Related to Oil and Gas Producing Activities
 
  The following table presents total capitalized costs of proved and unproved
oil and gas properties and associated accumulated depreciation, depletion, and
amortization:
 
<TABLE>
<CAPTION>
                                                            DECEMBER 31,
                                                        ----------------------
                                                           1997        1996
                                                        ----------  ----------
<S>                                                     <C>         <C>
Proved Oil and Gas Properties, at Cost................. $  334,972  $  300,784
Unproved Oil and Gas Properties, at Cost...............     27,600     488,290
Equipment and Software.................................  1,908,818   1,343,655
Less--Accumulated Depreciation, Depletion, and
 Amortization.......................................... (1,521,693)   (955,422)
                                                        ----------  ----------
Net Capitalized Costs.................................. $  749,697  $1,177,307
                                                        ==========  ==========
</TABLE>
 
 Costs Incurred in Oil and Gas Property Acquisition, Exploration and
Development Activities
 
  Presented below are costs incurred in oil and gas property acquisition,
exploration and development activities:
 
<TABLE>
<CAPTION>
                                                    YEAR ENDED DECEMBER 31,
                                                 ------------------------------
                                                    1997       1996      1995
                                                 ---------- ---------- --------
<S>                                              <C>        <C>        <C>
Proved Property Acquisition Costs............... $   34,188 $        7 $ 77,573
Unproved Property Acquisition Costs.............     27,600    507,370       --
Exploration Costs...............................  5,070,453  1,639,519  660,559
Equipment and Software Additions................    565,163    569,973       --
                                                 ---------- ---------- --------
Total for Year.................................. $5,697,404 $2,716,869 $738,132
                                                 ========== ========== ========
</TABLE>
 
                                     F-19
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 Reserve Quantity Information (Unaudited)
 
  The following unaudited information has been provided pursuant to Statement
of Financial Accounting Standards No. 69, "Disclosures about Oil and Gas
Producing Activities". There are numerous uncertainties inherent in estimating
quantities of proved reserves and in projecting future rates of production and
timing of development expenditures, including many factors beyond the control
of the Company. Reserve engineering is a subjective process of estimating
underground accumulations of oil and gas that cannot be measured in an exact
way. Accordingly, reserve estimates are often different from quantities of oil
and gas that are ultimately recovered. The Company's proved oil and gas
reserves were estimated by Ryder Scott Company, Petroleum Engineers.
 
 Proved Developed Reserve Quantities (Unaudited)
 
  The Company's oil and gas producing activities have been conducted solely in
the United States. The Company had no proved undeveloped reserves at December
31, 1997, 1996, or 1995. The following table sets forth the changes in the
Company's total proved reserves (all of which are developed) for the years
ended December 31, 1997, 1996, and 1995:
 
<TABLE>
<CAPTION>
                                                         DECEMBER 31,
                                                   ---------------------------
                                                     1997      1996     1995
                                                   --------  --------  -------
                                                          OIL (BBLS)
<S>                                                <C>       <C>       <C>
Total Proved Reserves:
  Proved Oil Reserves at the Beginning of the
   Year...........................................   10,052    15,899       --
  Extensions, Discoveries, and Other Additions....       --        --   17,017
  Revisions of Previous Estimates.................    1,939    14,339       --
  Production......................................   (9,377)  (20,186)  (1,118)
                                                   --------  --------  -------
  Proved Oil Reserves at the End of the Year......    2,614    10,052   15,899
                                                   ========  ========  =======
<CAPTION>
                                                           GAS (MCF)
<S>                                                <C>       <C>       <C>
  Proved Gas Reserves at the Beginning of the
   Year...........................................  243,000   492,000       --
  Extensions, Discoveries, and Other Additions....       --        --  576,546
  Revisions of Previous Estimates.................  197,730   123,678       --
  Production...................................... (336,730) (372,678) (84,546)
                                                   --------  --------  -------
  Proved Gas Reserves at the End of the Year......  104,000   243,000  492,000
                                                   ========  ========  =======
Proved Developed Reserves:
  End of Year--Oil (Bbls).........................    2,614    10,052   15,899
                                                   ========  ========  =======
        Gas (Mcf).................................  104,000   243,000  492,000
                                                   ========  ========  =======
</TABLE>
 
                                     F-20
<PAGE>
 
                     ZYDECO ENERGY, INC. AND SUBSIDIARIES
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 Standardized Measure of Discounted Future Net Cash Flows Relating to Proved
   Oil and Gas Reserve Quantities (Unaudited)
 
  Future cash inflows from the sale of production of proved reserves, net of
estimated production and development costs, as calculated by the Company's
independent reserve engineers, are discounted at 10%. The calculations are
based on year-end prices and costs and statutory tax rates that relate to
existing proved oil and gas reserves in which the Company has mineral
interests. Actual oil and gas sales prices continue to be subject to wide
fluctuations due to market changes. The standardized measure is not intended
to represent the market value of reserves and, in view of the uncertainties
involved in the reserve estimation process, including the instability of
energy markets, may be subject to material future revisions. See "Note 1--
Organization and Summary of Significant Accounting Policies".
 
<TABLE>
<CAPTION>
                                                  YEAR ENDED DECEMBER 31,
                                               --------------------------------
                                                 1997       1996        1995
                                               --------  ----------  ----------
<S>                                            <C>       <C>         <C>
Future Cash Inflows..........................  $392,939  $1,116,568  $1,510,048
Future Production and Development Costs(1)...        --     (72,225)    (90,367)
Future Income Tax Expense....................        --          --          --
                                               --------  ----------  ----------
Undiscounted Future Net Cash Flows...........   392,939   1,044,343   1,419,681
Discount.....................................   (14,942)    (44,525)   (112,344)
                                               --------  ----------  ----------
Standardized Measure of Discounted Future Net
 Cash Flows..................................  $377,997  $  999,818  $1,307,337
                                               --------  ----------  ----------
</TABLE>
--------
(1) Estimated future costs associated with property development and plugging,
    abandonment, site restoration and dismantlement requirements at December
    31, 1996 and 1995 were approximately $32,500. In addition, the Company
    maintains an overriding royalty interest in its only producing property at
    December 31, 1997. Accordingly, there are no future costs associated with
    such an interest.
 
 Principal Sources of Change in the Standardized Measure of Discounted Future
   Net Cash Flows (Unaudited)
 
<TABLE>
<CAPTION>
                                               YEAR ENDED DECEMBER 31,
                                          ------------------------------------
                                             1997         1996         1995
                                          -----------  -----------  ----------
<S>                                       <C>          <C>          <C>
Balance at the Beginning of the Year..... $   999,818  $ 1,307,337  $       --
Sales, Net of Operating Costs............  (1,046,276)  (1,399,719)   (141,743)
Net Changes in Prices and Production
 Costs...................................    (215,759)     343,316          --
Development Costs Incurred...............      32,500           --          --
Extensions, Discoveries and Improved
 Recovery................................          --           --   1,449,080
Revisions of Quantity Estimates..........     658,065      685,619          --
Accretion of Discount....................      99,982      130,734          --
Other....................................    (150,333)     (67,469)         --
                                          -----------  -----------  ----------
Balance at the End of the Year........... $   377,997  $   999,818  $1,307,337
                                          ===========  ===========  ==========
</TABLE>
 
                                     F-21
<PAGE>
 
                                 EXHIBIT INDEX
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.                                 DESCRIPTION
 ------- ----------------------------------------------------------------------
 <C>     <S>
  3.1+   Certificate of Incorporation and Certificates of Amendment thereto
         (filed as Exhibit 3.1 to the Company's Annual Report on Form 10-K for
         the year ended December 31, 1995)
  3.2+   Form of Amended and Restated Bylaws (filed as Exhibit 3.2 to the
         Company's Registration Statement on Form S-1 (Reg. No. 33-65286))
  4.1+   Form of Certificate representing shares of Common Stock (filed as
         Exhibit 4.1 to the Company's Annual Report on Form 10-K for the year
         ended December 31, 1995)
  4.2+   Form of Certificate evidencing Common Stock Purchase Warrants (filed
         as Exhibit 4.2 to the Company's Annual Report on Form 10-K for the
         year ended December 31, 1995)
  4.3+   Unit Purchase Option Granted to Underwriters by the Company (filed as
         Exhibit 4.3 to the Company's Registration Statement on Form S-1 (Reg.
         No. 33-65286))
  4.4+   Warrant Agreement between Continental Stock Transfer & Trust Company
         and the Company (filed as Exhibit 4.4 to the Company's Registration
         Statement on Form S-1 (Reg. No. 33-65286))
  4.5+   Certificate of Designation evidencing shares of Preferred Stock (filed
         as Exhibit 4.5 to the Company's Annual Report on Form 10-K for the
         year ended December 31, 1995)
  4.6+   Form of Certificate evidencing shares of Preferred Stock (filed as
         Exhibit 4.6 to the Company's Annual Report on Form 10-K for the year
         ended December 31, 1995)
  4.7+   Form of Stock Purchase Warrant granted by Zydeco and Letter to holders
         from the Company (filed as Exhibit 4.7 to the Company's Annual Report
         on Form 10-K for the year ended December 31, 1995)
  4.8+   Form of Warrant Agreement by and among the Company and Brean Murray &
         Co., Inc. and Gaines, Berland Inc. (filed as Exhibit 4.8 to the
         Company's Registration Statement on Form S-1 (Reg. No. 333-27679))
 10.1+   Share Escrow Agreement between the Company and Continental Stock
         Transfer & Trust Company (filed as Exhibit 10.6 to the Company's
         Registration Statement on Form S-1 (Reg. No. 33-65286))
 10.2+   Warrant Agreement (filed as Exhibit 4.4 to the Company's Registration
         Statement on Form S-1 (Reg. No. 33-65286))
 10.3+   Zydeco 1995 Employee Stock Option Plan and form of letter to Optionees
         from the Company (filed as Exhibit 10.3 to the Company's Annual Report
         on Form 10-K for the year ended December 31, 1995)
 10.4+   Employment Agreement between Zydeco and Stephen W. Knecht (filed as
         Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year
         ended December 31, 1995)
 10.5+   Employment Agreement between Zydeco and John W. McTigue, Jr. (filed as
         Exhibit 10.5 to the Company's Annual Report on Form 10-K for the year
         ended December 31, 1995)
 10.6+   Exploration Agreement between Zydeco and Lagniappe Exploration, Inc.
         (predecessor to Fortune Petroleum, Inc.) (filed as Exhibit 10.6 to the
         Company's Annual Report on Form 10-K for the year ended December 31,
         1995)
 10.7+   Farmout Agreement between Zydeco and Bois D'Arc Exploration (filed as
         Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year
         ended December 31, 1995)
 10.8+   Farmout Agreement between Zydeco, Fortune and Southern Gas Company of
         Delaware (filed as Exhibit 10.8 to the Company's Annual Report on Form
         10-K for the year ended December 31, 1995)
 10.9+   Option Agreement dated February 7, 1996, between the Company and
         Norman Neidell concerning certain Wave field Imaging Technology (filed
         as Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
         three months ended March 31, 1996)
</TABLE>
 
                                      E-1
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
   NO.                                 DESCRIPTION
 ------- ----------------------------------------------------------------------
 <C>     <S>
 10.10+  Exploration Agreement between Zydeco Exploration, Inc. and Cheniere
         Energy Operating Co., Inc. (formerly FX Energy, Inc.) dated April 4,
         1996 (filed as Exhibit 10.10 to the Company's Quarterly Report on Form
         10-Q for the three months ended June 30, 1996)
 10.11+  Master Geophysical Data Acquisition Agreement dated June 12, 1996,
         (executed August 5, 1996) between Zydeco Exploration, Inc. and Grant
         Geophysical, Inc. (filed as Exhibit 10.11 to the Company's Quarterly
         Report on Form 10-Q for the three months ended September 30, 1996)
 10.12+  Second Amendment to the Exploration Agreement between Zydeco
         Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX
         Energy, Inc.) dated August 5, 1996 (filed as Exhibit 10.12 to the
         Company's Quarterly Report on Form 10-Q for the three months ended
         September 30, 1996)
 10.13+  Third Amendment to the Exploration Agreement between Zydeco
         Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX
         Energy, Inc.) dated October 31, 1996 (filed as Exhibit 10.13 to the
         Company's Quarterly Report on Form 10-Q for the three months ended
         September 30, 1996)
 10.14+  Fourth Amendment to the Exploration Agreement between Zydeco
         Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX
         Energy, Inc.) dated November 29, 1996 (filed as Exhibit 11.1 to the
         Company's Annual Report on Form 10-K for the year ended December 31,
         1996)
 10.15+  Master Geophysical Data Acquisition Agreement dated March 14, 1997,
         between Zydeco Exploration, Inc. and Grant Geophysical, Inc. (filed as
         Exhibit 10.15 to the Company's Quarterly Report on Form 10-Q for the
         three months ended March 31, 1997)
 10.16+  1996 Incentive Equity Plan (filed on May 20, 1997, as Exhibit 99.1 to
         the Company's Registration Statement on Form S-8)
 10.17+  1996 Non-employee Directors Stock Option Plan (filed on May 20, 1997,
         as Exhibit 99.1 to the Company's Registration Statement on Form S-8)
 10.18+  Agreement and Plan of Merger dated July 1, 1997, by and between the
         Company, Wavefield Image, Inc. and certain stockholders of Wavefield
         Image, Inc. (filed on May 20, 1997, as Exhibit 99.1 to the Company's
         Registration Statement on Form S-8)
 10.19+  Employment Agreement between Zydeco Energy, Inc. and Norman S. Neidell
         (filed on May 20, 1997, as Exhibit 99.1 to the Company's Registration
         Statement on Form S-8)
 10.20+  Fifth Amendment to the Exploration Agreement between Zydeco
         Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX
         Energy, Inc.) dated April 28, 1997 (filed on May 20, 1997, as Exhibit
         99.1 to the Company's Registration Statement on Form S-8)
 10.21+  Sixth Amendment to the Exploration Agreement between Zydeco
         Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX
         Energy, Inc.) dated July 21, 1997 (filed on May 20, 1997, as Exhibit
         99.1 to the Company's Registration Statement on Form S-8)
 10.22+  Seventh Amendment to the Exploration Agreement between Zydeco
         Exploration, Inc. and Cheniere Energy Operating Co., Inc. (formerly FX
         Energy, Inc.) dated August 28, 1997 (filed as Exhibit 10.22 to the
         Company's Quarterly Report on Form 10-Q for the three months ended
         September 30, 1997)
 10.23   Eighth Amendment to the Exploration Agreement between Zydeco
         Exploration, Inc. and Cheniere Energy, Inc. (formerly FX Energy, Inc.)
         dated October 30, 1997.
 11.1    Computation of per share earnings
 21.1    List of Subsidiaries
 23.1    Consent of Arthur Andersen LLP
 23.2    Consent of Ryder Scott Company
 27      Financial Data Schedule
</TABLE>
--------
+ Incorporated herein by reference to the indicated filing.
 
                                      E-2