<PAGE>
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 23, 1997
REGISTRATION STATEMENT NO. 333-22599
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------
PRE-EFFECTIVE AMENDMENT NO. 2
TO
FORM S-2
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933, AS AMENDED
--------------------------
FORTUNE PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
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<S> <C> <C>
DELAWARE 1311 95-4114732
(State or other jurisdiction (Primary Standard Industrial (I.R.S. Employer
of Classification Code Number) Identification
incorporation or organization) No.)
</TABLE>
515 WEST GREENS ROAD, SUITE 720
HOUSTON, TEXAS 77067
(281) 872-1170
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
TYRONE J. FAIRBANKS
FORTUNE PETROLEUM CORPORATION
515 WEST GREENS ROAD, SUITE 720
HOUSTON, TEXAS 77067
(281) 872-1170
(Name, address, including zip code, and telephone number, including area code,
of agent for service)
COPIES TO:
BRUCE L. ASHTON, ESQ. JOHN J. HALLE, ESQ.
REISH & LUFTMAN STOEL RIVES LLP
11755 WILSHIRE BLVD., 10TH FLOOR 900 SW 5TH AVENUE
LOS ANGELES, CALIFORNIA 90025 PORTLAND, OREGON 97204
(310) 478-5656 (503) 224 3380
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
--------------------------
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [ ]
If the registrant elects to deliver its latest annual report to security
holders, or a complete and legible facsimile thereof, pursuant to Item 11(a)(1)
of this Form, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
--------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
PROPOSED MAXIMUM PROPOSED AMOUNT
TITLE OF EACH CLASS OF AMOUNT TO OFFERING PRICE OF AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED BE REGISTERED PER UNIT(2) OFFERING PRICE REGISTRATION FEE
<S> <C> <C> <C> <C>
Common Stock, $.01 par value................ 2,300,000(1) $2.56(1) $5,888,000 $1,784
</TABLE>
(1) Includes 300,000 shares of Common Stock subject to an over-allotment option.
(2) Estimated solely for purposes of calculating the registration fee.
Registration fee previously paid.
--------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO
SECTION 8(A), MAY DETERMINE.
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<PAGE>
CROSS REFERENCE SHEET
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<CAPTION>
ITEM IN FORM S-2 LOCATION IN PROSPECTUS
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<S> <C> <C>
ITEM 1. Forepart of the Registration Statement and
Outside Front Cover Page of Prospectus........... Outside Front Cover Page of Prospectus
ITEM 2. Inside Front and Outside Back Cover Pages of
Prospectus....................................... Inside Front and Outside Back Cover Page of
Prospectus; "Available Information"
ITEM 3. Summary Information, Risk Factors and Ratio of
Earnings to Fixed Charges........................ "Prospectus Summary"; "Risk Factors";
"Management's Discussion and Analysis of
Financial Condition and Results of Operations"
ITEM 4. Use of Proceeds.................................. "Prospectus Summary"; "Use of Proceeds"
ITEM 5. Determination of Offering Price.................. Outside Front Cover Page of Prospectus
ITEM 6. Dilution......................................... "Dilution"
ITEM 7. Selling Security Holders......................... Not Applicable
ITEM 8. Plan of Distribution............................. Outside Front Cover Page of Prospectus;
"Underwriting"
ITEM 9. Description of Securities to be Registered....... "Description of Securities"
ITEM 10. Interests of Named Experts and Counsel........... "Experts"
ITEM 11. Information with Respect to the Registrant....... "Business and Properties"
ITEM 12. Incorporation of Certain Information by
Reference........................................ Not Applicable
ITEM 13. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities...................................... "Description of Securities"
</TABLE>
<PAGE>
SUBJECT TO COMPLETION, DATED APRIL 23, 1997
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY
OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT BECOMES
EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE SECURITIES
IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE UNLAWFUL PRIOR
TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF ANY SUCH STATE.
<PAGE>
[LOGO]
FORTUNE PETROLEUM CORPORATION
2,000,000 SHARES OF COMMON STOCK
Fortune Petroleum Corporation ("Fortune" or the "Company") hereby offers
2,000,000 shares ("Shares") of Common Stock, $.01 par value per share (the
"Common Stock"). The Common Stock is listed on the American Stock Exchange
("AMEX") under the symbol FPX. On April 8, 1997, the last reported sale price of
the Common Stock on the AMEX was $2.25 per share.
THESE SECURITIES INVOLVE A HIGH DEGREE OF RISK. SEE "RISK FACTORS" BEGINNING
ON PAGE 7.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
UNDERWRITING PROCEEDS TO
PRICE TO PUBLIC DISCOUNT (1) COMPANY (2)
<S> <C> <C> <C>
Per Share.......................................
Total (3).......................................
</TABLE>
(1) The Company has reimbursed Paulson Investment Company, Inc., the
representative ("Representative") of the several Underwriters, for $35,000
of its expenses related to this offering and has agreed to pay to the
Representative a non-accountable expense allowance of 3% of the initial
public offering price of the securities sold to the Underwriters, which
amount will include the $35,000 already advanced. The Company has also
agreed to issue to the Representative or its designees warrants (the
"Representative's Warrants") to purchase up to 200,000 shares of Common
Stock for $ per share (120% of the initial public offering price of the
Shares) and to indemnify the Underwriters against certain liabilities. (See
"Underwriting.")
(2) Before deducting expenses estimated to be $340,000, including the
Representative's non-accountable expense allowance.
(3) The Company has granted to the Underwriters an option to purchase up to
300,000 additional shares of Common Stock to cover overallotments. (See
"Underwriting.") If all such shares are purchased, the Price to Public,
Underwriting Discount and Proceeds to Company will be $ , $ and
$ , respectively.
------------------------
The Shares are offered by the several underwriters when, as and if delivered
to and accepted by the Underwriters and subject to their right to reject any
order in whole or in part. It is expected that delivery of the Shares will be
made against payment therefor on or about , 1997.
PAULSON INVESTMENT COMPANY, INC.
THE DATE OF THIS PROSPECTUS IS , 1997
<PAGE>
[MAP]
[DESCRIPTION OF MAP]
The map consists of coastal Texas, Louisiana, Mississippi and Alabama and
their near-shore Gulf of Mexico waters. It depicts, through the use of differing
symbols, the Company's producing and exploration properties and the seismic
programs in which the Company is included.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed by the Company with the Commission pursuant to
the Exchange Act (File No. 1-12334) are incorporated in this Prospectus by
reference and are made a part hereof:
1. Annual Report on Form 10-K/A for the year ended December 31, 1996 (the
"Fortune Petroleum 10-K/A"), filed on April 11, 1997;
2. Current report on Form 8-K filed March 24, 1997.
3. Current report on Form 8-K filed on April 7, 1997.
4. Current report on Form 8-K filed on April 18, 1997.
All documents filed by the Company with the Commission pursuant to Section
13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of this
Prospectus and prior to the termination of the offering of the securities made
hereby shall be deemed to be incorporated by reference in this Prospectus and to
be a part hereof from the date of the filing of such documents. Any statement
contained in a document incorporated or deemed to be incorporated herein by
reference shall be deemed to be modified or superseded for purposes of this
Prospectus to the extent that a statement contained herein or in any other
subsequently filed document which also is incorporated or deemed to be
incorporated by reference herein modifies or supersedes such statement. Any such
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon oral or written request, a copy of any or all of
the documents incorporated herein by reference (other than exhibits to such
documents, unless such exhibits are specifically incorporated by reference in
such documents). Written or telephone requests should be directed to Fortune
Petroleum Corporation,
<PAGE>
515 West Greens Road, Suite 720, Houston, Texas 77061. Attention: Dean W.
Drulias, General Counsel (telephone (281) 872-1170).
------------------------
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE AMERICAN STOCK EXCHANGE. SUCH STABILIZING,
IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS. CAPITALIZED TERMS ARE USED AS DEFINED IN THE GLOSSARY INCLUDED
ELSEWHERE IN THIS PROSPECTUS. UNLESS OTHERWISE INDICATED, THE INFORMATION
PRESENTED IN THIS PROSPECTUS ASSUMES THAT THE UNDERWRITERS' OVERALLOTMENT OPTION
IS NOT EXERCISED.
THE COMPANY
Fortune Petroleum Corporation ("Fortune" or the "Company") is an independent
oil and natural gas company whose primary focus is exploration for and
development of domestic oil and natural gas. Fortune's principal areas of
interest include onshore and offshore Louisiana and Texas, including the
relatively shallow transition zone where the use of modern geophysical
technology and advanced interpretation techniques offers the opportunity for new
discoveries in areas of proven historical production.
Fortune seeks to participate, generally as a minority, non-operating
interest holder, in a variety of exploration and development projects developed
with industry partners using state-of-the-art technologies including, where
appropriate, three dimensional ("3D") seismic and computer-aided exploration
("CAEX") technology. Fortune believes that these techniques have undergone
important technological advances in recent years and that their use can provide
Fortune and its project partners with a more accurate and complete prospect
evaluation, materially increasing the likelihood of finding commercial
quantities of oil and gas at lower average reserve finding costs.
Although Fortune does not currently operate properties or originate oil and
gas exploration prospects, it actively participates in the evaluation of the
opportunities presented to it, both at the time of its initial investment in a
prospect and thereafter during the evaluation and selection of drilling
projects. In order to use state-of-the-art technology while controlling fixed
operating costs, Fortune relies heavily on industry consultants for its project
evaluations.
Fortune's strategy is to offer its shareholders an opportunity to invest in
a diversified portfolio of oil and gas exploration and development properties
within the Company's area of interest. Fortune seeks to achieve a balance
between the risks of exploration drilling and return on investment by generally
taking minority interests in projects with large potential reserves and
additional development potential. In furtherance of this strategy, Fortune has
developed close working relationships with other independent resource companies
operating in its area of interest and has acquired interests in over 25
exploration projects, which are currently in various stages of evaluation,
acquisition and preparation for drilling.
Fortune has a 12.9% working interest in the Schwing #1 field discovery well
at East Bayou Sorrel, Iberville Parish, Louisiana. The well began producing in
December 1996 and has been producing from permanent facilities since January 22,
1997. Although the well reached production rates as high as 1,711 BOPD and 1,710
MCFD during February 1997 on a 12/64" choke, sustained production will be
limited to an average of approximately 1,400 BOPD under the State of Louisiana
allowance for the producing reservoir unless an exemption is granted by the
State. Fortune expects to spend approximately $2 million as its share of the
projected development costs for the East Bayou Sorrel property over the next 18
months, including the drilling of up to four additional wells.
Fortune has a 12.5% interest in the producing 5,000 acre South Timbalier
Block 76. The producing well on this property accounts for about 50% of the
Company's current production and cash flow. The well was shut in on March 24,
1997 for a workover to repair a failed packer. The repair was completed and the
well was put back on production on April 19, 1997. The Company believes this
property has significant development potential.
The Company also has a 12.5% working interest in the South Lake Arthur
prospect well drilled in Jefferson Davis Parish, onshore South Louisiana. The
well was temporarily plugged and abandoned in April 1997 upon determining that
the well had crossed a fault and failed to reach the primary objective
3
<PAGE>
target. The Company is currently evaluating its options on the well. In
addition, the Company has a 37.5% interest in the La Rosa Field and an 18.75%
interest in a 24 square mile proprietary 3D seismic survey currently underway in
Refugio County, Texas.
In addition to exploration projects onshore Louisiana and Texas, the Company
has entered into a multi-year proprietary 3D seismic joint venture to evaluate
and identify exploration prospects in and around the Texas transition zone
including the intracoastal waters at Espiritu Santo Bay, and certain surrounding
areas. Fortune owns a 12.5% working interest in the 166.5 square mile AMI and a
135 square mile proprietary 3D seismic venture. Fortune's principal partners are
Fairfield Resources Corporation, a wholly owned subsidiary of Fairfield
Industries, Inc., and Smith Management Company, Inc. Fairfield Industries, Inc.
has designed a new state-of-the-art proprietary transition zone 3D seismic
acquisition system specifically for use on this project. CAEX Services, Inc.,
also a minority equity partner in the joint venture, will process and interpret
the seismic data with input from Interpretation(3).
In February 1995, Fortune formed a strategic joint venture with Zydeco
Exploration, Inc. ("Zydeco") to conduct a multi-year program to identify,
evaluate and explore oil and gas prospects in the Louisiana transition zone and
Timbalier Trench. The joint venture has identified and acquired an interest in
20 exploration projects in the shallow Gulf Coast waters of Louisiana (the
"Joint Venture Projects"). To date, wells have been drilled on two of the Joint
Venture Projects, the Aurora and Polaris prospects. Hydrocarbons were
encountered in both wells, but neither well was completed as a producer. The
joint venture is currently seeking to farm out both of these prospects for
additional exploration. It is anticipated that drilling will commence on at
least one of the other Joint Venture Projects during 1997, although there is no
assurance that drilling will take place during 1997 or at all.
Under its exploration agreement with Zydeco, Fortune holds a 50% interest in
each of the Joint Venture Projects. The Company contributed $4,800,000 to the
venture, which is being used to pay 100% of the budgeted leasehold acquisition
and seismic costs for the projects. Through December 31, 1996, $2,507,000 had
been expended. Using advanced interpretation techniques, Zydeco and Fortune have
blended 2D and 3D seismic and CAEX technologies with production data and
characteristics of existing wells to identify the Joint Venture Projects. In
keeping with its strategy of balancing risk and return, the Company does not
currently expect to retain a working interest of more than 25% in any well
drilled on the Joint Venture Projects, as a general rule, and intends to farm
out its remaining interest to other oil and gas companies.
Prior to mid-1994, the Company focused its efforts on the acquisition of
producing properties in an effort to take advantage of competitive prices for
proved reserves with development potential in relation to the cost of reserves
discovered through exploration activities. In mid-1994, the Company made a
strategic decision to shift its emphasis from the acquisition of producing
properties to exploration for oil and natural gas reserves, although the Company
continues to examine attractive acquisition opportunities. This decision was
prompted by increasing price competition for attractive producing properties as
well as the recent important advances in exploration technology. To help
facilitate its exploration strategy and focus its efforts, the Company sold all
of its California producing properties and prospects in early 1996. The Company
relocated its headquarters from Los Angeles, California to Houston, Texas in
February 1996.
All of the Company's current and proposed exploration activities involve a
high degree of risk, including the risk that the Company will make substantial
investments in properties and wells without achieving commercial production.
While the Company attempts to manage exploration risk through careful evaluation
of potential investments and diversification, there is no assurance that the
Company's efforts will result in successful development of oil or gas wells.
The Company's principal executive offices are located at 515 West Greens
Road, Suite 720, Houston, Texas 77067. Its telephone number at that address is
(281) 872-1170. At its 1997 Annual Meeting, the shareholders will be asked to
vote on an amendment to the Company's charter to change the name of the
4
<PAGE>
corporation to "Fortune Natural Resources Corporation," the name under which
Fortune currently operates in Louisiana and Texas.
THE OFFERING
<TABLE>
<S> <C>
Common Stock Offered.............. 2,000,000 shares
Common Stock to be outstanding
after the offering.............. 14,154,961 shares
Common Stock reserved for issuance
under options, warrants and
debentures...................... 7,423,189 shares
Use of proceeds................... Further development of the Company's existing
properties; acquisition of additional properties and/or
geological and geophysical data; general corporate
purposes, including possible reduction of outstanding
debt. (See "Use of Proceeds.")
AMEX symbol....................... FPX
</TABLE>
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(1) The Company has outstanding options and warrants that, in the aggregate, are
exercisable to purchase, up to 7,260,508 shares of Common Stock at prices
ranging from $2.40 to $6.00 per share and with expiration dates ranging from
December 1997 to February 2002. The Company also has outstanding
subordinated Debentures (the "Debentures") that are convertible into 162,681
shares of Common Stock at a price of $6.32 per share and are due December
31, 1997. (See "Description of Securities.")
5
<PAGE>
SUMMARY FINANCIAL AND OPERATING DATA
The following Summary Condensed Financial Data for each of the years in the
three year period ended December 31, 1996, are derived from, and qualified by
reference to, the Company's audited financial statements, appearing elsewhere
herein. The Summary Condensed Financial Data should be read in conjunction with
the financial statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing elsewhere herein. The data for
years ending prior to 1996 have been restated to reflect the change in the
Company's method of accounting for oil and gas operations to the full cost
method of accounting. (See Note 2 to Financial Statements.)
SUMMARY CONDENSED FINANCIAL DATA
(dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
----------------------------------------
1994* 1995* 1996
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<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total Revenues........................................................ $ 3,397 $ 3,143 $ 4,040
Net Loss.............................................................. $ (4,453) $ (5,876) $ (1,330)
Net Loss per share.................................................... $ (1.69) $ (0.90) $ (0.12)
Net weighted average shares outstanding............................... 2,639 6,556 11,351
OPERATING DATA:
Net Production:
Crude oil, condensate and gas liquids (Bbl)......................... 88,000 92,000 57,000
Natural gas (Mcf)................................................... 1,017,000 909,000 1,038,000
Gas equivalent (MCFE)............................................... 1,542,000 1,461,000 1,383,000
Average Sales Price:
Crude oil, condensate and gas liquids ($ per Bbl)................... $ 14.14 $ 14.66 $ 20.24
Natural gas ($ per Mcf)............................................. $ 2.09 $ 1.77 $ 2.56
<CAPTION>
DECEMBER 31,
----------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Total Assets.......................................................... $ 10,066 $ 17,800 $ 16,335
Total Debt............................................................ $ 7,123 $ 4,897 $ 2,933
Net Stockholders' Equity.............................................. $ 2,130 $ 12,314 $ 13,037
RESERVES:
Estimated Net Proved Reserves (1):
Crude oil and condensate (MBbl)..................................... 1,647 347 249
Natural gas (Bcf)................................................... 5.9 5.9 3.5
Estimated future net revenues before income taxes..................... $ 15,932 $ 12,600 $ 14,112
Present value of estimated future net revenues before income taxes
(discounted at 10% per annum)....................................... $ 8,148 $ 8,942 $ 10,820
</TABLE>
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* Restated
(1) Estimates of oil and gas reserves in future years are based in part on the
sales price at December 31 of the respective year. To the extent that the
cost of producing the oil and gas, plus applicable taxes, from any
particular property exceeds the sales price, the quantity of proved reserves
is reduced. (See "Business and Properties--Oil and Gas Operations--Oil and
Gas Reserves.")
6
<PAGE>
RISK FACTORS
This Prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933. Such forward-looking statements may
be found in this section and under "Prospectus Summary," "Use of Proceeds,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business and Properties." Forward looking statements include
statements regarding: future oil and gas production and prices, future
exploration and development spending, future drilling and operating plans,
reserve and production potential of the Company's properties and prospects and
the Company's business strategy. Actual events or results could differ
materially from those discussed in the forward-looking statements as a result of
various factors including, without limitation, the risk factors set forth below
and elsewhere in this Prospectus. An investment in the Shares involves a high
degree of risk. The Shares should not be purchased by persons who cannot afford
the loss of their entire investment. Prospective investors should carefully
consider all of the information contained in this Prospectus, including the
following risk factors:
RISKS ASSOCIATED WITH THE COMPANY
EXPLORATION RISKS. The business of exploring for and, to a lesser extent,
of developing oil and gas properties is an inherently speculative activity that
involves a high degree of business and financial risk. Property acquisition
decisions generally are based on various assumptions and subjective judgments
that are speculative. Although available geological and geophysical information
can provide information with respect to a potential oil or gas property, it is
impossible to determine accurately the ultimate production potential, if any, of
a particular property or well. Moreover, the successful completion of an oil or
gas well does not ensure a profit on the Company's investment therein. The
Company's current investments are primarily in exploration projects. Drilling
for oil and natural gas involves numerous risks, including the risk that no
commercially productive hydrocarbon reservoirs will be encountered. These risks
are substantially greater in the case of exploratory drilling than in the case
of wells drilled into established production. The Company's future drilling
activities may not be successful. For example, the first well drilled on one of
the Joint Venture Projects (the Aurora prospect) was plugged and abandoned in
January 1996 after the Company determined that even though the well had
discovered hydrocarbons, the costs of completion and construction of production
facilities made the well uneconomic. Some other prospects in which the Company
had participated have resulted in less than anticipated success, and it is to be
expected that a substantial number of the projects in which the Company invests
will fail to achieve commercial production or to justify the investment made in
them.
CHANGE IN STRATEGY. In mid-1994, Fortune changed its strategy from the
acquisition of producing oil and gas properties with anticipated development
potential to a strategy that primarily stresses exploratory drilling for oil and
natural gas. In furtherance of this change in strategy, Fortune made substantial
changes in management and personnel and, in 1996, sold all of its California
properties, which accounted for a significant portion of the Company's oil and
gas reserve volumes at the time of the sale, and relocated its offices to
Houston, Texas. It has also developed a new area of interest and new working
relationships, and invested in new prospects, the operating results of which are
too preliminary to support meaningful evaluation of their potential. Because of
these changes in business strategy, current and future results of operations may
not be comparable to historical performance.
NET LOSSES INCURRED BY COMPANY. The Company has incurred substantial net
losses in each of the last three years. These losses equaled $4,453,000,
$5,876,000 and $1,330,000 for 1994, 1995 and 1996, respectively. There is no
assurance that losses will not continue in 1997 and thereafter. The Company has
incurred a $316,000 non-cash expense in connection with the recent exchange of a
portion of its outstanding Debentures for Common Stock and warrants. (See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations.")
7
<PAGE>
NEED TO REPLACE DECLINING RESERVES. The Company's future oil and natural
gas reserves and production, and thus cash flow and income, are highly dependent
on the Company's ability to find or acquire additional reserves. Without adding
new reserves in the future, the Company's oil and gas reserves and production
will decline over the long term. There is no assurance that the Company will be
able to find and develop or acquire additional reserves.
DEPENDENCE ON LIMITED NUMBER OF WELLS. Over one-half of the Company's oil
and gas revenues, cash flow and proved oil and gas reserves is currently
accounted for by two wells, the South Timbalier Block 76 well and the East Bayou
Sorrel well. Although the East Bayou Sorrel well only began producing in
December 1996, this field is expected to have a significant impact on 1997
operations. The South Timbalier Block 76 well was shut-in for repairs for one
month in 1997 and was shut in for over two months during 1996 as the result of a
mechanical failure. (See "Risks Associated with the Oil and Gas Industry--
Operating Hazards" and "Business and Properties--Property Acquisition
Activity--South Timbalier Block 76 Acquisition.") A significant curtailment or
loss of production from either of these wells for a prolonged period before the
Company could replace the reserves through new discoveries or acquisitions would
have a material adverse effect on the Company's projected operating results and
financial condition in 1997.
WORKING CAPITAL; NEED FOR ADDITIONAL FINANCING. Investment in oil and gas
exploration requires the commitment of substantial amounts of capital over
significant periods of time. For the three year period ended December 31, 1996,
the Company incurred over $15 million of capital costs in its oil and gas
exploration and development activities. The Company expects to make additional
capital investments of approximately $2.5 million to $5 million in 1997. While
the Company believes it will have sufficient capital or cash flow to meet all of
its projected capital needs over the short-term, if the operators of the
properties in which the Company has invested propose an accelerated drilling
schedule, or if capital requirements otherwise exceed, or capital resources fall
short of, expectation, the Company may not have sufficient liquid capital
resources to participate at its existing working interest level or at all. If
the Company declines participation, its interest in the project is substantially
reduced. In the case of the joint venture with Zydeco, the Company generally
does not intend to retain its current 50% working interest in the Joint Venture
Projects and therefore intends to preserve its investment in these projects at a
lower percentage level by finding other oil and gas companies to participate in
a farmout arrangement. There is no assurance that the Company will be able to
farm out any portion of its interest in any of the Joint Venture Projects. The
Company is required to assign to Zydeco, in exchange for an overriding royalty
and back-in working interest, any portion of its interest it does not fund or
farm out. (See "Business and Properties-- Exploration Activities--Joint Venture
with Zydeco.")
DEPENDENCE ON OPERATORS, CONSULTANTS AND OTHERS. Fortune is currently
organized to be a participant in exploration projects but does not currently
intend to operate any such projects and will thus be dependent on other oil and
gas companies to conduct operations in a prudent and competent manner. Although
it expects to be actively involved in project evaluations, Fortune may have
little or no control over the way in which such operations are conducted or the
timing of exploitation of particular projects. If the entity selected to act as
operator proves incompetent, Fortune could be forced to incur additional costs
to conduct remedial procedures and could lose its investment in a property
altogether. Because Fortune employs a variety of technological approaches to its
evaluation of properties and projects, it relies heavily on outside consultants
for the required technological expertise. The Company has no long-term
agreements with such consultants, all of whom are available to other natural
resource companies, including the Company's competitors.
ACCOUNTING RISKS. The Company reports its operations using the full cost
method of accounting for oil and gas properties. Under full cost accounting
rules, all productive and non-productive costs incurred in connection with the
exploration for and development of oil and gas reserves are capitalized.
Dispositions of oil and gas properties are generally accounted for as
adjustments of capitalized costs, with no gain or
8
<PAGE>
loss recognized, unless such disposition is deemed to be significant. (See Note
4 of Notes to Financial Statements.) Under full cost accounting rules, the net
capitalized costs of oil and gas properties may not exceed a "ceiling" limit of
the tax effected present value of estimated future net revenues from proved
reserves, discounted at 10%, plus the lower of cost or fair market value of
unproved properties. This rule requires calculating future revenues at
unescalated prices in effect as of the end of each fiscal quarter and requires a
write-down if the net capitalized costs of the oil and gas properties exceed the
ceiling limit, even if price declines are temporary. The risk that the Company
will be required to write-down the carrying value of its oil and gas properties
increases when oil and gas prices are depressed or unusually volatile. The use
of the full cost accounting method also exposes the Company to the potential for
large write-downs of assets if and when non-producing properties carried at cost
are disposed of below that cost or abandoned.
PROPERTIES PLEDGED TO SECURE DEBT. All of the Company's producing
properties are pledged to secure its bank credit facility. A failure to pay the
principal or interest or breaches of financial covenants under the credit
facility could cause the Company to lose all or part of its interest in its
principal producing properties. The entire principal balance of the credit
facility is due October 1, 1997. If Fortune's operating activities are
significantly curtailed or Fortune's financial position weakens significantly
and it is unable to repay such debt when it comes due, it is possible that
substantially all of Fortune's productive properties could be seized by the bank
through a foreclosure. (See "Management's Discussion and Analysis of Financial
Condition and Results of Operations.")
UNINSURED RISKS. Under the terms of operating agreements entered into with
the operator of wells in which the Company has an interest, it is anticipated
that the operators will carry insurance against certain risks of oil and gas
operations. The Company would normally be required to pay its proportionate
share of the premiums for such insurance and be named as an additional insured
under the policy. In addition to such insurance, the Company also carries
insurance against certain oil and gas operating risks. However, the Company may
not be fully insured against all risks, either because such insurance is not
available or because of premium costs.
DEPENDENCE ON KEY OFFICER. The Company depends to a large extent on the
abilities and continued participation of its key employee, Tyrone J. Fairbanks,
President and Chief Executive Officer. The loss of Mr. Fairbanks could have a
material adverse effect on the Company. In an effort to reduce the risk, the
Company has entered into an employment agreement with Mr. Fairbanks which
expires December 31, 1997. (See "Management.") The Company has obtained $500,000
of key man life insurance on the life of Mr. Fairbanks.
RISKS ASSOCIATED WITH THE OIL AND GAS INDUSTRY
VOLATILITY OF OIL AND GAS PRICES. The Company's revenues, profitability and
future rate of growth are substantially dependent upon prevailing market prices
for natural gas and oil, which can be extremely volatile and in recent years
have been depressed by excess domestic and imported supplies. In addition to
market factors, actions of state and local agencies, the United States and
foreign governments, and international cartels affect oil and gas prices. All of
these factors are beyond the control of the Company. These external factors and
the volatile nature of the energy markets make it difficult to estimate future
prices of natural gas and oil. There is no assurance that current price levels
can be sustained or that the Company will be able to produce oil or gas on an
economic basis in light of prevailing market prices. Any substantial or extended
decline in the price of natural gas would have a material adverse effect on the
Company's financial condition and results of operations, including reduced cash
flow and borrowing capacity, and could reduce both the value and the amount of
the Company's oil and gas reserves. The average gas prices received by the
Company were $2.09, $1.77 and $2.56 per Mcf in 1994, 1995 and 1996,
respectively. The average oil prices received by the Company were $14.14, $14.66
and $20.24 per Bbl in 1994, 1995 and 1996, respectively. At February 26, 1997,
the Company was receiving an average of approximately $2.96 per Mcf for its gas
production and $20.62 per Bbl for its oil production. These current
9
<PAGE>
prices represent declines from December 1996 and January 1997 prices and the
Company expects further price declines through the spring and summer of 1997.
UNCERTAINTY OF ESTIMATES OF PROVED RESERVES AND FUTURE NET REVENUES. 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 producer. The
reserve data set forth in this Prospectus represent only estimates. Estimating
quantities of proved reserves is inherently imprecise. Such estimates are based
upon certain assumptions about future production levels, future natural gas and
crude oil prices and future operating costs made using currently available
geologic engineering and economic data, some or all of which may prove to be
incorrect over time. As a result of changes in these assumptions that may occur
in the future, and based upon further production history, results of future
exploration and development, future gas and oil prices and other factors, the
quantity of proved reserves may be subject to downward or upward adjustment. In
addition, the estimates of future net revenues from proved reserves of the
Company and the present value thereof are based on certain assumptions about
future production levels, prices, and costs that may not prove to be correct
over time. The rate of production from oil and gas properties declines as
reserves are depleted. Except to the extent the Company acquires additional
properties containing proved reserves, conducts successful exploration and
development activities or, through engineering studies, identifies additional
behind-pipe zones or secondary recovery reserves, the proved reserves of the
Company will decline as oil and gas are produced. Future oil and gas production
is, therefore, highly dependent upon the Company's level of success in acquiring
or finding additional reserves. (See "Business and Properties--Oil and Gas
Operations--Oil and Gas Reserves.")
OIL AND GAS LEASES. The Company's right to explore and produce oil and gas
from its properties derives from its oil and gas leases with the owners of the
properties. There are many versions of oil and gas leases in use. The oil and
gas leases in which the Company has an interest were, in most cases, acquired
from other companies who first entered into the leases with the landowners. Oil
and gas leases generally call for annual rental payments and the payment of a
percentage royalty on the oil and gas produced. Courts in many states have
interpreted oil and gas leases to include various implied covenants, including
the lessee's implied obligation to develop the lease diligently, to prevent
drainage of oil and gas by wells on adjacent land, to seek diligently a market
for production, and to operate prudently according to industry standards. Oil
and gas leases with similar language may be interpreted quite differently
depending on the state in which the property is located. The Company believes it
(or the operator of its properties) has followed industry standards in
interpreting its oil and gas leases in the states where it operates. However,
there is no assurance that the leases will be free from litigation concerning
the proper interpretation of the lease terms. Adverse decisions could result in
material costs to the Company or possibly the loss of one or more leases.
Oil and gas leases typically have a primary term of three to ten years.
During that time the lessee has the obligation to drill a productive well or the
lease expires. If a productive well is drilled, the lease is extended for the
life of the production. Many of the leases in the Company's exploration projects
will expire over the next three to five years. If productive wells are not
drilled on these projects before that time, the leases will terminate. There is
no assurance that the Company and its industry partners will be able to drill or
farm out all of the existing exploration projects prior to expiration of the
leases in those prospects or that the Company will be able to renew those
existing leases.
OPERATING HAZARDS. The cost of drilling, completing and operating wells is
often uncertain, and drilling operations may be curtailed, delayed or canceled
as a result of a variety of factors, including unexpected drilling conditions,
equipment failures or accidents and adverse weather conditions. The Company's
operations are subject to all of the risks normally incident to the operation
and development of oil and gas properties and the drilling of oil and gas wells,
including encountering unexpected formations or pressures, corrosive or
hazardous substances, mechanical failure of equipment, blowouts, cratering and
fires, which
10
<PAGE>
could result in damage or injury to, or destruction of, formations, producing
facilities or other property or could result in personal injuries, loss of life
or pollution of the environment. Any such event could result in substantial loss
to the Company which could have a material adverse effect on the Company's
financial condition. In 1996 and 1997, the Company experienced mechanical
failures of downhole equipment at the Company's South Timbalier Block 76 well.
As a result of each of these equipment failures, the well was shut in for
approximately two months in 1996 and one month in 1997, and the Company incurred
significant repair costs. (See "Business and Properties--Property Acquisition
Activities--South Timbalier Block 76 Acquisition.") Although such operational
risks and hazards may to some extent be minimized, no combination of experience,
knowledge and scientific evaluation can eliminate the risk of investment or
assure a profit to any company engaged in oil and gas operations.
WEATHER HAZARDS. Weather conditions, including severe rains and winter
conditions, have adversely impacted the Company's oil and gas operations. Heavy
rains during the winter of 1995 washed out a road to one of the Company's
California properties, which required the producing wells on the property to be
shut in. Severe winter conditions on the San Juan Basin, New Mexico property
caused a curtailment of operations, including attempts to complete wells which
had been drilled. The inability to produce existing wells and to complete wells
which may yield commercial quantities of oil or gas has an adverse impact on the
Company's cash flow and financial condition. Furthermore, weather conditions in
the future, including hurricanes in the Gulf of Mexico, could interrupt or
prevent production and drilling operations in the Gulf of Mexico and the coastal
counties and parishes, and could result in damage to equipment or facilities.
ENVIRONMENTAL HAZARDS. Oil and gas operations present risks of
environmental contamination from drilling operations and leakage from oil field
storage or transportation facilities. The Company has never experienced a
significant environmental mishap, but spills of oil could occur which could
create material liability to the Company for clean-up expenses. Environmental
contamination occurred on the San Juan Basin, New Mexico property prior to the
Company's acquisition of its interest but has been cleaned up at no cost to the
Company. Although there is no assurance of any third party recovery in the event
of a material liability, the Company generally seeks an indemnity from the
seller against claims for environmental hazards on properties acquired through
its acquisition program. In addition, the Company carries $2,000,000 of
environmental insurance with a $10,000 deductible to cover potential liability
for onshore environmental hazards and $1,000,000 coverage with a $25,000
deductible for offshore hazards.
The Company is not currently a party to any judicial or administrative
proceedings which involve environmental regulations or requirements and believes
that it is in substantial compliance with all applicable environmental
regulations. The Company believes that it is reasonably likely that the trend in
environmental legislation and regulations will continue toward stricter
standards. The Company is unaware of future environmental standards that are
reasonably likely to be adopted that will have a material effect on the
Company's financial position or results of operations, but cannot rule out the
possibility. (See "Business and Properties--Governmental Regulation.")
COMPETITION. The oil and gas exploration, production and acquisition
business is highly competitive. A large number of companies and individuals
engage in acquiring properties or drilling for oil and gas, and there is a high
degree of competition for desirable oil and gas prospects and properties. There
is also competition between the oil and gas industries and other industries in
supplying the energy and fuel requirements of industrial, commercial,
residential and other consumers. Many of the Company's competitors have greater
financial and other resources than does the Company, and there is no assurance
that the Company will be able to compete successfully in acquiring desirable
opportunities.
GOVERNMENT REGULATION. The Company's business is regulated by certain
federal, state and local laws and regulations relating to the development,
production, marketing and transmission of oil and gas, as well as environmental
and safety matters. State conservation laws regulate the rates of production
from oil and gas wells for the purpose of ensuring maximum production of the
resource. Such regulations may require the Company to produce certain wells at
less than their maximum flow rate. Production from the East
11
<PAGE>
Bayou Sorrel well is currently restricted to approximately 1,400 Bbl. of oil per
day because of such a state mandated restriction. (See "Business and
Properties--Exploration Activities--East Bayou Sorrel Field, Iberville Parish,
Louisiana.") State law also governs the apportionment of production among
property owners and producers where numerous wells may be producing from a
single reservoir (referred to as unitization proceedings). Rulings in
unitization proceedings may allocate production in a particular reservoir in a
manner that decreases the Company's share of production. There is no assurance
that laws and regulations enacted in the future will not adversely affect the
Company's exploration for or production and marketing of oil and gas. From time
to time, proposals are introduced in Congress or by the Administration which
could affect the Company's oil and gas operations. (See "Business and
Properties-- Governmental Regulation.")
SHORTAGES OF SUPPLIES AND EQUIPMENT. The Company's ability to conduct its
operations in a timely and cost effective manner is subject to the availability
of oil and gas operations equipment, supplies, and service crews. The industry
is currently experiencing a shortage of certain types of drilling rigs and work
boats in the Gulf of Mexico. This shortage could result in delays in the
Company's operations as well as higher operating and capital costs. Shortages of
other drilling equipment, tubular goods, drilling service crews and seismic
crews could occur from time to time, further hindering the Company's ability to
conduct its operations as planned.
RISKS ASSOCIATED WITH INVESTMENT IN THE COMMON STOCK
MARKET PRICE VOLATILITY. The market price of the Common Stock may be
subject to significant fluctuations in response to drilling results and the
financial results of operations. Developments affecting the oil and gas industry
generally, including national and international economic conditions and
government regulation, could also have a significant impact on the market price
of the Common Stock. In addition, the stock market in recent years has
experienced significant price and volume fluctuations that often have been
unrelated or disproportionate to the operating performance of companies, and the
price of the Common Stock could be affected by such fluctuations.
SHARES ELIGIBLE FOR FUTURE SALE. At February 28, 1997, 12,154,961 shares of
Common Stock were outstanding, of which 11,981,489 shares were freely tradeable
and 173,472 shares were "restricted securities" as that term is defined in Rule
144 adopted by the Commission under the Act. At that date, the Company also had
outstanding options and warrants to acquire an aggregate of 7,260,508 shares of
Common Stock, effectively all of which are currently exercisable. The Company
also has outstanding subordinated Debentures that are convertible into 162,681
shares of Common Stock at a price of $6.32 per share and are due December 31,
1997. Sales of substantial amounts of the Common Stock in the public market
could adversely affect the market price of the Company's Common Stock. (See
"Description of Securities.")
The Company's Public Warrants contain provisions that protect the holders
against dilution by adjustment of the exercise price in certain events,
including, but not limited to, the Company selling Common Stock at a price below
the effective exercise price of the Public Warrants. Currently, the Public
Warrantholders are entitled to purchase 1.4375 shares of Common Stock for $3.75
per Public Warrant (an effective exercise price of $2.61 for each share of
Common Stock received). Because the public offering price is less than $2.61 per
share, the number of shares of Common Stock each Public Warrant represents will
increase above the current 1.4375 shares of Common Stock. (See "Description of
Securities-- Warrants".)
DILUTION. The initial public offering price of the Shares is expected to be
substantially higher than the net tangible book value per share of the Company.
Accordingly, purchasers of the Shares will experience substantial and immediate
dilution in the value of the Shares as measured by their pro-rata share of the
Company's net tangible book value. In addition, the outstanding options,
warrants and Debentures to acquire shares of Common Stock can be expected to be
exercised or converted, if at all, at a time at which the exercise price is less
than the market value of the Common Stock so obtained. Dilution resulting from
12
<PAGE>
any such exercises, or the potential therefor, can have a depressive effect on
the price of the Common Stock and can make additional financing more difficult
or less attractive. (See "Dilution.")
Certain shareholders of the Company have filed suit to require the issuance
to them of additional shares of Common Stock under certain "reset" provisions
which required the Company to issue additional shares if the market price of the
Common Stock declined during certain recalculation periods. ("Business and
Properties--Legal Proceedings.") While the Company believes that it is not
obligated to issue any additional shares, any such issuance would be dilutive to
the other shareholders. The exercise price and number of shares to be acquired
upon exercise of the Company's publicly-traded Common Stock Purchase Warrants
(the "Public Warrants") may require adjustment if the Company is required to
issue the "reset" shares in the above-described lawsuit or for other reasons.
USE OF PROCEEDS
The net proceeds from the sale of the 2,000,000 Shares offered hereby are
estimated to be approximately $4,610,000 ($5,327,750 if the Underwriters'
overallotment option is exercised in full) assuming a public offering price of
$2.75 per share. The Company anticipates that substantially all of the net
proceeds, together with its operating cash flow, will be used to purchase
interests in additional oil and gas properties and/or geological and geophysical
data related to such additional properties, to fund the exploration and
development of oil and gas projects and possibly to reduce outstanding debt. At
the date hereof, the Company has committed approximately $2.5 million to capital
expenditures for 1997, including further development of the East Bayou Sorrel
and LaRosa projects and acquisition of an interest in and initial evaluation of
the Espiritu Santo Bay project. However, a variety of unanticipated events,
including reductions in market prices for oil and gas, less than anticipated
production, mechanical or weather problems requiring shutting in producing
wells, an accelerated development schedule for existing properties, an inability
to farm out portions of its interests in existing properties or higher than
expected operating expenses could cause the Company to use net proceeds of this
offering to cover existing property expense, general overhead or other costs.
DILUTION
The pro forma(1) net tangible book value of the Company at December 31,
1996, was $13.7 million or $1.13 per share of Common Stock. Net tangible book
value per share represents the amount of the Company's total tangible assets
less total liabilities, divided by the number of shares of Common Stock
outstanding. After giving effect to the sale of 2,000,000 shares of Common Stock
offered hereby at an assumed public offering price of $2.75 per share, the pro
forma adjusted net tangible book value of the Company at December 31, 1996,
would have been $18.3 million or $1.30 per share of Common Stock. This
represents an increase in net tangible book value to existing stockholders and a
substantial dilution to new investors acquiring Common Stock in this offering.
The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Public offering price per share........................... $ 2.75
Pro forma net tangible book value per share at December
31, 1996................................................ $ 1.13
Increase attributable to this offering.................... .17
---------
Adjusted pro forma net tangible book value after this
offering................................................ 1.30
---------
Dilution to new investors................................. $ 1.45
---------
---------
</TABLE>
- ------------------------
(1) Pro forma net tangible book value per share gives retroactive effect to the
exchange of certain Debentures for Common Stock and warrants that occurred
in February 1997. (See Note 6 of Notes to Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations.")
13
<PAGE>
CAPITALIZATION
The following table sets forth (i) the historical capitalization of the
Company as of December 31, 1996, (ii) the pro forma capitalization at that date
as if the exchange of a portion of the Debentures for Common Stock and warrants
consummated in February 1997 had occurred on that date and (iii) as further
adjusted to give retroactive effect to the sale of the 2,000,000 Shares at an
estimated offering price of $2.75 per Share:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------------------ -------------- --------------
<S> <C> <C> <C>
Cash and cash equivalents.......................... $ 2,174,000 $ 2,174,000 $ 6,784,000
------------------ -------------- --------------
------------------ -------------- --------------
Long-term debt (excluding current portion)......... 680,000(1) -- --
Stockholders' equity
Preferred stock, $1.00 par value, 2,000,000
shares authorized, none outstanding............ -- -- --
Common stock, $.01 par value, 40,000,000 shares
authorized, 11,853,663 shares outstanding at
December 31, 1996, 12,072,521 shares
outstanding after the Debenture exchange;
14,072,521 shares outstanding as adjusted...... 119,000 121,000 141,000
Additional paid-in capital......................... 29,273,000 30,245,000 34,835,000
Accumulated deficit (2)............................ (16,355,000) (16,671,000) (16,671,000)
------------------ -------------- --------------
Net stockholders' equity........................... 13,037,000 13,695,000 18,305,000
------------------ -------------- --------------
Total capitalization............................... $ 13,717,000 $ 13,695,000 $ 18,305,000
------------------ -------------- --------------
------------------ -------------- --------------
</TABLE>
- ------------------------
(1) Constitutes the portion of Debentures exchanged effective February 26, 1997.
Although the Debentures constituted short-term debt, the subsequent exchange
prior to the issuance of the auditors' report for 1996 caused the exchanged
Debentures to be classified as long-term debt at December 31, 1996.
(2) Pro Forma columns include $316,000 non-cash debt conversion expense incurred
in the first quarter of 1997 in connection with the Debenture exchange. (See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources--Convertible Subordinated
Debentures.")
14
<PAGE>
DIVIDEND POLICY
The Company has not paid dividends on its Common Stock and does not intend
to pay such dividends in the foreseeable future. Under the Company's line of
credit, the Company may not pay dividends on its capital stock without the prior
written consent of its lending bank. The Indenture under which the Debentures
were issued restricts the payment of dividends in the event the Company is in
default on the Debentures.
PRICE RANGE OF COMMON STOCK
The following table sets forth the high and the low closing prices of the
Common Stock and certain publicly traded warrants of the Company on the AMEX for
the periods indicated.
<TABLE>
<CAPTION>
COMMON STOCK WARRANTS
--------------------- -------------------
HIGH LOW HIGH LOW
--------- -------- -------- -------
<S> <C> <C> <C> <C>
1995
First Quarter......................... $ 2 1/2 $ 1 3/4 $ 7/8 $ 1/2
Second Quarter........................ 3 5/16 1 5/8 1 1/4
Third Quarter......................... 3 15/16 2 5/8 2 1/2 1 1/2
Fourth Quarter........................ 4 15/16 3 3/8 3 7/16 1 7/8
1996
First Quarter......................... 5 2 3 3/16 1 3/8
Second Quarter........................ 4 2 5/8 3 1 3/8
Third Quarter......................... 3 11/16 2 1/4 2 3/8 1 1/4
Fourth Quarter........................ 3 1/2 2 1/4 1 3/4 1
1997
First Quarter......................... 3 1/4 2 1/4 1 7/8 1
Second Quarter (through April 8,
1997)............................... 2 3/8 2 3/16 1 1/8 1
</TABLE>
At April 8, 1997, the closing price of the Common Stock was $2.25 per share.
At February 28, 1997, there were 12,154,961 shares of the Company's Common Stock
outstanding held of record by approximately 3,000 stockholders.
15
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following Summary Condensed Financial Data for each of the years in the
five year period ended December 31, 1996, are derived from, and qualified by
reference to, the Company's audited financial statements, appearing elsewhere
herein. The Summary Selected Financial Data should be read in conjunction with
the financial statements and "Management's Discussion and Analysis of Financial
condition and Results of Operations" appearing elsewhere herein. The data for
years ending prior to 1996 have been restated to reflect the change in the
Company's method of accounting for oil and gas operations to the full cost
method of accounting. (See Note 2 to Financial Statements.)
(dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------------------------------------
1992* 1993* 1994* 1995* 1996
---------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total Revenues............................. $ 2,160 $ 2,834 $ 3,397 $ 3,143 $ 4,040
Net Loss................................... (174) (3,703) (4,453) (5,876) (1,330)
Net Loss per share......................... (0.24) (2.09) (1.69) (0.90) (0.12)
Net weighted average shares outstanding.... 714 1,773 2,639 6,556 11,351
OPERATING DATA:
Net Production:
Crude oil, condensate and gas liquids
(Bbl).................................. 87,000 79,000 88,000 92,000 57,000
Natural gas (Mcf)........................ 234,000 724,000 1,017,000 909,000 1,038,000
Gas equivalent (MCFE).................... 758,000 1,196,000 1,542,000 1,461,000 1,383,000
Average Sales Price:
Crude oil, condensate and gas liquids ($
per Bbl)............................... $ 17.57 $ 14.33 $ 14.14 $ 14.66 $ 20.24
Natural gas ($ per Mcf).................. 2.39 2.28 2.09 1.77 2.56
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------------
1992* 1993* 1994* 1995* 1996
------------ ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total Assets............................. $ 8,199 $ 10,429 $ 10,066 $ 17,800 $ 16,335
Total Debt............................... 3,574 3,003 7,123 4,897 2,933
Net Stockholders' Equity................. 4,177 6,588 2,130 12,314 13,037
RESERVES:
Estimated Net Proved Reserves (1):
Crude oil and condensate (MBbl)........ 2,066 813 1,647 347 249
Natural gas (Bcf)...................... 4.8 5.6 5.9 5.9 3.5
Estimated future net revenues before
income taxes......................... $ 20,358 $ 12,835 $ 15,932 $ 12,600 $ 14,112
Present value of estimated future net
revenues before income taxes
(discounted at 10% per annum).......... $ 8,555 $ 8,554 $ 8,148 $ 8,942 $ 10,820
</TABLE>
- ------------------------
*Restated.
(1) Estimates of oil and gas reserves in future years are based in part on the
sales price at December 31 of the respective year. To the extent that the
cost of producing the oil and gas, plus applicable taxes, from any
particular property exceeds the sales price, the quantity of proved reserves
is reduced. (See "Business and Properties--Oil and Gas Operations--Oil and
Gas Reserves")
16
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
All of the Company's operating revenues are derived from the production of
oil and natural gas. Prior to 1994, the Company was principally engaged in the
purchase and production of oil and gas reserves, primarily in California. In
1995, the Company changed its business strategy and now concentrates in
exploration projects onshore and offshore Louisiana and Texas and in the related
transition zone.
From 1994 to 1995, operating revenues decreased, primarily as a result of
lower natural gas prices and weather related production curtailments. In 1996
the Company sold its California properties, but revenues increased as production
from an existing offshore Louisiana well contributed to revenues for a full
year. The Company expects that revenues will increase substantially in 1997 as a
result of an additional well put on production in late December 1996 and any
other wells that may be put into production during the year.
Operating results in 1994 were substantially affected by impairment expense
related to lower oil and natural gas prices while 1995 operating results were
substantially affected by a loss on sale related to the Company's California
properties. No such loss or expense was recorded in 1996. General and
administrative expense, however, increased significantly in 1996 because of the
Company's relocation to Houston and the addition of executive personnel. The
Company anticipates that general and administrative expense may increase further
as the scope of the Company's oil and gas exploration activities are expanded in
future years.
The Company experienced substantial operating and net losses in 1994 and
1995, primarily attributed to the impairment and loss on sale expenses described
above, and a significantly smaller loss in 1996. Operations contributed cash in
1994 and 1996, primarily due to relatively high natural gas prices and increases
in production, but consumed cash in 1995 because of low natural gas prices
during early 1995 and the shut-in of one of the Company's primary California
properties. The Company made substantial net investments in oil and gas
properties in 1994 and 1995, primarily for acquisitions, and a somewhat smaller
net investment in oil and gas properties in 1996, principally for exploration.
The Company funded its operating deficits and property investments from
commercial borrowing in 1994, a substantial portion of which was repaid by the
end of 1996, and from the sale of equity securities in 1995. The Company
anticipates that operating revenues will be sufficient to sustain budgeted
operations through 1997 but expects to use additional funds, including the
proceeds of this offering, to participate in additional exploration
opportunities and to purchase geological and geophysical data.
Substantial sales of equity securities in 1995 resulted in significant
increases in the weighted average shares outstanding in both 1995 and 1996. Net
loss per share decreased in 1995 despite an increase in the net loss from
operations and also decreased in 1996 as a result of a decrease in the net loss
from operations and an increase in the weighted average shares outstanding.
In the fourth quarter of 1996, the Company elected to change to the full
cost method of accounting. Management of the Company believes that full cost
accounting is preferable because it will more accurately reflect the results of
the Company's future operations. (See Notes 1 and 2 to the Financial Statements
for a further discussion of the reasons for and impact of this change in
accounting method.)
RESULTS FOR THE FIRST QUARTER OF 1997
On the basis of the Company's review of preliminary accounting information,
the Company expects to report increased revenues during the first quarter of
1997, as compared to the fourth quarter of 1996, primarily as the result of
revenues from the East Bayou Sorrel discovery well that began producing in late
December 1996. (See "Business and Properties--Exploration Activities--East Bayou
Sorrel Field, Iberville Parrish, Louisiana.") The Company expects that its other
components of income and expense for
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the first quarter of 1997 will be comparable to the fourth quarter of 1996,
except for a one-time non-cash debt conversion expense of $316,000 recorded in
the first quarter of 1997 in connection with the Exchange Offer. (See "Liquidity
and Capital Resources--Convertible Subordinated Debentures".) Furthermore, the
Company may incur an impairment to oil and gas properties as a result of price
declines in March 1997. Although average prices received by the Company during
the first quarter of 1997 appear to have been comparable to the fourth quarter
of 1996, March prices of approximately $1.80 per Mcf and $19.00 per Bbl. were
significantly lower than yearend 1996. However, as of April 21, 1997, the
Company's prices had increased to approximately $1.90 per mcf and $19.50 per
Bbl. As a result of these factors, the Company may incur a net loss during the
first quarter of 1997 which is substantially larger than the net loss in the
fourth quarter of 1996.
RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 AND 1995
Fortune had a net loss of $1.3 million in 1996 compared to a net loss of
$5.9 million in 1995. The higher net loss in 1995 is primarily attributable to a
$3.6 million loss on the sale of the California properties.
Net revenues from sales of oil and gas increased 29% to $3.8 million for
1996, compared to 1995. The increase resulted primarily from the combination of
higher natural gas prices and a full year of production from the South Timbalier
Block 76. The 1995 production was adversely affected by a 5 1/2 month shut down
of the Company's Hopper Canyon, California oil field due to storm damage.
Revenues for 1996 were adversely affected by a two month shut down of the
Company's South Timbalier Block 76 well due to a mechanical failure in the
second quarter of 1996. Fortune has a 9.375% net revenue interest in the well,
which accounted for about 50% of the Company's oil and gas revenues in 1996. The
Company incurred approximately $300,000 in workover costs to repair the problem,
most of which was expensed as production and operating expense in June and July
1996.
Natural gas prices for the Company's production averaged $2.56 per MCF for
1996 as compared to $1.77 per MCF for 1995. Oil prices averaged $20.24 per
barrel in 1996 compared to $14.66 per barrel in 1995. These higher average
prices contributed to the increase in revenues.
Other income consisted primarily of interest income in 1996 and 1995.
Production and operating expenses decreased by $342,000 (23%) in 1996
compared to 1995 despite the expense of the South Timbalier workover discussed
above. The decrease in operating expenses resulted primarily from the Company's
sale of its California properties in early 1996.
In 1996, Fortune's general and administrative expenses increased by $712,000
(59%) over 1995. The increase was due primarily to increased legal fees
resulting from certain litigation, costs incurred in the sale of the Company's
California properties, increased shareholder reporting expense and increased
personnel expense. The Company also incurred non-recurring office relocation and
severance costs of $216,000 during 1996 in connection with the Company's move to
Houston. Interest expense decreased by $435,000 (50%) for 1996 compared to 1995
due to the lower debt balance in 1996. The lower depletable property balance,
resulting from the year end 1995 impairment, led to a decrease in the Company's
provision for depletion, depreciation and amortization of $193,000 (11%) in 1996
as compared to 1995. Depletion, depreciation and amortization decreased from
$1.22 per MCFE in 1995 to $1.14 per MCFE in 1996.
YEARS ENDED DECEMBER 31, 1995 AND 1994
During 1995, Fortune had a net loss of $5.9 million compared to a net loss
of $4.5 million for 1994. The net loss for 1995 was primarily due to a $3.6
million loss on sale attributable to the sale of the California properties. The
Company also had an impairment expense of $3.3 million in 1994 attributable to
the full cost ceiling test. (See Note 4 to the Financial Statements.)
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Net revenues from sales of oil and gas decreased $380,000 (11%) in 1995,
compared to 1994. The decrease resulted primarily from lower natural gas prices
combined with shutting in the Company's Hopper Canyon, California oil field for
5 1/2 months due to a storm damaged access road. Natural gas prices averaged
$1.77 for 1995, compared to $2.09 for 1994. Oil prices averaged $14.66 per
barrel for 1995 as compared to $14.14 per barrel for 1994.
Other income consisted primarily of interest income and operator's overhead
fees earned by the Company on its operated wells, all of which were sold as of
December 31, 1995.
Production and operating expenses increased during 1995 by $424,000 (39%)
compared to 1994. The increase was due primarily to the additional operating
expenses from the acquired production in Rio Arriba County, New Mexico, Refugio
County, Texas and offshore Louisiana; additional wells brought on production in
New Mexico and Refugio County, Texas; and additional expenses incurred in Hopper
Canyon Field for repairs due to storm damage.
During 1995, Fortune's general and administrative expenses increased by
$192,000 (19%) over 1994. The increase was due primarily to increased insurance
costs, legal fees, public relations expenses, shareholder expenses and expenses
in preparing to relocate the Company's headquarters. Interest expense increased
by $410,000 (89%) in 1995 compared to 1994, due to increased debt from the
Refugio County, Texas and Rio Arriba County, New Mexico acquisitions. The
Company's provision for depletion, depreciation and amortization increased by
$108,000 (6%) in 1995, compared to 1994 as a result of a higher depletion,
depreciation and amortization per unit of production. The higher rate resulted
from lower reserves in 1995.
LIQUIDITY AND CAPITAL RESOURCES
CASH BALANCE AND WORKING CAPITAL
The Company's cash balance at year end 1996 increased to $2.2 million as
compared to $1.9 million at year end 1995. This increase was primarily
attributable to increased cash flow from operations in 1996 as well as cash
proceeds from a 1996 private placement and the exercise of private warrants and
options. The Company's cash balance and its total working capital at December
31, 1995, increased compared to December 31, 1994, because of the cash proceeds
from two 1995 stock offerings and the classification of the California
properties held for resale as a current asset at December 31, 1995. The Company
also reduced its total debt balance by $4.2 million (59%) from December 31, 1994
through December 31, 1996. As a result of the Debenture Exchange Offer discussed
below, the Company has reduced debt by another $697,000 at February 26, 1997.
Although the Company's cash balance increased in 1996, working capital
decreased by $157,000 as a result of a significant portion of the Company's debt
being classified as current liabilities at December 31, 1996. The Company's
outstanding debt is comprised of bank debt and Debentures.
Fortune's internal liquidity and capital resources in the near term will
consist primarily of working capital derived from its oil and gas operations
along with the capital raised in connection with the public offering discussed
herein. At December 31, 1996, the Company also had $2.3 million of restricted
cash held by the joint venture with Zydeco which is available for lease and
seismic acquisition and seismic processing in the Transition Zone and Timbalier
Trench areas offshore Louisiana. (See "Business and Properties-- Exploration
Activities--Joint Venture with Zydeco.")
CASH FLOWS FROM OPERATING ACTIVITIES
Fortune's cash flow provided by operating activities increased for 1996 to
$607,000 as compared to an operating cash flow deficit of $744,000 for 1995.
This increase resulted from higher natural gas prices and higher gas production
in 1996 as discussed above. Cash flow in 1996 was adversely affected by the
shut-in of the South Timbalier Block 76 well for over two months in the second
quarter of 1996, resulting in a loss
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of revenues from the well, and workover expenses incurred to bring the well back
on production. Fortune's 1995 operating cash flow deficit of $744,000 compares
to cash flow from operating activities of $491,000 in 1994. The 1995 cash flow
deficit resulted primarily from lower natural gas prices, the shut-in of the
Company's Hopper Canyon Field and higher operating costs.
The Company's 1996 discovery well at East Bayou Sorrel, Iberville Parish,
Louisiana began producing on December 20, 1996. This discovery had no impact on
the Company's revenues in 1996 but the Company believes that this well will have
a positive impact on its cash flow from operations in 1997. Drilling on the
first development well in this field commenced in March 1997.
CASH USED IN INVESTING ACTIVITIES--CAPITAL EXPENDITURES
Capital expenditures funded with cash for the years ended December 31, 1994,
1995 and 1996 were $4.3 million, $5.7 million and $3.2 million, respectively.
1994 capital expenditures consisted primarily of the following: $1.7 million for
the acquisition of New Mexico properties; $760,000 for the acquisition of the La
Rosa gas field in Refugio County, Texas; and capital expended to explore and
develop the New Mexico, La Rosa and AWP properties. The increase in capital
expenditures for 1995 was principally attributable to capital expended to
acquire, explore and develop the Company's New Mexico, LaRosa and AWP
properties; begin the acquisition of seismic and leases offshore Louisiana;
acquire South Timbalier Block 76 for $2.2 million; and drill the exploratory
well at Aurora. 1996 capital expenditures were primarily for four exploratory
wells (East Bayou Sorrel, Lirette, DABM and South Lake Arthur) and continued
lease and seismic acquisition offshore Louisiana. The Company also received $2.2
million of proceeds from the sale of oil and gas properties in 1996, including
$1.2 million for the sale of the California properties that was used to retire
debt in February 1996. The Company also received $940,000 for the sale of 25% of
its interest in South Timbalier Block 76. (See "Business and
Properties--Exploration Activities" and
"--Property Acquisition Activities.")
Fortune's capital expenditures for 1997 are currently estimated to range
from approximately $2.5 million to $5.0 million depending on the Company's
available capital resources. The Company intends to provide for these
expenditures with its available cash and either the exercise of outstanding
warrants, the recovery of prospect costs advanced by the Company, or the
proceeds of this offering. Should such funds not be available to the Company as
required for timely drilling, the Company can reduce its working interest
participation in the wells, farm-out additional interests or, in the joint
venture with Zydeco, put its interest back to Zydeco for an overriding royalty
and an after payout working interest. Should the Company's working interest in
exploration projects be reduced, the Company would not derive as great a benefit
as it may have otherwise enjoyed in the event of an exploration success.
CASH FLOWS FROM FINANCING ACTIVITIES--CASH PROVIDED FROM EQUITY TRANSACTIONS
Fortune's primary source of additional capital during 1995 and 1996 has been
stock offerings and the exercise of warrants and options. In December 1996, the
Company sold 412,000 shares of common stock at a price of $3.00 per share in a
private placement. Net proceeds of approximately $1.1 million were received from
the sale of these shares. On December 11, 1995, the Company closed a private
placement of 1,321,117 shares to acquire a producing property and raise
additional capital. From this sale, the Company netted approximately $3.3
million after payment of expenses of the offering. (See "Description of
Business--Property Acquisition Activities--South Timbalier Block 76
Acquisition.")
On June 30, 1995, the Company closed an underwriting of 4,100,000 shares of
Common Stock at a price of $2.00 per share. On July 5, 1995, the underwriters
exercised their overallotment option for an additional 500,000 shares. The
Company netted approximately $8.1 million after deduction of underwriting
discounts and costs of the offering. In February 1995, the Company netted
$795,000 in a private placement of Common Stock. The proceeds were used to fund
the initial contribution to the joint venture with Zydeco. (See "Business and
Properties--Exploration Activities--Joint Venture with Zydeco.")
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OUTSTANDING DEBT AND DEBT REDUCTION
As of February 27, 1997, the Company has $2.1 million of debt outstanding,
all of which is due in 1997. Outstanding debt is currently comprised of $1.1
million of bank debt and $1.0 million outstanding Debentures. As discussed
above, this represents a substantial reduction (70%) in the Company's total debt
since December 31, 1994. The Company believes it will have the financial
resources during 1997 to either pay off or extend all of its outstanding debt.
In the event that the public offering described herein is completed, the Company
may use a portion of the proceeds to pay off the remaining balance of the
Debentures.
CREDIT FACILITY
The Company's bank debt was incurred under a $10 million secured master
revolving credit facility with Bank One, Texas, N.A. which has been in place
since January 14, 1994 (the "Credit Facility"). The amount the Company may
borrow under the Credit Facility is determined by the borrowing base as
calculated by the Bank semi-annually on the basis of the Company's oil and gas
reserves. The principal balance of the Credit Facility at February 26, 1997 was
$1,100,000. The Credit Facility is secured by a mortgage on all of the Company's
existing producing oil and gas properties and currently requires monthly
principal payments of $75,000. During February 1996, the Company made a
principal reduction of $1,100,000, primarily from the proceeds of the sale of
its California properties.
Under the terms of the Credit Facility, the Company is subject to certain
covenants, including restrictions or requirements with respect to working
capital, tangible net worth, net cash flow, additional debt, asset sales and
certain mergers. In certain quarters during 1995 and 1996, the Company was not
in compliance with its cash flow coverage ratio covenant in the Credit Facility.
Under the terms of the Credit Facility, the bank has the right to demand
repayment of the entire loan balance in the event of covenant defaults. The
Company obtained waivers of these past defaults; however, the Company has
determined that it was in compliance with the cash flow coverage ratio for each
of the last two quarters of 1996. The Company is not able to borrow any
additional amounts under the Credit Facility at this time.
The Credit Facility is due October 1, 1997, at which date the loan balance
would be $575,000 after payment of the required monthly principal reductions.
Prior to that date, the Company expects its borrowing base will be sufficient to
allow the Company to extend the term of this debt. The Company has not received
a commitment to extend the term of this debt, and there can be no assurance that
the term will be extended. However, the Company believes that it will have the
financial resources, as discussed herein, to renew or repay the Credit Facility
during 1997. If the bank is unwilling to extend the term of the Credit Facility,
the Company will seek to refinance the debt with another lender or will use a
portion of the proceeds of this offering to retire the remaining balance. (See
"Risk Factors--Risks Associated with the Company--Working Capital; Need for
Additional Financing" and "-- Properties Pledged to Secure Debt" and "Use of
Proceeds.")
CONVERTIBLE SUBORDINATED DEBENTURES
The Company's Debentures are due December 31, 1997. On February 26, 1997,
the Company closed an exchange offer for these Debentures which resulted in
$697,000 principal amount of Debentures being exchanged for 218,858 shares of
Common Stock and 174,250 Common Stock Warrants. Consequently, the balance due on
the Debentures at December 31, 1997 is $1,028,000. Furthermore, the Company will
record a non-cash debt conversion expense of approximately $316,000 during the
first quarter of 1997. The non-cash debt conversion expense represents the
difference between the fair market value of all of the Common Stock and warrants
issued in connection with the Exchange Offer and the fair market value of the
lower number of shares of Common Stock that could have been issued upon the
conversion of the Debentures under the Indenture prior to the exchange offer.
(See "Description of Securities-- Debentures.")
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OIL AND GAS PRICES AND RESERVES
The price Fortune receives for its oil and gas production is influenced by
conditions outside of Fortune's control. As of February 26, 1997, the Company
was receiving approximately $20.62 per Bbl as an average price for its oil
production and $2.96 per Mcf as an average price for its gas production. At
December 31, 1996, the Company received approximately $4.04 per Mcf for its gas
production and $22.79 per Bbl for its oil production. At December 31, 1995, the
Company received approximately $2.32 per Mcf for its gas production and $16.10
per Bbl for its oil production. At December 31, 1994, the Company received
approximately $14.62 per Bbl for its oil production and $1.39 per Mcf as an
average price for its gas production. (See "Risk Factors--Risks Associated with
the Oil and Gas Industry--Volitility of Oil and Gas Prices".)
The Company's December 31, 1996 oil and gas reserve report prepared by
Huddleston & Co. Inc., of Houston, Texas, its independent petroleum engineers,
indicated a net present value, discounted at 10%, of the Company's proved
reserves equal to $10.8 million at December 31, 1996, compared to an $8.9
million discounted value at December 31, 1995. Of that total value, the proved
developed producing wells had a discounted value of $6.3 million at December 31,
1996 compared to $6.7 million at December 31, 1995.
Total net proved recoverable reserves at December 31, 1996 decreased to
249,000 barrels of oil and 3.5 billion cubic feet of natural gas from 347,000
barrels of oil and 5.9 billion cubic feet of natural gas at December 31, 1995.
The increase in the present value of the reserves is attributable to the higher
oil and gas prices at year end 1996 vs. 1995. The decrease in proved reserves
was primarily attributable to the sale of 25% of the Company's interest in South
Timbalier Block 76 in March 1996, the sale of the one remaining California
property and a West Texas property in 1996 and natural depletion, offset by the
reserve addition at East Bayou Sorrel. (See "Business and Properties--Property
Acquisition Activities.")
ACCOUNTING FOR STOCK OPTIONS
The Company follows the intrinsic value method for accounting for stock
options granted to employees. In October 1995, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standard No. 123,
"Accounting for Stock-Based Compensation." The Company did not adopt, for
accounting purposes, the fair value method of accounting for stock-based
compensation plans as compensation expense over the period options are vested,
which is an optional provision of Accounting Standard 123. (See Note 11 to the
Financial Statements.)
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BUSINESS AND PROPERTIES
GENERAL
Fortune is an independent public oil and natural gas company whose primary
focus is on exploration for and development of domestic oil and natural gas
properties. The Company's principal properties are located onshore and offshore
Louisiana and Texas.
During 1995, the Company implemented a program of exploration for
significant oil and natural gas reserves using state-of-the-art 3D seismic and
CAEX technology. The Company believes that the use of 3D seismic and CAEX
technology provides more accurate and comprehensive geological data for
evaluation of drilling prospects than traditional 2D evaluation methods. Since
early 1995, the Company has acquired, with other industry partners, interests in
over 25 oil and gas prospects in the Louisiana Gulf Coast, including the Joint
Venture Projects, and is continually evaluating other 3D and 2D exploration
projects.
The Company also seeks to take advantage of attractive acquisition targets
which will enable it to acquire reserves at an attractive price. In furtherance
of that objective, on December 11, 1995, the Company purchased for cash an
interest in the South Timbalier Block 76, a producing oil and gas property
located in the Gulf of Mexico offshore Louisiana.
STRATEGY
Fortune's strategy is to offer its shareholders an opportunity to invest in
a diversified portfolio of oil and gas exploration and development properties
within its area of interest. It seeks to achieve a balance between the risks of
exploration drilling and return on its investment by generally taking minority
interests in projects with large potential reserves and additional development
potential. Together with other industry partners, Fortune has invested in
seismic exploration programs to identify new exploration prospects, in
exploration prospects ready to drill, and in producing properties believed to
have additional development potential, each described in more detail below.
Fortune seeks to participate, generally as a minority, non-operating
interest holder, in a variety of exploration and development projects with
industry partners. The Company's approach to prospect acquisition is twofold. It
seeks prospects on an opportunistic basis, evaluating individual prospect
opportunities presented to it by other oil and gas companies or consultants. It
also seeks to develop prospects through multi-year strategic joint ventures
designed to evaluate a wide area for potential drilling prospects, such as the
joint venture with Zydeco and the recently commenced venture along the Texas
intracoastal waters and Matagorda Island at Espiritu Santo Bay.
In all cases, Fortune and its partners use state-of-the-art technologies
including, where appropriate, 3D seismic and CAEX technology in defining and
evaluating drilling prospects. Fortune believes that these techniques have
undergone important technological advances in recent years and that their use
can provide Fortune and its project partners with a more accurate and complete
prospect evaluation, materially increasing the likelihood of finding commercial
quantities of oil and gas at lower average reserve finding costs.
Although Fortune does not currently operate properties or originate
exploration prospects, it actively participates in the evaluation of
opportunities presented by its industry partners, both at the time of its
initial investment in a prospect and thereafter during the evaluation and
selection of drilling locations. In order to maintain the ability to employ
state-of-the-art technology while controlling fixed operating costs, Fortune
relies heavily on industry consultants for its project evaluations. With
aggressive downsizing by major oil companies in recent years and the
reorganization of many independent oil companies, Fortune has found that highly
qualified prospect originators and technical advisors are available as
consultants and joint venturers, enabling Fortune to acquire expert technical
assistance in its target geographic areas while avoiding the overhead associated
with a larger number of permanent employees.
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Currently, Fortune employs the services of Interpretation(3), a consulting
company headed by Daniel Shaughnessy, formerly an exploration supervisor with
Mobil Oil Company, to assist in evaluating prospects. Mr. Shaughnessy recently
became a director of Fortune. (See "Management.") The Company employs Huddleston
& Co., Inc., Houston, Texas, independent petroleum engineers, to estimate
reserves in successful wells and in properties being evaluated for acquisition.
The Company does not have contracts with these consultants that obligate the
consultants to continue their availability to the Company. However, the Company
has no reason to believe that these consultants will cease providing services in
the foreseeable future. In addition, the Company has formed strategic alliances
with, among others, National Energy Group, Inc., Sandefer Oil & Gas Company and
Zydeco Exploration, Inc. as further described below. These industry partners,
along with others, play an important role in bringing attractive prospects to
Fortune's attention, though there can be no assurance that these companies will
continue to offer prospects to the Company.
EXPLORATION ACTIVITIES
Fortune has evaluated and elected to participate in various exploration
projects proposed by industry partners. The Company reviews prospects developed
by companies that have particular expertise in specific exploration areas and
uses its consultants and management knowledge to analyze the exploration data.
By taking a minority non-operated position in such wells, the Company gains
opportunities to participate in significant discoveries while minimizing its
losses if the exploration wells are unproductive.
EAST BAYOU SORREL FIELD, IBERVILLE PARISH, LOUISIANA
On December 15, 1995, the Company entered into a Participation Agreement
with National Energy Group, Inc. and others to drill a well on the East Bayou
Sorrel prospect in Iberville Parish, Louisiana. The area has produced
substantial amounts of oil from other wells. The exploration project was
developed by geologists with Sandefer Oil & Gas Company who have many years of
experience in the area. Fortune's share of the initial costs to acquire,
evaluate and drill the prospect was approximately $312,000. Subsequently, the
Company acquired an additional 1.5% working interest in the field for $357,000,
bringing its total working interest to approximately 12.9%. The well began
producing in December 1996 and has been producing from permanent facilities
since January 22, 1997. Although the well reached production rates as high as
1,711 BOPD and 1,710 MCFD during February 1997 on a 12/64" choke, sustained
production will be limited to an average of approximately 1,400 BOPD under the
State of Louisiana allowance for the producing reservoir unless an exemption is
granted by the State. This well is in an AMI totaling approximately 3,500 acres.
Since the well has only been on production since late December 1996, it is
difficult to assign meaningful proved reserves to the well. The well is now
producing from the lowest of seven zones containing oil and gas encountered when
drilling. The remaining zones in the well have not been tested. Based on this
limited data, at December 31, 1996, the Company's reserve engineers estimate
future net revenues from proved reserves in the well, discounted at 10%, of $1.5
million to the Company's net revenue interest. The Company expects that
additional reserves will be assigned to the well as the field is developed.
The Company has approximately a 12.9% non-operated working interest
(approximately 9.3% net revenue interest) in the East Bayou Sorrel well before
payout and an approximate 11.3% working interest (approximately 8.2% net revenue
interest) after payout. The Company is participating in a development well in
the same area on which drilling commenced in March 1997. The Company is also
considering participation in other prospects in the same area. Fortune's share
of the development well drilling costs is expected to be approximately $318,000.
Although the Company believes that the chances for success with the development
well are very good, there is no assurance that additional production will be
discovered.
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LIRETTE PROSPECT, LAFOURCHE PARISH, LOUISIANA
Also in 1996, Fortune entered into a Participation Agreement with National
Energy Group and others to drill an exploratory well on the Lirette Prospect,
Lafourche Parish, Louisiana. The well was plugged and abandoned as a dry hole in
August 1996. The total cost to the Company of this exploration project at that
stage was $260,000. At the end of 1996, Unocal, which owned a 60% working
interest in the prospect, quitclaimed its interest to Fortune, so that Fortune
now has a 70% working interest in the leases. By virtue of its leasehold
position, the Company will be able to use, free of cost, new 3D seismic data
being prepared in the area. The Company retains an interest in 120 acres of
mineral leases on this prospect and, using the new 3D seismic information, will
evaluate whether to conduct further exploration drilling. The Company expects to
abandon the leases on this prospect before substantial delay rental payments
become due in May 1997 unless it is able to identify additional exploration
sites using such 3D seismic data.
SOUTH LAKE ARTHUR, JEFFERSON DAVIS PARISH, LOUISIANA
In November 1996, the Company entered into a third Participation Agreement
with National Energy Group and others to drill a well on the South Lake Arthur
prospect in Jefferson Davis Parish, Louisiana. This prospect was also developed
by Sandefer geologists. The Company has acquired an interest in approximately
1,900 acres of mineral leases, with rights to participate in additional leases
acquired in an AMI covering approximately 2,800 acres.
The test well on this prospect was commenced on January 9, 1997 and was
temporarily plugged and abandoned in late April 1997 after it was determined
that the well crossed a fault and failed to reach the primary objective target.
Fortune's working interest in the well is 12.5% before payout and 10% after
payout. Fortune estimates its share of the total cost of drilling and
temporarily plugging and abandoning the well to be approximately $380,000.
Fortune believes that the well may have encountered potential hydrocarbons in a
shallower reservoir; however, the working interest partners do not currently own
any rights to such reservoir. The operator is in discussion with the owner of
the shallow reservoir in an attempt to negotiate a mutually acceptable farmout
of that reservoir. Such discussions have not yet been completed and there can be
no assurance that such an agreement will ever be reached. If the parties are
unable to negotiate a farmout, the well will be permanently plugged and
abandoned by the working interest owners.
JOINT VENTURE WITH ZYDECO
Fortune owns a 50% interest in 20 Joint Venture Projects and a 10% interest
in one additional project (the DABM Prospect) located in the Transition Zone and
Timbalier Trench regions offshore Louisiana. Each of these projects, except
DABM, were identified and acquired by a multi-year joint venture formed by
Fortune with Zydeco to identify, evaluate and explore oil and gas prospects in
this AMI. Each of these projects were identified using a combination of advanced
2D and 3D seismic and CAEX technology in conjunction with geological analysis of
existing wells.
The Joint Venture Projects are in various stages of evaluation and leasehold
acquisition. At the date of this prospectus, approximately 21,000 acres are
under lease in the aggregate. The leases have initial lease terms varying from 3
to 5 years, during which period the venture must either commence drilling
operations or lose the leases. The Company expects that wells will be drilled on
several of the projects before the end of 1998, but no assurance can be given
when, or if, any such wells will be drilled.
Fortune has contributed $4,800,000 to the joint venture which is being used
to pay 100% of the budgeted leasehold acquisition and seismic costs for the
projects. Of this amount, $2,507,000 had been expended as of December 31, 1996.
Each party agreed to pay its prorata share (50%) of any leasehold acquisition
and seismic costs in excess of $4,800,000 and the cost of drilling wells on the
Joint Venture Projects. Fortune expects that it will participate in the drilling
of wells on the projects, subject to its evaluation of the exploration risk and
potential return on a prospect-by-prospect basis.
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The Company does not currently expect that wells will be drilled on all 20
of the Joint Venture Projects or that it will retain a working interest of more
than 25%, except in certain circumstances, in wells that are drilled on the
Joint Venture Projects. Fortune intends to farm out its remaining interest to
other oil companies, giving Fortune an interest in the production from a
successful well greater than its working interest in the well. Fortune may
retain larger or smaller working interests in certain projects depending upon
capital availability and other factors. Under a farmout arrangement, the Company
would be relieved of all or part its obligation to pay drilling expenses, and
could recover its acquisition and exploration costs but would wind up with a
smaller interest in any given prospect. No assurance can be given that Fortune
will be able to farm out any of the projects or that, if it is successful in
doing so, that the farmout will be on the exact terms described above.
Each of the parties in the joint venture has a right to farm out a portion
or all of its interest in each prospect to the other under a "put" arrangement
in the exploration agreement. In the event of such a farmout of a 50% working
interest, Fortune or Zydeco would retain a negotiated overriding royalty
convertible into a working interest or a default arrangement of a one percent
overriding royalty interest in the project, convertible into a 12.5% working
interest after Zydeco or Fortune recouped its drilling costs for the well from
production. Should either Fortune or Zydeco farm out a smaller working interest
to the other, the overriding royalty and after-payout working interests would be
proportionately reduced.
In May 1995, the joint venture farmed out the Polaris Prospect to Southern
Gas Company of Delaware ("Southern"). Under the terms of the farmout, Southern
paid an aggregate of $100,000 in exchange for 100% of the working interest in
the Project. The joint venture also retained an overriding royalty interest
convertible to a working interest after payout. In March 1996, Southern conveyed
its rights under the farmout to a third party which subsequently drilled a well.
The well was plugged and abandoned in October 1996 because of mechanical
difficulties encountered in an attempt to complete the well. The 100% working
interest in the Polaris Project has reverted back to Fortune and Zydeco pursuant
to the terms of the farmout agreement. The joint venture is attempting to farm
out the prospect to another party.
In January 1996, the Company drilled a well on the Aurora Prospect. Zydeco
did not participate in drilling the well. The well reached total depth on
January 18, 1996. Well logs indicated that the well had penetrated three
hydrocarbon reservoirs. However, given the significant costs of completing the
well as an oil producer and installing production facilities, management elected
not to complete it. The Company incurred costs of approximately $832,000,
primarily in 1995, to drill and plug the well. The joint venture is attempting
to sell or farm out the Aurora Project to third parties.
Although not part of the joint venture with Zydeco, the Company participated
with Zydeco in another well on a prospect known as DABM, which encountered
mechanical difficulties before reaching its first objective. Operations were
suspended and the well was temporarily plugged in August 1996, pending an
evaluation by the working interest owners as to methods to overcome the
difficulties experienced in the well. The Company incurred drilling costs of
approximately $395,000 attributable to its 13.3% non-operating working interest
in the third quarter of 1996.
The Company believes that many of the Joint Venture Projects represent
excellent opportunities to find significant oil and gas production. Many are in
the vicinity of other recent discoveries in the Transition Zone and Timbalier
Trench. However, there can be no assurance that Fortune will have sufficient
resources to participate in all exploration wells proposed, that it will be able
to farm out its interest on favorable terms or that any of the exploration wells
will be drilled or be successful.
Fortune acquired its interest in the joint venture through its acquisition
in May 1995 of Lagniappe Exploration, Inc. ("LEX"), for 1,200,000 shares of
Common Stock and 1,200,000 stock purchase warrants exercisable at $4.75 per
share through May 12, 2000. The interest in the joint venture was the only
significant asset of LEX. A portion of such shares and warrants remain in escrow
pending the resolution of a dispute which has arisen among the former LEX
stockholders and others regarding who is entitled to the
26
<PAGE>
shares of Common Stock and stock purchase warrants issued by Fortune at the
closing of the LEX acquisition. (See "Principal Stockholders.")
ESPIRITU SANTO BAY PROPRIETARY 3D SEISMIC EXPLORATION JOINT VENTURE
On February 27, 1997, Fortune entered into a multi-year proprietary 3D
seismic joint venture to evaluate and identify exploration prospects in and
around the Texas transition zone, including the intracoastal waters at Espiritu
Santo Bay, and certain surrounding areas. Fortune owns a 12.5% working interest
in the 166.5 square mile AMI and a 135 square mile proprietary 3D seismic
venture. Fortune's principal partners are Fairfield Resources Corporation, a
wholly owned subsidiary of Fairfield Industries, Inc., and Smith Management
Company, Inc. Fairfield Resources Corporation was formed for the purpose of
Fairfield Industries, Inc.'s first equity participation in oil and gas
exploration. Fairfield Industries, Inc. has designed a new state-of-the-art
proprietary transition zone 3D seismic acquisition system specifically for use
on this 3D project. CAEX Services, Inc., also a minority equity partner in the
joint venture, will process and interpret the seismic data with input from
Interpretation(3). (See "Management.")
Fortune paid approximately $155,000 for its share of pre-seismic acquisition
expenses incurred prior to forming the joint venture and approximately
$1,750,000 for its share of seismic acquisition and processing costs over the
term of the program, exclusive of any exploration drilling costs. The term of
the joint venture agreement extends through July 15, 2002 but may be extended,
if necessary. Under the Agreement, upon delineation of each exploration
prospect, Fortune may then elect whether to participate in drilling an initial
well or farming out all or part of its interest to other joint venture parties
or third parties. Seismic acquisition activities commenced in April 1997 and are
expected to be completed in August or September 1997. It is not expected that
any exploration drilling activities will begin before early 1998, although no
assurance can be given that any exploration prospects will be identified or that
any commercial quantities of hydrocarbons will be discovered.
On March 13, 1997, each of the Espiritu Santo Bay 3-D Seismic Project joint
venture partners, including Fortune, elected to acquire their pro-rata shares of
the Steamboat Pass Field, Calhoun County, Texas from Neumin Production Company
("Neumin"). The Steamboat Pass Field is adjacent to Matagorda Island and beneath
Espiritu Santo Bay. The field is currently producing approximately 550 Mcf of
natural gas per day from four shallow gas wells. The acquisition also entitles
Fortune to its pro-rata share of the existing facilities located on site.
Fortune acquired a 12.5% working interest in the 5,766 acres held by production
in the field. The acquisition was made in exchange for the assumption of
Neumin's future obligation to plug and abandon the field. The cost of such
abandonment is not expected to be material to the Company. The transaction
closed April 18, 1997.
LA ROSA PROPRIETARY 3D SEISMIC EXPLORATION PROGRAM
On February 13, 1997, Fortune and its working interest partners commenced a
proprietary 3D seismic survey covering 24 square miles over its onshore Gulf
Coast La Rosa Field and surrounding acreage in Refugio County, Texas. The survey
is being conducted using a state-of-the-art technology and is expected to be
completed by the end of April 1997. Fortune will oversee the processing and
interpretive stages of the program after the seismic is acquired.
The Company currently owns an undivided 37.5% working interest in existing
reserves and production. (See "--Property Acquisition Activities--Refugio
County, Texas--La Rosa Field.") The Company recently farmed out 50% of its
rights in this proprietary seismic program and in any new exploration
opportunities generated by that program in exchange for the payment of 100% of
Fortune's costs of such survey.
27
<PAGE>
PROPERTY ACQUISITION ACTIVITIES
SOUTH TIMBALIER BLOCK 76 ACQUISITION
On December 11, 1995, Fortune acquired a 16.67% working interest (12.5% net
revenue interest) in a 5,000 acre producing oil and gas property offshore
Louisiana in South Timbalier Block 76. The seller was Petrofina, S.A. This
property ("Block 76") includes a producing well which was completed in 1990,
drilling and production platform and a transmission line. The effective date of
the acquisition was June 1, 1995. Therefore, Fortune received the net cash flow
from the well to its interest from June 1, 1995. The effective date for
financial reporting purposes was November 1, 1995. The Company initially paid
$2.2 million for its interest in Block 76 plus 150,000 common stock purchase
warrants exercisable over a two-year period at prices from $4.625 to $6.00 per
share. In the acquisition, Fortune granted an intermediary the option,
exercisable until March 11, 1996, to acquire a 4.167% working interest in the
property for $790,000 plus the retention by Fortune of a $150,000 deposit for a
total of $940,000. The option was timely exercised, which reduced the Company's
interest in the block to a 12.5% working interest (9.375% net revenue interest)
effective January 1, 1996.
On April 29, 1996, the Block 76 well was shut in due to a mechanical failure
of downhole equipment. A remedial workover, started June 16, 1996, cost the
Company approximately $300,000. The well came back on line July 6, 1996 and
resumed production at a rate of approximately 16,000 MCFD and 1,100 BOPD.
Notwithstanding this shut-in, the well has already returned Fortune's investment
and the Company is evaluating the possibilities for development wells. The well
was also shut-in on March 24, 1997, preparatory to beginning work to locate and
repair a leak which has caused the well to lose casing pressure. The workover
was completed and the well was put back on production April 19, 1997 at an
estimated cost to the Company of $360,000.
In order to finance the acquisition of the South Timbalier Block and to
provide the Company with additional working capital, Fortune issued 1,321,117
shares of its Common Stock to a group of overseas investors in a transaction
which qualified for an exemption from the registration requirements of the
Securities Act of 1933 under Regulation S. From this sale in December 1995, the
Company netted approximately $3.3 million after payment of expenses of the
offering. The balance of approximately $1.1 million remaining after payment of
the purchase price for the South Timbalier Block interest was added to working
capital to be used for general corporate purpose. The shares were sold subject
to certain "reset" provisions pursuant to which the purchasers could receive
additional shares if the price of the Common Stock were to drop. Despite a drop
in the price of the Common Stock during the calculation period, the Company does
not expect to issue any reset shares. (See "--Legal Proceedings.")
RIO ARRIBA COUNTY, NEW MEXICO--SAN JUAN BASIN
On June 24, 1994, Fortune concluded the purchase of a 25% interest in
EnRe-1, LLC, a newly formed Texas Limited Liability Company, which owned three
Jicarilla Apache Minerals Development Agreements ("MDA's") covering 60,000
producing, development and exploratory acres in Rio Arriba County, New Mexico
and associated tangible property, and an approximately 22% working interest in
certain mineral, oil and gas leasehold interests in an additional 10,000
exploratory acres in Rio Arriba County, New Mexico. These interests were
acquired for $1.7 million. Since that date, Fortune has expended approximately
$1.5 million for its share of the cost of drilling wells in the San Juan Basin.
In 1996, one of the MDA's comprising approximately 20,000 acres terminated and
the acreage reverted back to the lessors.
Of the seven wells drilled during 1994 and 1995, two were completed as
producing wells. Total production from the New Mexico properties in 1996 was
approximately 74 MCFD and 8 BOPD to the Company's net revenue interest. The
Company did not participate in the drilling of any additional wells in 1996.
Production revenues from the properties have not exceeded the total cost of
acquiring and conducting drilling operations on the properties. The Company's
reserve engineers have not assigned any proved reserves to the San Juan Basin
properties because of the limited data available from which to
28
<PAGE>
evaluate the properties. Given the tight sands and the production history, the
engineers were unable to determine whether the future production would be
economic and, therefore, were unable to conclude that any proved reserves should
be assigned to the producing wells.
There are no immediate plans to conduct further evaluations of the wells
that are temporarily shut in or to drill additional wells in this field. AMPOLEX
USA, Inc. (AMPOLEX), the current operator of the field, was recently acquired by
Mobil Oil, and has informed Fortune that AMPOLEX has reached an agreement in
principle to sell its interest in the field. Such a sale would result in a
change of operator of the field.
As of December 31, 1996, the Company has $1.3 million of unevaluated costs
attributable to the approximately 49,000 undeveloped and unevaluated acres which
will become subject to depreciation, depletion and amortization and the full
cost ceiling test to the extent it exceeds what the Company will realize from a
sale or further evaluation of its interest. If the entire amount were included
in the full cost ceiling test, the risk of a ceiling cost writedown is
significantly increased. In late July 1996, the Company received invoices from
AMPOLEX, billing Fortune for $232,805 of costs not paid by two other working
interest owners in the properties. The Company has reviewed this matter and does
not believe that it owes any portion of such amounts.
WEBB COUNTY, TEXAS - BELLE PEPPER AND BELLE JEFFERS FIELDS
On October 5, 1993, the Company completed the acquisition of certain
mineral, oil and gas leasehold interests and associated tangible property from
Michael Petroleum Corporation, Brazos Resources, Inc., Pioneer Drilling Company
and Endowment Energy Partners. The mineral, oil and gas leasehold interests
include working interests in producing and non-producing oil and gas properties
located in Webb County, Texas, known as the Belle Pepper and Belle Jeffers
Fields. The Company acquired interests in approximately 2,300 acres of mineral
leases, including 10 producing gas wells. The Lobo sand in this area has very
low permeability (under one millidarce) which has qualified all the acquired
production as a "tight" gas sand. As a tight gas sand, the production from wells
drilled before January 1, 1993 (which includes 9 of the wells on the property)
is exempt from Texas state severance tax.
Fortune paid an adjusted price of $6.5 million in cash and 195,000
three-year common stock purchase warrants exercisable at $3.88 for the
properties. Aggregate production from the producing wells acquired by Fortune
has not yet returned the Company's investment in this area.
In June 1994, the Company participated in the drilling of a 10,000 foot
exploratory test well to the Lobo sand which was determined to be
non-commercial. Fortune had a 25% working interest in this well, and its dry
hole costs were $115,000. The Company has a 20% interest in a proved undeveloped
infill location within the Belle Pepper Field.
REFUGIO COUNTY, TEXAS--LA ROSA FIELD
On February 8, 1994, the Company completed an acquisition of a 50% working
interest in a 3,689 acre lease in the La Rosa Natural Gas Field in Refugio
County, Texas from Brooklyn Union Exploration Company, Inc. for $760,000. The
effective date of the transaction using the purchase method of accounting was
February 1, 1994. The acquisition consisted of 12 producing wells, four
saltwater disposal wells and 35 shut-in wells with total new proved reserves to
the Company of one BCFE and additional probable reserves behind pipe. The lease
includes 2,700 undeveloped acres adjacent to production which was acquired for
future exploration.
Since acquiring an interest in the LaRosa Field in February 1994, the
Company has participated in over 50 natural gas and oil recompletions in new
zones of shut-in wells, of which a majority have been successful. The LaRosa
Field produced an average of 607 MCFD and 30 BOPD during 1996 to the Company's
net revenue interest. The Company plans to participate in a 3D seismic program.
(See "--Exploration Activities--La Rosa Proprietary 3D Seismic Exploration
Program.")
29
<PAGE>
In January 1997, Laroco LLP, the Company's working interest partner,
exercised its right to accelerate its one-eighth back-in by paying Fortune
approximately $85,000, the amount necessary to repay Fortune's remaining net
investment in the Field attributable to the back-in interest. This reduced the
Company's working interest in the Field to 37.5%. In February 1997, Fortune
farmed out 50% of its rights in the proprietary 3D seismic acquisition program
currently underway over the Field and in any new wells drilled in exchange for
the payment of 100% of Fortune's costs of conducting the seismic survey. The
Company now owns a 37.5% working interest in the existing reserves and
production and an 18.75% working interest in new discoveries that result from
the 3D survey.
MCMULLEN COUNTY, TEXAS--AWP FIELD
In 1992, the Company acquired a 10% working interest in the AWP Field,
McMullen County, Texas as part of a package of California and Texas properties
for a purchase price of 243,153 shares of Common Stock and the assumption of a
$2,000,000 Note. The Company has since sold the California properties and paid
off the $2,000,000 Note. The property includes approximately 3,500 acres of oil
and gas leases and 10 proved developed locations remaining to be drilled on
either 40 or 80 acre spacing. The operator of the field is currently in
discussion with the landowners to reduce their royalty from 35% to 25% on
several of the remaining locations. The Company's estimated share of the
drilling and completion costs for each of these wells is $48,000. In February
1996, developmental drilling was resumed with the commencement of drilling the
Bracken Ranch #47 well location which was successfully completed as a producer.
The Bracken Ranch #48 well was completed as a producer in January 1997. Total
production in this field averaged 350 MCFD and 14 BOPD in 1996 to the Company's
net revenue interest. Production to date has not returned the Company's
investment.
DIVESTITURE OF CALIFORNIA PROPERTIES
At December 31, 1995, Fortune owned and operated 39 gross and 29.92 net
wells located in California (including all the wells that were sold in 1996).
Production in California during 1995 totaled approximately 57,160 net barrels of
oil and 66,292 net Mcf of gas. This represented about 62% of the Company's 1995
oil production and about 7% of its gas production. The Sespe property comprised
approximately 26% of Fortune's net proved oil reserves and 1% of Fortune's net
proved gas reserves as of December 31, 1995.
Despite the high percentage of the Company's oil production represented by
these properties, the costs of operating the wells in California was, in the
view of management, disproportionately high in relation to the revenues
generated. The high cost of production in California on the Company's properties
was a result of several factors, including the low gravity of the oil, the small
production from each well and environmental and worker's compensation costs.
On February 23, 1996, Fortune sold its interest in all but one of its
California properties for cash in the amount of $840,000. The properties sold
consisted of the Company's interest in the Hopper Canyon, Holser Canyon, Oxnard
and Sheils Canyon Fields in Ventura County and the Bacon Hills Field in Kern
County. The sale was effective December 31, 1995. In connection with the sale,
Fortune paid commissions and expenses of approximately $75,000. The Company sold
its remaining California property, the Sespe Field, Ventura County, California,
to Seneca Resources for approximately $300,000 net of closing adjustments in
April 1996. The Company recorded a loss on sale of $3.6 million in 1995 as a
result of these divestitures.
All of the Company's California properties were pledged to secure the
Company's Credit Facility with Bank One. Concurrently with the closing of the
sale of the non-Sespe properties, Fortune paid down the Credit Facility by $1.1
million, representing the entire indebtedness secured by the Company's
California properties. The closing of the sale of the California properties and
the relocation of the Company's headquarters to Houston completed the Company's
strategic move to focus its efforts on exploration in the Gulf Coast.
Prior to 1994, the Company made various other acquisitions, primarily of
producing properties located in California, which have since been sold.
30
<PAGE>
OIL AND GAS OPERATIONS
DRILLING ACTIVITIES
The following table sets forth information regarding development and
exploratory wells drilled by Fortune in the years ended December 31, 1994, 1995
and 1996:
WELL DRILLING ACTIVITY
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
Gross Wells
Productive...................................................................... 5 1 3
Dry............................................................................. 3 -- 3
--- --- ---
Total......................................................................... 8 1 6
--- --- ---
--- --- ---
Net Wells
Productive...................................................................... 1.18 .20 .31
Dry............................................................................. .47 -- 1.21
--- --- ---
Total......................................................................... 1.65 .20 1.52
--- --- ---
--- --- ---
</TABLE>
OIL AND GAS RESERVES
The Company's reserves are located in Texas and onshore and offshore
Louisiana. Proved reserves represent estimated quantities of crude oil and
natural gas which geological and engineering data demonstrate to be reasonably
certain to be recoverable in the future from known reservoirs under existing
economic and operating conditions. Proved developed oil and gas reserves are
proved reserves that can be expected to be recovered through existing wells
using existing equipment and operating methods.
The oil and gas reserve estimates at December 31, 1994, were reviewed by
Huddleston & Co., Inc., Houston, Texas, independent petroleum engineers, and
Sherwin D. Yoelin, Los Angeles, California, independent petroleum engineer. For
the years ended December 31, 1995 and 1996, the oil and gas reserve estimates
were reviewed by Huddleston & Co., Inc..
Such estimates are subject to numerous uncertainties inherent in the
estimation of quantities of proved reserves and in the projection of future
rates of production, prices and the timing of development expenditures. The
accuracy of any reserve estimate is a function of available data and of
engineering and geological interpretation and judgment. The future cash inflow,
as reflected in the "Standardized Measure of Discounted Future Net Cash Flows
Relating to Proved Oil and Gas Reserves," determined from such reserve data, are
estimates only, and the present values thereof should not be construed to be the
current market values of the Company's oil and gas reserves or the costs that
would be incurred to obtain equivalent reserves. While the reserve estimates
presented herein are believed to be reasonable, they should be viewed with the
understanding that subsequent production of oil and gas from each reservoir, the
timing and success of future development drilling and changes in pricing
structure or market demand will affect the reserve estimate. (See "Risk
Factors--Risks Associated with the Oil and Gas Industry-- Uncertainty of
Estimates of Proved Reserves and Future Net Revenues.")
The following sets forth information with respect to estimated proved oil
and gas reserves as determined by Fortune's independent petroleum engineers
attributable to the Company's interests in oil and gas properties as of December
31, 1994, 1995 and 1996.
31
<PAGE>
ESTIMATED NET RESERVE QUANTITIES
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------
1994 1995 1996
------------ ---------- ----------
<S> <C> <C> <C>
Total Proved Reserves (1):
Oil (Bbls).................................................... 1,647,000 347,000 249,000
Natural Gas (Mcf)............................................. 5,911,000 5,938,000 3,481,000
------------ ---------- ----------
Equivalent Mcf (MCFE) (2)....................................... 15,793,000 8,020,000 4,975,000
------------ ---------- ----------
------------ ---------- ----------
Total Proved Developed Reserves:
Oil (Bbls).................................................... 675,000 324,000 160,000
Natural Gas (Mcf)............................................. 3,317,000 4,686,000 1,749,000
------------ ---------- ----------
Equivalent Mcf (MCFE) (2)....................................... 7,367,000 6,630,000 2,709,000
------------ ---------- ----------
------------ ---------- ----------
</TABLE>
- ------------------------
(1) Estimates of oil and gas reserves are based in part on the price at which
the product was sold as of the end of each year; and if the cost of
producing the oil and gas exceeds the sales price, the quantity of
"recoverable reserves" is reduced. The decrease in proved reserves from 1995
to 1996 was primarily attributable to the sale of 25% of the Company's
interest in South Timbalier Block 76 in March 1996, the sale of the one
remaining California property and a West Texas property in 1996 and natural
depletion, offset by the reserve addition at East Bayou Sorrel. The decrease
in reserves from 1994 to 1995 is primarily due to the transfer to oil and
gas properties held for sale of reserves attributed to the Company's
California properties which were sold in February 1996, and which
represented approximately 1.4 million barrels of oil and 1.5 BCF of natural
gas in the Company's Proved Reserves at December 31, 1994, partially offset
by the acquisition of the South Timbalier Block 76.
(2) After conversion (1:6); one Bbl of crude oil to six Mcf of natural gas.
DISCOUNTED PRESENT VALUE OF FUTURE NET REVENUES
The following table represents the estimated future net revenues (using
unescalated prices and discounted at 10% per annum) and the present value of the
future estimated net reserves from the proved developed producing, proved
developed non-producing and the proved undeveloped reserves at December 31,
1994, 1995 and 1996.
DISCOUNTED PRESENT VALUE OF FUTURE NET REVENUES
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------
1994 1995 1996
------------- ------------- -------------
<S> <C> <C> <C>
Cumulative Future Net Revenue (1)......................... $ 15,932,000 $ 12,600,000 $ 14,112,000
less adjustment to give effect to a 10% annual
discount.............................................. (7,784,000) (3,658,000) (3,292,000)
------------- ------------- -------------
8,148,000 8,942,000 10,820,000
less discounted present value of future income taxes.... -- -- --
------------- ------------- -------------
$ 8,148,000 $ 8,942,000 $ 10,820,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
- ------------------------
(1) The increase in the present value of the reserves from 1995 to 1996 is
attributable to the higher prices at year end 1996 of $4.04 per MCF and
$22.79 per Bbl vs. $2.32 per MCF and $16.10 per Bbl at December 31, 1995.
The increase in 10% discounted value at year end 1995 vs 1996 is due to the
net effect of acquiring the high production rate reserves offshore Louisiana
offset by the exclusion of the longer life California properties sold in
February 1996. The decrease in net revenues from 1994 to 1995 is primarily
due to the significant reduction in reserve volumes attributable to the
exclusion of the California properties.
32
<PAGE>
PRODUCTION
The approximate net production data related to the Company's properties for
the periods ended December 31, 1994, 1995 and 1996 is set forth below:
NET PRODUCTION DATA
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1994 1995 1996
---------- --------- ----------
<S> <C> <C> <C>
Oil (Bbls)............................................... 88,000 92,000 57,000
Gas (Mcf)................................................ 1,017,000 909,000 1,038,000
</TABLE>
PRICES AND PRODUCTION COSTS
The following table sets forth the approximate average sales prices and
production (lifting) costs per barrel of oil and per Mcf of gas produced and
sold in the United States from the Company's oil and gas leases for the years
ended December 31, 1994, 1995 and 1996:
AVERAGE SALES PRICES AND PRODUCTION COSTS
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
Average Sales Price Received:
Oil (per Bbl)............................................................ $ 14.14 $ 14.66 $ 20.24
Gas (per Mcf)............................................................ 2.09 1.77 2.56
Average Production and Operating Cost per MCFE........................... 0.71 1.04 0.85
</TABLE>
PRODUCING WELLS
The following table lists the total gross and net producing oil and gas
wells in which Fortune had an interest at December 31, 1996:
PRODUCING WELLS
<TABLE>
<CAPTION>
GROSS
----------- NET
OIL --------------------
-- GAS OIL GAS
--- --------- ---------
<S> <C> <C> <C> <C>
Texas.................................................................. 39 40 3.90 13.40
Louisiana.............................................................. 1 1 .11 .12
New Mexico............................................................. 2 -- .43 --
-- --
--- ---------
Total................................................................ 42 41 4.44 13.52
-- --
-- --
--- ---------
--- ---------
</TABLE>
PRINCIPAL CUSTOMERS
For the year ended December 31, 1994, 48% of the Company's produced gas was
sold to Michael Gas Marketing Co., Inc., 25% to Tenneco and 15% to Enron, while
72% of the Company's produced oil was sold to Texaco Trading and Transportation
and 8% to Enron. During 1995, 56% of the Company's oil production was sold to
Texaco Trading and Transportation and 10% to Laroco, LLP; 29% of the Company's
gas production was sold to Laroco LLP, 26% to Michael Gas Marketing and 16% to
AWP. During 1996, 54% of the Company's oil production was sold to Scurlock
Permian Corporation; of the Company's gas production 26% was sold to CNG Energy
Services Corporation, 23% to Fina Natural Gas Company, 20% to Texana Pipeline
Joint Venture and 17% to Michael Gas Marketing.
33
<PAGE>
The Company believes that the loss of any of these customers should not have
any material adverse effect on the Company, since there are a large number of
companies which purchase crude oil and natural gas in the areas in which the
Company operates.
PROPERTIES
LEASEHOLD ACREAGE
Fortune's holdings of developed and undeveloped leasehold acreage as of
December 31, 1996 were approximately as follows:
LEASEHOLD ACREAGE
<TABLE>
<CAPTION>
DEVELOPED UNDEVELOPED
-------------------- --------------------
GROSS NET GROSS NET
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Louisiana..................................................... 660 81 28,441 10,995
Texas......................................................... 5,504 1,080 3,960 1,468
New Mexico.................................................... 1,320 285 48,680 11,231
Oklahoma...................................................... -- -- 80 5
--------- --------- --------- ---------
Total....................................................... 7,484 1,446 81,161 23,699
--------- --------- --------- ---------
--------- --------- --------- ---------
</TABLE>
TITLE TO PROPERTIES
Detailed title examinations were performed for many of the Company's
properties in December 1993 and January 1994 in conjunction with the
establishment of the Company's bank credit facility, and title opinions were
issued. In November 1995, title on the Company's South Timbalier Block 76
offshore Louisiana acquisition was examined. The Company believes it holds valid
title on all its properties, free and clear of any liens or encumbrances except
for encumbrances described herein. Title opinions are obtained on newly acquired
properties as of the date of the closing. As is customary in the oil and gas
industry, the Company performs only a perfunctory title examination at the time
exploratory oil and gas properties are acquired. Prior to the commencement of
drilling operations, a thorough title examination of the drillsite and any
pass-through parcels is conducted and any significant defects are remedied
before proceeding with operations. All of the Company's producing leasehold
interests have been pledged to secure corporate indebtedness with Bank One,
Texas. Transfers of many of the Company's properties are subject to various
restrictions, including the requirement of obtaining the consent of the
landowner in many instances.
OFFICE FACILITIES
In February 1996, the Company relocated its headquarters to Houston, Texas.
Prior to that, the Company leased office space in Agoura Hills, California. The
lease in Agoura Hills, California currently expires in 1997. On February 13,
1996, the Company entered into an agreement with Animation Magazine to sublease
the Agoura Hills office space, under terms and conditions identical to those
contained in the Company's lease with its landlord, for the balance of the term
of Fortune's lease. Fortune also assumed the term remaining on Animation
Magazine's lease on its prior location for the period from March through October
1996. Rent for the 4,777 square feet which the Company occupied was $53,000 in
1995 and $45,000 in 1994. At its present location Fortune occupies approximately
5,400 square feet of office space under a lease agreement with a term of 5
years. The first year's rent on this space was $42,000 and is expected to be
$84,000 in 1997. (See Note 9 of Notes to Financial Statements)
34
<PAGE>
COMPETITION
The principal raw materials and resources necessary for the exploration for,
and the acquisition, development, production and sale of, oil and natural gas
are leasehold prospects under which oil and gas reserves may be discovered,
drilling rigs and related equipment to explore for such reserves, and
knowledgeable personnel to conduct all phases of oil and gas operations. The
Company must compete for such raw materials and resources with both major
companies and independent oil and gas operators. Each of these resources is
currently in high demand. Many of the companies with which Fortune competes for
these resources are better equipped to acquire them. There is no assurance that
the Company will be able to acquire any portion of these resources in a timely
and economical manner.
EMPLOYEES
As of February 28, 1997, the Company employed eight persons, all in
management and administration. In addition, the Company utilizes the services of
outside consultants in certain technical aspects of the Company's business.
Fortune utilizes these consultants to aid in the evaluation of Company projects
and to evaluate oil and gas assets for potential acquisitions. On February 5,
1996, the Company relocated its corporate headquarters to Houston, Texas and has
adequate room for expansion at the new location in the event the Company chooses
to hire additional experienced personnel to support its program of exploration
and expansion.
GOVERNMENTAL REGULATION
Environmental laws and regulations are having an increasing impact on
Fortune's operations in nearly all the jurisdictions where it has production.
Drilling activities and the production of oil and gas are subject to regulations
under federal and state pollution control and environmental laws and
regulations. It is impossible to predict the effect that additional
environmental requirements may have on future earnings and operations, but it
will continue to be necessary to incur costs in complying with these laws and
regulations. Fortune spent approximately $3,000, $25,000, and $14,000 in
environmental compliance costs in 1996, 1995 and 1994, respectively.
The Company is not currently a party to any judicial or administrative
proceedings which involve environmental regulations or requirements and believes
that it is in substantial compliance with all applicable environmental
regulations. The Company believes that it is reasonably likely that the trend in
environmental legislation and regulations will continue toward stricter
standards. The Company is unaware of future environmental standards that are
reasonably likely to be adopted that will have a material effect on the
Company's financial position or results of operations, but cannot rule out the
possibility.
The Company has never had a material environmental problem, but if a
property in which Fortune has an interest is found to be contaminated, the
Company could be required to participate in a "clean up" program. Such a clean
up, depending on its magnitude and the Company's ownership interest therein,
could require undetermined amounts of capital and exceed the Company's ability
to pay. The Company has obtained primary insurance against oil spills providing
$2,000,000 of coverage with a $10,000 deductible for onshore hazards and
$1,000,000 of coverage with a $25,000 deductible for offshore hazards.
The operations of oil and gas properties covered by leases in which the
Company has or may acquire an interest will require compliance with spacing and
other conservation rules of various state commissions and of the United States
Geological Survey and the Bureau of Land Management with respect to federal oil
and gas acreage. Further, production may be limited under state regulations for
the prevention of waste. At the present time, the Company has no operations
which are adversely affected by well permitting, spacing regulations or
production limitations.
35
<PAGE>
LEGAL PROCEEDINGS
On March 26, 1996, Fortune was served with a lawsuit which had been filed in
the Federal District Court in Delaware by one of the purchasers of Fortune
common stock in an offering in December 1995 under Regulation S. Under the terms
of the subscription agreement pursuant to which the plaintiff acquired his
shares, he was entitled to receive additional shares of Fortune stock if the
market price fell below a stated level during a specified period following the
40-day holding period prescribed by Regulation S. Fortune vigorously contested
this action, believing that plaintiff either participated in a scheme to
unlawfully manipulate the market price of the Common Stock or benefitted from
such manipulation by others. On February 3, 1997, the plaintiff voluntarily
dismissed the complaint without prejudice, and the court ordered the return to
Fortune of shares of Common Stock which had been voluntarily placed in escrow by
Fortune. Management does not anticipate that the action will be refiled.
On April 16, 1996, Fortune was advised that similar suits had been filed in
Federal District Court in New York by two other buyers in the same offering.
Fortune responded to the suits, admitting that the stock price declined but
alleged that suspicious trading activity in Fortune stock occurred immediately
prior to and during the time period in which the additional-share allocation was
computed. Fortune believes that it has discovered evidence of active market
manipulation in the Common Stock by these plaintiffs; accordingly, it has
commenced a countersuit for damages suffered by the Company and its shareholders
as a result of these acts and has also sought leave of court to add third-party
defendants whose actions furthered this market manipulation. Fortune intends to
continue to vigorously defend plaintiffs' actions and prosecute its own
counterclaims.
36
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
DIRECTOR
EXECUTIVE OFFICER AGE SINCE TITLE
- --------------------------------- --- ----------- --------------------------------------------------------------
<S> <C> <C> <C>
Tyrone J. Fairbanks.............. 40 1991 President, Chief Executive Officer, and Director
Dean W. Drulias(1)............... 50 1990 Executive Vice President, General Counsel, Corporate Secretary
and Director
J. Michael Urban................. 43 -- Vice President, Chief Financial Officer and Assistant
Secretary
John L. Collins.................. 52 -- Vice President of Investor Relations
Graham S. Folsom(2).............. 39 1992 Director
William T. Walker, Jr.(1)........ 65 1993 Director
Barry Feiner(1).................. 62 1995 Director
Gary Gelman(2)................... 31 1995 Director
Daniel Shaughnessy(2)............ 46 1997 Director
</TABLE>
- ------------------------
(1) Member of Compensation Committee
(2) Member of Audit Committee
Mr. Tyrone J. Fairbanks serves as President and Chief Executive Officer of
the Company. Mr. Fairbanks served as Vice President and Chief Financial Officer
of the Company from January 1991 to June 1994. Prior to joining Fortune, Mr.
Fairbanks served as President, Chief Executive Officer and Director of Fairbanks
& Haas, Inc. from January 1990 to January 1991. Fairbanks & Haas, Inc. was an
oil and gas exploration, production, acquisition and operations company located
in Ventura, California. Mr. Fairbanks co-founded Fairbanks & Haas, Inc. and
served in the capacity of Director and Executive Vice President from February
1987 to January 1990.
Mr. Dean W. Drulias was hired effective October 16, 1996 as Executive Vice
President and General Counsel. Prior to his employment by the Company, Mr.
Drulias was a stockholder of and a practicing attorney at the law firm of
Burris, Drulias & Gartenberg, a Professional Corporation, which served as
counsel to the Company since its incorporation in May 1987. He practiced law in
the Los Angeles area since 1977, specializing in the areas of energy,
environmental and real property law.
Mr. J. Michael Urban was hired effective March 11, 1996, as the Company's
Vice President and Chief Financial Officer. Mr. Urban formerly served as
Vice-President, Finance with Norcen Explorer, Inc. ("Norcen"), a Houston based
oil and gas company with operations primarily in the offshore Gulf of Mexico.
Norcen is a wholly owned subsidiary of Norcen Energy Resources Limited, a
Canadian public company. Mr. Urban had been with Norcen since March 1986. Mr.
Urban received his B.B.A. in Accounting from the University of Texas in 1976 and
has been a Certified Public Accountant in the State of Texas since 1978.
Mr. John L. Collins was hired by the Company as Vice President of Investor
Relations effective May 30, 1995. Mr. Collins formerly served as Vice President
of Investor Relations with Texas Meridian Resources Corporation, a Texas based
oil and gas company, a position he held from January 1991 until his resignation
to join Fortune in May 1995. Mr. Collins became a registered representative in
1970 and spent approximately 20 years in the securities industry.
Mr. Graham S. Folsom has served as the Chief Financial Officer of Klein
Ventures, Inc. since April 1987. Klein Ventures, Inc. is a diversified
investment company. Mr. Folsom has been active in the oil investments of such
company and its affiliates since 1987. Mr. Folsom has been licensed as a
Certified
37
<PAGE>
Public Accountant in the State of California since 1982 and is responsible for
all of the accounting and financial affairs of Klein Ventures and its
affiliates. Mr. Folsom is chairman of the Company's Audit Committee.
Mr. William T. Walker, Jr. founded Walker Associates, a corporate finance
consulting firm for investment banking, in 1985 and has participated in or been
instrumental in completing over $250 million in public and private offerings
since its inception. He also serves on the board of directors of Go Video, Inc.
(AMEX).
Mr. Barry Feiner is a member of the Bar of the State of New York. He has
practiced law in the State of New York since 1965. His practice concentrates on
the areas of corporate and securities law. Prior to beginning private practice,
Mr. Feiner served on the staff of the Securities and Exchange Commission. He is
Chairman of the Company's Compensation Committee.
Mr. Gary Gelman has served as president of GAR-COR Holding Corporation, a
real estate management and brokerage firm, since 1989. Mr. Gelman is a principal
of and serves as a loan consultant for National Bank of New York City.
Mr. Daniel Shaughnessy is a geologist and geophysicist. He is the founder
and president of Interpretation(3), a company which specializes in
interpretation of 2D and 3D seismic data. His firm provides consultation
services to Fortune. Prior to organizing Interpretation(3), Mr. Shaughnessy
served as a consultant with Interactive Exploration Solutions, Inc. (INXES) for
approximately one year. For most of the period from 1980 through 1993, he worked
for Mobil Oil, most recently as Exploration Supervisor in Louisiana.
DIRECTOR COMPENSATION
The Company pays outside directors fees of $2,500 per quarter. Inside
directors do not receive any compensation for serving as directors.
38
<PAGE>
EXECUTIVE COMPENSATION
The following table lists the total compensation paid by the Company to
persons who served in the capacity of chief executive officer during the periods
indicated and to the three other executive officers who received annual
compensation in excess of $100,000 (or at a rate in excess of $100,000):
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM COMPENSATION AWARDS
------------------------------
ANNUAL COMPENSATION SECURITIES PAYOUTS
--------------------------------- RESTRICTED UNDERLYING -----------
SALARY OTHER(1) STOCK OPTIONS/WARRANTS LTIP
NAME AND PRINCIPAL POSITION YEAR ($) BONUS ($) ($) AWARDS ($) (#) PAYOUTS ($)
- ----------------------------------- --------- --------- --------- ----------- ----------- ----------------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks................ 1996 150,000 -- 20,934 -- 80,000 --
President and CEO 1995 125,000 25,000 -- -- 105,599 --
1994 102,500 15,000 -- -- 78,900 --
Dean W. Drulias.................... 1996 26,291 250 -- -- 56,000(2) --
Executive Vice President
J. Michael Urban................... 1996 97,308 -- -- -- 55,000(3) --
Chief Financial Officer
John L. Collins 1996 96,000 2,000 -- -- 80,000 --
Vice President, Investor 1995 56,738 1,600 -- -- 25,000(4) --
Relations
<CAPTION>
ALL OTHER
COMPENSATION
NAME AND PRINCIPAL POSITION ($)
- ----------------------------------- ---------------
<S> <C>
Tyrone J. Fairbanks................ 3,000
President and CEO --
--
Dean W. Drulias.................... 1,972
Executive Vice President
J. Michael Urban................... 4,750
Chief Financial Officer
John L. Collins 4,090
Vice President, Investor --
Relations
</TABLE>
- ------------------------
(1) Amounts include automobile expenses and loan forgiveness, but are shown only
if such amounts exceed 10% of the total annual salary and bonus.
(2) Includes 20,000 stock purchase warrants exercisable at $2.75 per share (the
market price of the Common Stock on October 16, 1996, the date of issue) and
expiring on October 16, 2001.
(3) Includes 35,000 stock purchase warrants exercisable at $2.5625 per share
(the market price of the Common Stock on March 11, 1996, the date of issue)
and expiring on March 11, 2001.
(4) Includes 25,000 stock purchase warrants exercisable at $3.25 per share (the
market price of the Common Stock on May 30, 1995, the date of issue) and
expiring May 30, 2000.
Charles A. Champion served as Chief Executive Officer from June 23, 1994,
through January 5, 1995. During 1994, he received compensation of $36,000 as
Chief Executive Officer.
The following table lists the outstanding options held on December 31, 1996
by the Company's executive officers under Company's Stock Option Plans:
<TABLE>
<CAPTION>
NUMBER OF
UNEXERCISED VALUE OF UNEXERCISED
OPTIONS/ IN-THE-MONEY OPTIONS
SHARES VALUE WARRANTS AT FY-END AT FY-END
ACQUIRED REALIZED EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE ($) UNEXERCISABLE(1) UNEXERCISABLE
- -------------------------------------------- ------------- ----------- ------------------- --------------------
<S> <C> <C> <C> <C>
Tyrone J. Fairbanks......................... -- -- 296,999 / 0 --
Dean W. Drulias............................. 6,575 -- 82,400 / 0 --
J. Michael Urban............................ -- -- 55,000 / 0 --
John L. Collins............................. -- -- 105,000 / 0 --
</TABLE>
- ------------------------
(1) Includes warrants reflected in the preceeding table.
39
<PAGE>
EMPLOYMENT AGREEMENTS
The Company has entered into an employment agreement with Tyrone J.
Fairbanks, its President and Chief Executive Officer. The agreement provides
that if employment is terminated for any reason other than for cause, death or
disability within two years following a change in control (which for purposes of
this agreement means a change in the majority of the Board of Directors
following certain special events), Mr. Fairbanks is entitled to receive a single
payment equal to two years' compensation and all shares of Common Stock subject
to stock options then held by him without payment of the exercise price
therefor. Mr. Fairbanks' agreement also provides for two years of consulting
services upon the completion of the primary term of his contract at 40% of the
last compensation thereunder. Mr. Fairbanks' current employment agreement
provides for an annual salary of $150,000. The term of Mr. Fairbanks' employment
contract expires December 31, 1997.
The Company has entered into an employment agreement with Dean W. Drulias,
its Executive Vice President and General Counsel. The agreement provides that if
employment is terminated for any reason other than for cause, death or
disability within two years following a change in control (which for purposes of
this agreement means a change in the majority of the Board of Directors
following certain special events), Mr. Drulias is entitled to receive a single
payment equal to two years' compensation and all shares of Common Stock subject
to stock options then held by him without payment of the exercise price
therefor. Mr. Drulias' current employment agreement provides for an annual
salary of $125,000. The term of Mr. Drulias' employment contract expires
December 31, 1998.
STOCK OPTIONS
Fortune has three Stock Option Plans, and expects to present a new plan to
its shareholders for approval at the 1997 annual meeting. The plans cover all
officers and employees of the Company. One of the plans also provides for
options for directors of the Company, as will the new plan expected to be
approved in 1997 (the "1998 Plan"). Awards are made by the Board of Directors
upon recommendations of its Compensation Committee. There is no performance
formula or measure. Options granted under the 1987 and 1988 plans must be
exercised within ten years of the date of grant or they are forfeited. Options
granted under the 1993 plan must be exercised within five years of the date of
grant or they are forfeited.
All options available under the 1987 and 1988 plans have been granted, and
no shares remain under either of these plans on which options may be granted.
Options have been granted as follows: (1) under the 1987 plan, options for
12,500 shares at a price of $2.60 per share; (2) under the 1988 plan, options
for 27,500 shares at $2.60 per share; and (3) under the 1993 plan, options for
75,000 shares at $5.00 per share granted in 1993, options for 263,000 shares at
$5.48 per share granted in 1994, options for 264,000 shares at $6.03 per share
granted in 1995, options for 450,000 shares at $3.125 per share granted in 1996,
and options for 585,000 shares at $3.00 per share granted in 1997. The exercise
prices of all options granted in 1993, 1994 and 1995 were reduced to $2.75 on
January 12, 1995.
The 1998 Plan will be substantially identical to the 1993 plan.
40
<PAGE>
The following table shows the grants of stock options during 1996 to each of
the executives named in the Summary Compensation Table.
OPTION/WARRANT GRANTS IN 1996(1)
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT
INDIVIDUAL GRANTS ASSUMED ANNUAL RATES
---------------------------------------------------------------------------- OF
NUMBER OF % OF TOTAL STOCK PRICE
SECURITIES OPTIONS/WARRANTS APPRECIATION
UNDERLYING GRANTED TO FOR OPTION TERM
OPTIONS/WARRANTS EMPLOYEES IN EXERCISE OR BASE EXPIRATION --------------------
NAME GRANTED FISCAL YEAR PRICE ($/SH) DATE 5% 10%
- ----------------------- ------------------- ------------------- ----------------- --------------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks.... 80,000 12.7 3.125 April 5, 2001 $ 69,072 $ 152,624
Dean W. Drulias........ 36,000 5.7 3.125 April 5, 2001 31,082 68,681
October 16,
20,000(2) 3.2 2.75 2001 15,180 33,578
J. Michael Urban....... 20,000 3.2 3.125 April 5, 2001 17,268 38,156
35,000(2) 5.6 2.5625 March 11, 2001 24,779 54,754
John L. Collins........ 80,000 12.7 3.125 April 5, 2001 69,072 152,624
</TABLE>
- ------------------------------
(1) In addition, the following options were granted on February 14, 1997, at an
exercise price of $3.00 per share: Tyrone J. Fairbanks, 120,000; Dean W.
Drulias, 75,000; J. Michael Urban, 100,000; and John L. Collins, 92,000.
(2) Compensatory warrants granted in 1996 in connection with comencement of
employment.
In the event of a change in control of the Company, the shares of Common
Stock subject to options granted to all option holders under the Company's stock
option plans will be issued to them without further action on their part or the
payment of the exercise price for such shares.
RETIREMENT PLAN
During 1996, the Company adopted the Fortune Petroleum Corporation 401(k)
Profit Sharing Plan for its eligible employees. Under the plan, all employees on
the Company's payroll as of November 1, 1996, and all employees hired after that
date who have attained age 21 and three months of service, are permitted to make
salary deferrals up to the lesser of 15% of their annual compensation or $9,500.
Salary deferrals will be matched 50% by the Company and are 100% vested after
two years of service with the Company. Salary deferrals are 100% vested at all
times. The Company does not make profit sharing contributions to the plan.
Messrs. Drulias and Urban are the trustees of the plan.
For 1996, the Company's matching contribution was $14,000, all of which will
be paid in shares of Common Stock. The amounts to be contributed to the plan as
matching contributions for executives of the Company are shown in the
Compensation table set forth above.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
As part of the relocation of Fortune Petroleum Corporation's headquarters to
Houston, Texas, the Company provided Tyrone J. Fairbanks, its President and
Chief Executive Officer, with an incentive relocation package to facilitate his
move to Texas. The package consisted of a payment by the Company of Mr.
Fairbanks' moving expenses, a non-recourse, unsecured loan in the amount of
$80,000 bearing interest at the rate of 6% per annum, with $20,000 of such loan
forgiven in each of four consecutive years beginning in 1996 provided Mr.
Fairbanks is still employed by the Company or has been terminated by the Company
without cause, and a secured recourse loan in the amount of $70,000 also bearing
interest at the rate of 6% per annum, payable interest only for two years with a
$35,000 principal payment due on the second and third anniversary of the loan.
The Company also extended the term of Mr. Fairbanks' employment contract through
December 31, 1997. At February 28, 1997, the outstanding principal balance of
the non-recourse loan was $40,000.
41
<PAGE>
On April 24, 1995, the Company obtained a $300,000 "bridge" loan to enable
it to pay certain expenses, including $100,000 on its Credit Facility. The loan
was obtained from LEX, which in turn had borrowed the funds from several
individuals. Upon the consummation of the Company's acquisition of LEX, it
became liable on such loans. The loans were repaid out of the proceeds of the
Company's public offering of Common Stock in 1995. Among the individuals who
loaned funds to LEX were Mrs. William H. Forster, mother of William D. Forster,
a principal of LEX and a principal stockholder and former director of Fortune,
and John E. McConnaughy, Jr., formerly a principal stockholder of the Company.
Each of Mrs. Forster and Mr. McConnaughy loaned LEX $100,000 and received from
LEX, as an inducement to make the loan, 33,333 shares of Common Stock and 33,333
stock purchase warrants out of 170,000 shares and 170,000 warrants issued to LEX
prior to the closing of the acquisition. W. Forster & Co., Inc., a corporation
wholly owned by William D. Forster, received a $30,000 placement fee from the
Company for assistance in arranging the $300,000 bridge loan. As a result of its
acquisition of LEX, Fortune was required, at the time the bridge loan was
repaid, to accelerate the amortization of the value of the shares paid by LEX to
the lenders in connection with the bridge loan in the amount of $150,000.
In order to provide additional capital for development activities, in
December 1994, the Company borrowed an aggregate of $750,000 from certain
principal stockholders and from each of its directors then serving (Messrs.
Champion, Drulias, Fairbanks, Folsom and Walker). The directors loaned $175,000
to the Company in the aggregate. $375,000 was obtained from Klein Ventures,
Inc., and $200,000 was obtained from Jack Farber. (See "Principal Stockholders")
The notes were unsecured, bore interest at 11% per annum (1.5% above the Bank
One, Texas, prime rate), payable monthly, and were due six months from their
respective dates of issue. The loans from each of the directors were repaid in
full on December 21, 1995. Both the Klein Ventures, Inc. and Farber notes
permitted the holder to elect to exchange their notes for shares of Common Stock
at the price on the date the notes were issued ($2.00 and $1.875 per share,
respectively), and Fortune reserved 294,166 shares of common stock for such
purpose. Klein Ventures, Inc. and the Estate of Jack Farber exercised the option
contained in their note agreements to convert the note to Fortune Common Stock.
This option was not available to the directors.
As additional consideration for making these loans, Klein Ventures, Inc.
received 10,000 stock purchase warrants with an exercise price of $2.40 per
share, and Mr. Farber received 35,000 stock purchase warrants with an exercise
price of $1.875 per share. Klein Ventures, Inc. and the successors to Mr. Farber
each exercised the warrants issued in connection with this transaction.
During 1995 and 1996, the law firm in which Dean Drulias was formerly a
shareholder billed the Company a total of $183,000 and $152,000, respectively,
for legal fees and costs. (See "Management-- Directors and Executive Officers.")
During 1996, Fortune paid $45,000 for consulting services to
Interpretation(3), of which Daniel Shaughnessy is the owner and president. Mr.
Shaughnessy was elected to the Company's board of directors in January 1997.
All of the foregoing transactions between the Company and members of
management or principal stockholders were, and any future transactions will be,
on terms no less favorable to the Company than those which could be obtained
from unaffiliated third parties. In addition, no future transaction will be
entered into between the Company and members of management or principal
stockholders unless such transactions are approved by a majority of the
directors who are not members of management or principal stockholders.
LIMITED LIABILITY OF DIRECTORS
In accordance with the Delaware General Corporation Law, the Company has
included a provision in its Certificate of Incorporation to limit the personal
liability of its directors for violations of their fiduciary duties. The
provision eliminates such directors' liability to the Company or its
stockholders for monetary damages, except (i) for any breach of the directors'
duty of loyalty to the Company or its stockholders,
42
<PAGE>
(ii) for acts or omissions not in good faith or which involve intentional
misconduct or a knowing violation of law, (iii) for unlawful payment of
dividends or unlawful stock purchases or redemptions or (iv) for any transaction
from which any director derived an improper personal benefit.
This provision protects the Company's directors against personal liability
for monetary damages arising from breaches of their duty of care. Directors
remain liable for breaches of their duty of loyalty to the Company and its
stockholders and for the specific matters set forth above, as well as for
violations of the federal securities laws. The provision has no effect on the
availability of equitable remedies such as injunction or rescission.
Additionally, these provisions do not protect a director from activities
undertaken in any capacity other than that of director.
INDEMNIFICATION OF OFFICERS AND DIRECTORS
The Company's bylaws provide for indemnification of its officers and
directors to the fullest extent permitted by the Delaware General Corporation
Law in effect at the time of a claim for indemnification. Such indemnification
applies to any threatened, pending or contemplated suit or proceeding arising by
reason of such person acting as an officer or director of the Company or its
affiliates.
Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers or persons controlling the Company pursuant to
the foregoing provisions, the Company has been informed that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is therefore unenforceable.
43
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table contains information at February 28, 1997, as to all
persons who, to the knowledge of the Company, were the beneficial owners of five
percent (5%) or more of the outstanding shares of the common stock of the
Company and of all officers and directors.
<TABLE>
<CAPTION>
AMOUNT AND
NATURE OF
BENEFICIAL PERCENT
NAME OWNERSHIP OF CLASS
- ------------------------------------------------------------------------- ------------------- ------------
<S> <C> <C>
Barry Blank ............................................................. 911,313 7.3%
5353 N. 16th St., Phoenix, AZ(4)
William D. Forster ...................................................... 715,000 5.8%
237 Park Ave, New York (1)(2)
BSR Investments, Inc. .................................................. 715,000 5.8%
Paris, France(1)(3)
Klein Ventures, Inc. ................................................... 640,017 5.3%
1307 E. Pine St., Lodi, CA(5)
Tyrone J. Fairbanks ..................................................... 438,440 3.6%
(Director, President, and CEO)
515 W. Greens Rd., Houston, TX(6)
John L. Collins ......................................................... 272,000 2.2%
(Vice President)
515 W. Greens Rd., Houston TX(6)
William T. Walker, Jr. ................................................. 226,278 1.9%
(Director)
515 W. Greens Rd., Houston TX(6)
Dean W. Drulias ......................................................... 181,241 1.5%
(Director, Executive Vice-President, General Counsel and Corporate
Secretary)
515 W. Greens Rd., Houston, TX(6)
J. Michael Urban ........................................................ 155,000 1.3%
(Vice President and CFO)
515 W. Greens Rd., Houston, TX(6)
Graham S. Folsom ........................................................ 135,522 1.1%
(Director)
515 W. Greens Rd., Houston, TX(6)(7)
Gary Gelman ............................................................. 94,083 *
(Director)
515 W. Greens Rd., Houston, TX(6)
Barry Feiner ............................................................ 87,862 *
(Director)
515 W. Greens Rd., Houston, TX(6) (8)
Daniel R. Shaughnessy ................................................... 10,000 *
(Director)
515 W. Greens Rd., Houston, TX(6)
All Officers and Directors as a group of nine (9) persons................ 1,600,426 12%
---------- ---
---------- ---
</TABLE>
- ------------------------
* indicates less than 1%.
(1) Forster and BSR are the record holders of these shares issued in connection
with the LEX acquisition. Ensign Financial Group Limited claims a one-third
interest in such shares and the stock purchase warrants issued in the
acquisition. In light of the dispute which has arisen over the ownership of
these shares and warrants, the Company is unable to state the beneficial
ownership of such shares and
44
<PAGE>
warrants. If Ensign's position is upheld by the New York courts and it is
awarded one-third of the securities issued in the LEX acquisition, to the
best of the Company's knowledge, the ownership, including shares underlying
the stock purchase warrants and other securities noted in footnote (2) and
(3), would be as follows:
<TABLE>
<CAPTION>
AMOUNT AND
NATURE OF
BENEFICIAL PERCENT
OWNERSHIP OF CLASS
------------------- -------------
<S> <C> <C>
Ensign Financial Group Limited, NY, NY............................. 800,000 6.5%
William D. Forster, New York, NY................................... 315,000 2.6%
BSR Investments, Inc., Paris, France............................... 315,000 2.6%
</TABLE>
(2) Includes 515,000 shares of Common Stock underlying stock purchase warrants
exercisable at $4.75 per share and expiring April 2000.
(3) Includes 515,000 shares of Common Stock underlying stock purchase warrants
exercisable at $4.75 per share and expiring April 2000. Based on information
provided to the Company by BSR, voting and dispositive power is exercised by
Samyr Souki, the president of BSR.
(4) Includes 279,200 shares of Common Stock and an additional 432,113 shares of
Common Stock which underly 300,600 stock purchase warrants held by Mr. Blank
and exercisable at $3.75 per share and 200,000 shares of Common Stock
underlying 200,000 stock purchase warrants, exercisable at $2.40 per share,
issued to the Underwriters in the Company's 1995 Equity Offering, which Mr.
Blank acquired from Coleman & Company Securities, Inc. Mr. Blank is a Vice
President and registered representative with Coleman & Company Securities,
Inc.
(5) Klein Ventures, Inc. is owned by Mr. Bud Klein. The number of shares shown
includes 138,888 shares underlying stock purchase warrants issued in a 1992
acquisition and 115,000 shares underlying 80,000 Public Warrants acquired in
the Company's 1993 public equity offering exercisable at $3.75 per share.
The number shown also includes an aggregate of 88,629 shares of stock owned
by Klein Bros. Holdings, Ltd. Each record owner possesses sole voting and
disposition power over such shares, and Klein Ventures, Inc. and Mr. Bud
Klein disclaim beneficial ownership of shares owned by Klein Bros. Holdings,
Ltd. which is owned by Klein Ventures, Inc. and five of Mr. Klein's children
and relatives. However, Klein Ventures, Inc., Klein Bros. Holdings, Ltd. and
Bud Klein may be considered a "group" under regulations of the Securities
and Exchange Commission.
(6) Includes 416,999 shares issuable to Mr. Fairbanks upon the exercise of stock
options granted to him under the Company's various stock option plans,
exercisable at prices of $2.75 to $3.125 per share; an aggregate of 799,700
shares issuable upon exercise of stock options granted to other officers and
directors under the Company's various stock option plans, exercisable at
prices of $2.75 to $3.125 per share; 88,289 shares issuable upon exercise of
stock purchase warrants (at $4.41 per warrant) and 22,264 shares issuable
upon exercise of 3,600 warrants (at $11.14 each for 3.3097 shares of Common
Stock and two stock purchase warrants exercisable at $3.75 each for 1.4375
shares) issued in connection with the Company's 1993 equity offering to
William T. Walker, Jr. prior to his becoming a director of the Company;
25,000 shares issuable upon the exercise of stock purchase warrants (at
$3.25 per share) issued to John L. Collins on May 30, 1995; 35,000 shares
issuable upon the exercise of stock purchase warrants (at $2.5625 per share)
issued to J. Michael Urban on March 11, 1996; and 20,000 shares issuable
upon the exercise of stock purchase warrants (at $2.75 per share) issued to
Dean W. Drulias on October 16, 1996.
(7) Includes 7,187 shares issuable upon exercise of 5,000 Public Warrants (at
$3.75 each) and 5,000 debentures convertible pursuant to their terms into
shares of Common Stock at a price of $6.32 per share.
(8) All shares shown are owned by Mrs. Barry Feiner, wife of Barry Feiner; Mr.
Feiner disclaims beneficial ownership of all such shares. The number shown
includes approximately 11,744 shares issuable upon exercise of approximately
8,170 Public Warrants (at $3.75 each).
45
<PAGE>
DESCRIPTION OF SECURITIES
COMMON AND PREFERRED STOCK
The following description is qualified in all respects by reference to the
Company's Certificate of Incorporation and all amendments thereto and the
Company's Bylaws, copies of which are filed as exhibits to the Registration
Statement of which this Prospectus is a part.
The Company's Certificate of Incorporation, as amended, currently authorizes
40,000,000 shares of Common Stock, $.01 par value and 2,000,000 shares of
preferred stock, $1.00 par value. Of this total, 12,154,961 shares of Common
Stock were issued and outstanding as of February 28, 1997. An additional
7,423,189 shares of Common Stock are issuable upon exercise of options and
warrants or conversion of Debentures outstanding at February 28, 1997. No
preferred stock is currently outstanding.
COMMON STOCK
Holders of shares of Common Stock are entitled to dividends when and as
declared by the Board of Directors from funds legally available therefor and
upon liquidation are entitled to share ratably in any distribution to
stockholders. All holders of Common Stock are entitled to one vote per share on
any matter coming before the stockholders for a vote, including the election of
directors. In keeping with stockholder democracy rights, Fortune's Certificate
of Incorporation permits the stockholders to remove any director or the entire
board of directors, with or without cause, upon a vote of a majority of the
outstanding shares.
All issued and outstanding shares of Common Stock are validly issued, fully
paid and non-assessable. Holders of the Common Stock do not have pre-emptive
rights or other rights to subscribe for unissued or treasury shares or
securities convertible into shares.
Additionally, under Section 145 of the Delaware General Corporation Law, the
Company has availed itself of the provisions permitting the limitation of
liability through the indemnification of officers, directors, employees and
agents of Delaware corporations. (See "Certain Relationships and Related
Transactions--Limited Liability of Directors" and "--Indemnification of Officers
and Directors.")
PREFERRED STOCK
The Certificate of Incorporation authorizes the Board of Directors to
establish and designate the classes, series, voting powers, designations,
preferences and relative, participating, optional or other rights, and such
qualifications, limitations and restrictions of the Preferred Stock as the
Board, in its sole discretion, may determine without further vote or action by
the stockholders.
The rights, preferences, privileges and restrictions or qualifications of
different series of preferred stock may differ with respect to dividend rates,
amounts payable on liquidation, voting rights, conversion rights, redemption
provisions, sinking fund provisions and other matters. The issuance of Preferred
Stock could decrease the amount of earnings and assets available for
distribution to holders of Common Stock, or could adversely affect the rights
and powers, including voting rights, of holders of Common Stock.
The existence of the Preferred Stock, and the power of the Board of
Directors of the Company to set its terms and issue a series of Preferred Stock
at any time without stockholder approval, could have certain anti-takeover
effects. These effects include that of making the Company a less attractive
target for a "hostile" takeover bid or rendering more difficult or discouraging
the making of a merger proposal, assumption of control through the acquisition
of a large block of Common Stock or removal of incumbent management, even if
such actions could be beneficial to the stockholders of the Company.
WARRANTS
The Company has issued various Common Stock purchase warrants from time to
time.
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<PAGE>
PUBLIC WARRANTS
The Company currently has outstanding a series of warrants which are
publicly traded (the "Public Warrants") which were issued in connection with a
1993 public offering. The Public Warrants are listed on the AMEX and expire
September 28, 1998.
Each Public Warrant originally entitled the holder to purchase one share of
Common Stock at a price of $3.75 per share. The Public Warrants contain
provisions that protect the holders against dilution by adjustment of the
exercise price in certain events, such as stock dividends and distributions,
stock splits, recapitalizations, mergers or consolidations and certain issuances
below the current market value of the Common Stock. As a result of the operation
of these provisions, the Public Warrants have been adjusted so that the holder
is entitled to purchase 1.4375 shares for an effective purchase price of $2.61
per share. The exercise price of each Public Warrant remains $3.75 per warrant.
The Public Warrants are redeemable by the Company, at $.05 per Public Warrant,
upon 30 days' notice, if the closing price per share of the Common Stock for 20
consecutive trading days within the 30-day period preceding the date notice of
redemption is given equals or exceeds $5.50 per share. In the event the Company
gives notice of its intention to redeem, a holder would be forced to exercise
his or her Public Warrant within 30 days of the notice of redemption or accept
the redemption price. (See "Risk Factors--Risks Associated with Investment in
the Common Stock--Shares Eligible for Future Sale".)
The Public Warrants were issued in registered form under a warrant agreement
between the Company and U.S. Stock Transfer, as warrant agent. The shares of
Common Stock underlying the Public Warrants, when issued upon exercise of a
Public Warrant, will be fully paid and nonassessable, and the Company will pay
any transfer tax incurred as a result of the issuance of Common Stock to the
holder upon its exercise. The Company is not required to issue fractional shares
upon the exercise of a Public Warrant. The holder of a Public Warrant does not
possess any rights as a stockholder of the Company until such holder exercises
the Public Warrant.
DEBENTURE EXCHANGE WARRANTS
On February 26, 1997, the Company closed an offer to exchange shares of
Common Stock and Common Stock purchase warrants (the "Exchange Warrants") for
outstanding Debentures. Exchange Warrants to purchase 174,250 shares of Common
Stock were issued. Such Exchange Warrants are not listed on the AMEX.
Each Exchange Warrant will entitle the holder to purchase one share of
Common Stock for a period of three years following the effective date of the
exchange offer. One-half of the Exchange Warrants received by exchanging
Debentureholders have an exercise price equal to the $4.00 per share and
one-half have an exercise price of $5.00 per share. The Exchange Warrants are
callable by the Company, at $.05 per Exchange Warrant, upon 30 days notice, at
any time after the closing price per share of the Common Stock for ten
consecutive trading days equals or exceeds $6.00 per share. In the event the
Company gives notice of its intention to redeem, a holder would be forced either
to exercise his or her Exchange Warrant within 30 days of the notice of
redemption or accept the redemption price.
The Exchange Warrants were issued in registered form under a warrant
agreement between the Company and the Debentureholders. The shares of Common
Stock underlying the Exchange Warrants, when issued upon exercise of an Exchange
Warrant, will be fully paid and nonassessable, and the Company will pay any
transfer tax incurred as a result of the issuance of Common Stock to the holder
upon its exercise. The Common Stock received by exchanging Debentureholders,
including any Common Stock received in connection with exercising the Exchange
Warrants, will not be tradable until May 27, 1997 (90 days following the closing
date of the Exchange Offer). The Company is not required to issue fractional
shares upon the exercise of an Exchange Warrant. The holder of an Exchange
Warrant does not possess any rights as a stockholder of the Company until such
holder exercises the Exchange Warrant.
47
<PAGE>
OTHER WARRANTS
The Company has also issued various other warrants to purchase shares of
Common Stock from time to time. The holders of such warrants have the right to
purchase up to 2,888,917 shares of Common Stock at prices ranging from $2.40 to
$6.00 and with expiration dates ranging from December 1997 to October 2001.
DEBENTURES
The Company has outstanding a series of 10 1/2% Convertible Subordinated
Debentures due December 31, 1997. Interest at the rate of 10 1/2% per annum is
payable semiannually on January 1 and July 1 of each year. At February 27, 1997,
there was $1,028,000 principal amount of Debentures outstanding.
The Debentureholders have the right, at the holder's option, to convert any
portion of the principal amount in integral multiples of $1,000, into shares of
Common Stock at a conversion price of $6.32 per share, subject to adjustment on
an anti-dilutive basis. The payment of principal and interest is subordinated to
the payment of the current portion of Senior Indebtedness of the Company (as
defined in the Indenture) outstanding from time to time. At December 31, 1996,
the Company's Senior Indebtedness was $1,250,000. The Indenture under which the
Debentures were issued does not limit the Company's ability to incur Senior
Indebtedness.
The Debentures are redeemable at the Company's option, as a whole or in
part. The Redemption Price is 100% of the principal amount, plus accrued
interest to the date fixed for redemption.
If certain Events of Default occur (as defined in the Indenture), either the
Trustee or the holders of at least 25% in aggregate principal amount of the
Debentures may accelerate the maturity of the Debentures. In addition, the
holders of Debentures representing not less than 25% of the aggregate principal
amount of the Debentures outstanding may (but are not obligated to) appoint one
person to the Company's board of directors so long as the default continues.
The Company expects to retire the Debentures which remain outstanding at or
before maturity, and a portion of the net proceeds of this offering may be used
for that purpose.
TRANSFER AGENT AND REGISTRAR
The principal transfer agent and registrar for the Common Stock is U.S.
Stock Transfer Corporation, Glendale, California. The co-transfer agent and
co-registrar for such securities is Chase Mellon Shareholder Services.
CERTAIN ANTI-TAKEOVER DEVICES
Section 203 of the Delaware General Corporation Law applies to Delaware
corporations with a class of voting stock listed on a national securities
exchange, authorized for quotation on an inter-dealer quotation system or held
of record by 2,000 or more persons. In general, Section 203 prevents an
"interested stockholder" (defined generally as any person owning, or who is an
affiliate or associate of the corporation and has owned in the preceding three
years, 15% or more of a corporation's outstanding voting stock and affiliates
and associates of such person) from engaging in a "business combination" (as
defined) with a Delaware corporation for three years following the date such
person became an interested stockholder unless (1) before such person became an
interested stockholder, the board of directors of the corporation approved
either the business combination or the transaction that resulted in the
stockholder becoming an interested stockholder; (2) the interested stockholder
owned at least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced (excluding stock held by directors who are also
officers of the corporation and by employee stock plans that do not provide
employees with the rights to determine confidentially whether shares held
subject to the plan will be tendered in a tender or exchange offer); or (3) on
or subsequent to the date such person became an interested stockholder, the
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<PAGE>
business combination is approved by the board of directors of the corporation
and authorized at a meeting of stockholders by the affirmative vote of the
holders of two-thirds of the outstanding voting stock of the corporation not
owned by the interested stockholder. Under Section 203, the restrictions
described above also do not apply to certain business combinations proposed by
an interested stockholder following the announcement or notification of one of
certain extraordinary transactions involving the corporation and a person who
had not been an interested stockholder during the previous three years or who
became an interested stockholder with the approval of a majority of the
corporation's directors.
These provisions could have the effect of delaying, deferring or preventing
a change of control of the Company.
The Commission has indicated the use of authorized unissued shares of voting
stock could have an anti-takeover effect. In such case, various specific
disclosures to the stockholders are required. Any business combination, as that
term is used in Section 203, would be reviewed by the Company's Board of
Directors solely for its impact on the Company.
The Company's board of directors has adopted certain amendments to its
charter and bylaws which may have an anti-takeover effect. The proposals to
amend the Company's charter must be approved by a majority of the outstanding
shares and will be presented to the shareholders at the 1997 Annual Meeting. No
assurance can be given that such proposals will be approved.
Among these amendments are: (1) adoption of a shareholders' rights plan
which will result in the issuance to existing shareholders of a right to
purchase preferred stock in the event of a tender or exchange offer for the
Common Stock; (2) revocation of the right of shareholders to act without a
meeting; (3) vesting with the board of directors the power to change the size of
the board and fill vacancies thereon; and (4) providing restrictions on the
manner in which business may be brought before a meeting of shareholders,
including the requirement that any shareholder nominations for members of the
board be presented not less than 60 days prior to the meeting.
49
<PAGE>
UNDERWRITING
The Underwriters named below (collectively, the "Underwriters"), for whom
Paulson Investment Company, Inc. is acting as the Representative, have severally
agreed, subject to the terms and conditions of the Underwriting Agreement with
the Company (the "Underwriting Agreement"), to purchase from the Company and the
Company has agreed to sell to the Underwriters the number of shares of Common
Stock set forth opposite their respective names below:
<TABLE>
<CAPTION>
UNDERWRITER NUMBER OF SHARES
- ------------------------------------------------------------------------------------- -----------------
<S> <C>
Paulson Investment Company, Inc......................................................
-----------------
TOTAL............................................................................ 2,000,000
-----------------
-----------------
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters are subject to certain conditions precedent and require that the
Underwriters purchase all of the shares of Common Stock offered hereby, if any
such shares are purchased.
The Company has been advised by the Representative that the Underwriters
propose to offer the shares of Common Stock to the public at the initial public
offering price set forth on the cover page of this Prospectus and to certain
selected dealers at such price less a concession within the discretion of the
Representative, of which an amount also within the discretion of the
Representative may be reallowed to other dealers. The public offering price and
concessions and discounts to dealers may be changed by the Representative after
the public offering.
The Company has granted to the Underwriters an option, exercisable not later
than 45 days after the date of this Prospectus, to purchase up to 300,000
additional shares of Common Stock at the public offering price, less
underwriting discounts and commissions. The Underwriters may exercise this
option only to cover any over-allotments in the sale of the 2,000,000 shares of
Common Stock offered hereby.
The Company has paid $35,000 to reimburse the Representative and has agreed
to pay to the Representative a non-accountable expense allowance equal to 3% of
the aggregate public offering price of the securities purchased by the
Underwriters, reduced by the $35,000 already paid to the Representative.
The Company's executive officers and directors have agreed not to sell any
equity securities of the Company owned by such person, pursuant to Rule 144
under the Securities Act or otherwise, without the prior written consent of the
Representative, for a period of 180 days after the date of this Prospectus.
The Underwriting Agreement contains indemnity provisions among the
Underwriters, the Company and the controlling persons thereof against certain
liabilities, including liabilities arising under the Securities Act of 1933, as
amended.
The Company has agreed to issue to the Representative the Representative's
Warrants to purchase up to 200,000 shares of Common Stock. The Representative's
Warrants are exercisable for a period of four years beginning one year from the
date of this Prospectus at a price of $ per share (120% of the initial
public offering price of the Common Stock offered hereby) and are
nontransferable for a period of one year following the date of this Prospectus,
except (a) to any of the Underwriters or to individuals who are either an
officer or a partner of an Underwriter of (b) by will or the laws of descent and
distribution. The holders of the Representative's Warrants will have, in that
capacity, no voting, dividend or other
50
<PAGE>
shareholder rights. Any profits realized by the Representative on the sale of
the securities issuable on exercise of the Representative's Warrants may be
deemed to be additional underwriting compensation.
The foregoing is a brief summary of the provisions of the Underwriting
Agreement and does not purport to be a complete statement of its terms and
conditions. A copy of the Underwriting Agreement has been filed as an exhibit to
the Registration Statement of which this Prospectus is a part.
LEGAL MATTERS
Reish & Luftman, Los Angeles, California, has passed upon the legality of
the securities offered hereby for the Company. C. Frederick Reish, a shareholder
of such firm, holds 2,500 shares of the Common Stock. Certain legal matters will
be passed on for the Underwriters by Stoel Rives LLP, Portland, Oregon.
EXPERTS
The financial statements of the Company as of December 31, 1995 and 1996 and
for each of the years in the three year period ended December 31, 1996, have
been included herein and in the Registration Statement in reliance upon the
report of KPMG Peat Marwick LLP, independent certified public accountants,
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing. The report of KPMG Peat Marwick LLP covering the
December 31, 1996, financial statements refers to a change from the successful
efforts method to the full cost method of accounting for oil and gas properties.
The information appearing herein with respect to net proved oil and gas
reserves of the Company at December 31, 1994, 1995 and 1996, was estimated by
Huddleston & Co., Inc., independent petroleum engineers, and at December 31,
1994 was estimated in part by Sherwin D. Yoelin, independent petroleum engineer,
and is included herein on the authority of such engineers as experts in
petroleum engineering.
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act") and, in accordance
therewith, files reports and other information with the Securities and Exchange
Commission (the "Commission"). Reports, proxy and information statements filed
by the Company with the Commission pursuant to the informational requirements of
the Exchange Act may be inspected and copied at the public reference facilities
maintained by the Commission, at Room 1024, Judiciary Plaza Building, 450 Fifth
Street, N.W. Washington, D.C. 20549, and the Regional offices of the Commission:
Seven World Trade Center, Suite 1300, New York, New York 10048, and Kluczynski
Federal Building, 230 South Dearborn Street, Room 3190, Chicago, Illinois 60604.
Copies of such material may be obtained at prescribed rates from the Public
Reference Section of the Commission at Room 1025, Judiciary Plaza Building, 450
Fifth St., N.W., Washington, D.C. 20549. In addition, reports and other
information concerning the Company can be inspected at the offices of the
American Stock Exchange, Inc., 86 Trinity Place, New York, New York 10006-1881,
on which the Common Stock is listed.
The Company has filed with the Commission a Registration Statement on Form
S-2 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Act"), with respect to the Common Stock offered hereby. This Prospectus,
filed as part of the Registration Statement, does not contain all the
information set forth in the Registration Statement and the exhibits and
schedules thereto, certain portions of which have been omitted in accordance
with the rules and regulations of the Commission. For further information with
respect to the Company and the Common Stock offered hereby, reference is made to
the Registration Statement and to the exhibits and schedules thereto, which may
be inspected at the Commission's offices without charge or copies of which may
be obtained from the Commission upon payment of the prescribed fees. Statements
made in the Prospectus as to the contents of any contract, agreement or document
referred to are not necessarily complete, and in each instance, reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement.
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<PAGE>
GLOSSARY
<TABLE>
<S> <C>
AMI. "AMI" means Area of Mutual Interest.
BBL. "Bbl" means barrel. "Mbbl" means thousand barrels. "MMBbl"
means million barrels.
BCF. "Bcf" means billion cubic feet.
BOPD. "BOPD" means barrels of oil (or condensate) per day of
production.
FARMOUT. "Farmout" means an agreement pursuant to which an owner of a
working interest sells a portion of its working interest in an
exploration well or prospect in exchange for either a payment
of previously incurred costs or an agreement to pay a
disproportionate share of future exploration costs. If the
exploration project is unsuccessful, the working interest
farmed out in this manner commonly reverts to the seller.
GROSS ACRES OR WELLS. "Gross Acres or Wells" are the total acres or wells, as the
case may be, in which an entity has an interest, either
directly or through an affiliate.
MCF. "Mcf" means thousand cubic feet. "Mmcf" means million cubic
feet. Natural gas volumes are stated at the legal pressure base
of the state or area in which the reserves are located at 60
degrees Fahrenheit.
MCFD. "MCFD" means Mcf of gas per day of gas production.
MCFE. "MCFE" means thousand cubic feet of gas equivalent, which is
determined using the ratio of one barrel of crude oil,
condensate or natural gas liquids to six Mcf of natural gas so
that one Bbl. of oil is referred to as six Mcf equivalent or
"MCFE". "MMCFE" means Million cubic feet of gas equivalent.
"BCFE" means billion cubic feet of gas equivalent.
NET ACRES OR WELLS. A party's "Net Acres" or "Net Wells" are calculated by
multiplying the number of gross acres or gross wells in which
that party has an interest by the fractional interest of the
party in each such acre or well.
NET REVENUE INTEREST. "Net Revenue Interest" reflects the percentage of net revenues
generated by operating activities on a property, exclusive of
any royalty or overriding royalty interests which may burden
that property.
OVERRIDING ROYALTY "Overriding Royalty Interest" is the right to share in the
INTEREST. gross revenues generated by a producing property, free of any
costs of exploration, acquisition, development, or operation,
and free of all risks in connection therewith.
PAYOUT. "Payout" refers to the point in time when initial working
interest owners recover a defined portion of acquisition,
exploration, development, and lease operating expenses from the
revenues generated by a property or well.
PRODUCING PROPERTIES OR "Producing Reserves" are Proved Developed Reserves expected to
RESERVES. be produced from existing completion intervals now open for
production in existing wells. A "Producing Property" is a
property to which Producing Reserves have been assigned by an
independent petroleum engineer.
</TABLE>
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<PAGE>
<TABLE>
<S> <C>
PROVED DEVELOPED NON- "Proved Developed Non-Producing Reserves" (PDNP) are Proved
PRODUCING RESERVES Developed Reserves that are recoverable from zones behind
cemented casing in existing wells which will require additional
completion work or a future recompletion prior to the start of
production. The cost of making such oil reserves available for
production is insignificant relative to the volume of reserves
expected to be recovered from the planned recompletion
programs. The PDNP reserves are supported by actual production
performance from wells completed in the same reservoir
elsewhere in the local area.
PROVED DEVELOPED "Proved Developed Producing Reserves" are Proved Developed
PRODUCING RESERVES. Reserves that are recoverable from completion intervals in
existing wells that are currently open and delivering
commercial volumes of hydrocarbons to market.
PROVED DEVELOPED "Proved Developed Reserves" are Proved Reserves which can be
RESERVES. expected to be recovered through existing wells with existing
equipment and operating methods.
PROVED RESERVES. "Proved Reserves" are the estimated quantities of crude oil,
natural gas and natural gas liquids which geological and
engineering data demonstrate with reasonable certainty to be
recoverable in future years from known oil and gas reservoirs
under existing economic and operating conditions, that is, on
the basis of prices and costs as of the date the estimate is
made and any price changes provided for by existing conditions.
PROVED UNDEVELOPED "Proved Undeveloped Reserves" are Proved Reserves which can be
RESERVES. expected to be recovered from new wells on undrilled acreage,
or from existing wells where a relatively major expenditure is
required for recompletion. The offset units containing the
proved-undeveloped reserves are reasonably certain of
commercial production when drilled.
RESERVES. "Reserves" means crude oil and natural gas, condensate and
natural gas liquids, which are net of leasehold burdens, are
stated on a net revenue interest basis, and are found to be
commercially recoverable.
ROYALTY INTEREST. A "Royalty Interest" is an interest in an oil and gas property
entitling the owner to a share of oil and gas production (or
the proceeds of the sale thereof) free of the costs of
production.
SEC METHOD. The "SEC Method" is a method of determining the present value
of proved reserves. Under the SEC method, the future net
revenues from proved reserves are estimated assuming that oil
and gas prices and production costs remain constant. The
resulting stream of revenues is then discounted at the rate of
10% per year to obtain a present value.
SHUT IN. "Shut in" refers to a well or wells which are capable of
producing oil and/ or gas, but which are not currently
operational due to required repairs or prevailing economic
conditions.
UNDEVELOPED ACREAGE. "Undeveloped Acreage" is oil and gas acreage (including, in
applicable instances, rights in one or more horizons which may
be penetrated by existing well bores, but which have not been
tested) to which Proved Reserves have not been assigned by
independent petroleum engineers.
</TABLE>
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<PAGE>
<TABLE>
<S> <C>
WORKING INTEREST. A "Working Interest" is the operating interest under an Oil and
Gas Lease which gives the owner the right to drill, produce and
conduct operating activities on the property and a share of
production, subject to all royalties, overriding royalties and
other burdens and to all costs of exploration, development and
operations and all risks in connection therewith. If a party
owns a "back-in" working interest, it has the right to acquire
a portion of the working interest owned by another party upon
the occurrence of a specified event, such as payout of the
costs incurred by the other party in drilling a well or
undertaking another operation on the property.
</TABLE>
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<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Independent Auditors' Report--KPMG Peat Marwick LLP........................................................ F-2
Balance Sheets--December 31, 1995 and December 31, 1996.................................................... F-3
Statements of Operations for the years ended December 31, 1994, 1995 and 1996.............................. F-5
Statements of Stockholders' Equity for the years ended December 31, 1994, 1995 and 1996.................... F-6
Statements of Cash Flows for the years ended December 31, 1994, 1995 and 1996.............................. F-7
Notes to Financial Statements.............................................................................. F-8
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Fortune Petroleum Corporation:
We have audited the financial statements of Fortune Petroleum Corporation as
listed in the accompanying index. 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 Fortune Petroleum
Corporation as of December 31, 1996 and 1995, and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 1996, in conformity with generally accepted accounting principles.
As discussed in note 2 to the financial Statements, the Company has given
retroactive effect to the change in accounting for oil and gas properties from
the successful efforts method to the full cost method.
KPMG PEAT MARWICK LLP
Houston, Texas
February 27, 1997
F-2
<PAGE>
FORTUNE PETROLEUM CORPORATION
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1995* 1996
-------------- --------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents....................................................... $ 1,888,000 $ 2,174,000
Accounts receivable............................................................. 1,035,000 695,000
Oil and gas properties held for sale............................................ 1,180,000 --
Prepaid expenses and oil inventory.............................................. 127,000 25,000
-------------- --------------
Total Current Assets............................................................ 4,230,000 2,894,000
-------------- --------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for using the full cost method................ 20,864,000 23,079,000
Automotive, office and other.................................................... 227,000 375,000
-------------- --------------
21,091,000 23,454,000
Less--accumulated depletion, depreciation and amortization...................... (10,922,000) (12,545,000)
-------------- --------------
10,169,000 10,909,000
OTHER ASSETS:
Materials, supplies and other................................................... 62,000 188,000
Bond issuance costs (net of accumulated amortization of $180,000 and $238,000 at
December 31, 1995 and 1996, respectively)..................................... 109,000 51,000
Restricted cash................................................................. 3,230,000 2,293,000
-------------- --------------
3,401,000 2,532,000
-------------- --------------
TOTAL ASSETS...................................................................... $ 17,800,000 $ 16,335,000
-------------- --------------
-------------- --------------
</TABLE>
- ------------------------
*Restated.
See accompanying notes to financial statements.
F-3
<PAGE>
FORTUNE PETROLEUM CORPORATION
BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1995* 1996
-------------- --------------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long term debt............................................... $ 3,208,000 $ 2,253,000
Accounts payable................................................................ 280,000 84,000
Accrued expenses................................................................ 96,000 77,000
Royalties and working interests payable......................................... 94,000 103,000
Accrued interest................................................................ 119,000 101,000
-------------- --------------
Total Current Liabilities....................................................... 3,797,000 2,618,000
-------------- --------------
LONG-TERM DEBT, net of current portion............................................ 1,689,000 680,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value:
Authorized--2,000,000 shares
Issued and outstanding--None.................................................... -- --
Common stock, $.01 par value
Authorized--40,000,000 shares
Issued and outstanding--11,139,709 and 11,853,663 shares at December 31, 1995
and 1996, respectively...................................................... 111,000 119,000
Capital in excess of par value.................................................. 27,228,000 29,273,000
Accumulated deficit............................................................. (15,025,000) (16,355,000)
-------------- --------------
NET STOCKHOLDERS' EQUITY.......................................................... 12,314,000 13,037,000
-------------- --------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........................................ $ 17,800,000 $ 16,335,000
-------------- --------------
-------------- --------------
</TABLE>
- ------------------------
*Restated.
See accompanying notes to financial statements.
F-4
<PAGE>
FORTUNE PETROLEUM CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
1994* 1995* 1996
------------- ------------- -------------
<S> <C> <C> <C>
REVENUES:
Sales of oil and gas, net of royalties............................. $ 3,339,000 $ 2,959,000 $ 3,825,000
Other income....................................................... 58,000 184,000 215,000
------------- ------------- -------------
3,397,000 3,143,000 4,040,000
------------- ------------- -------------
OPERATING EXPENSES
Production and operating........................................... 1,090,000 1,514,000 1,172,000
Provision for depletion, depreciation and amortization............. 1,708,000 1,816,000 1,623,000
General and administrative......................................... 1,020,000 1,212,000 1,924,000
Executive severance................................................ 225,000 -- --
Corporate relocation............................................... -- -- 216,000
Interest........................................................... 460,000 870,000 435,000
Loss on sale of oil and gas properties............................. -- 3,607,000 --
Impairment to oil and gas properties............................... 3,347,000 -- --
------------- ------------- -------------
7,850,000 9,019,000 5,370,000
------------- ------------- -------------
LOSS BEFORE PROVISION FOR INCOME TAXES............................... (4,453,000) (5,876,000) (1,330,000)
PROVISION FOR INCOME TAXES........................................... -- -- --
------------- ------------- -------------
NET LOSS............................................................. $ (4,453,000) $ (5,876,000) $ (1,330,000)
------------- ------------- -------------
------------- ------------- -------------
WEIGHTED AVERAGE NUMBER OF COMMON SHARES OUTSTANDING................. 2,638,672 6,555,875 11,351,211
------------- ------------- -------------
------------- ------------- -------------
NET LOSS PER COMMON SHARE............................................ $ (1.69) $ (0.90) $ (0.12)
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
- ------------------------
*Restated.
See accompanying notes to financial statements.
F-5
<PAGE>
FORTUNE PETROLEUM CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CAPITAL IN
COMMON STOCK EXCESS OF ACCUMULATED STOCKHOLDERS'
SHARES AMOUNT PAR VALUE DEFICIT EQUITY
----------- -------------- ------------ ------------- ------------
<S> <C> <C> <C> <C> <C>
BALANCE, December 31, 1993, as previously
reported............................... 2,633,471 $ 26,000 $ 11,258,000 $ (4,671,000) $6,613,000
Cumulative effect of change in accounting
principle, as retroactively applied.... -- -- -- (25,000) (25,000)
----------- -------------- ------------ ------------- ------------
BALANCE, December 31, 1993, as
restated............................... 2,633,471 $ 26,000 $ 11,258,000 $ (4,696,000) $6,588,000
----------- -------------- ------------ ------------- ------------
Common stock returned to treasury........ (80) -- (2,000) -- (2,000)
Adjustment to proceeds for 1993 public
offering............................... -- -- (29,000) -- (29,000)
Common stock issued for exercise of stock
options................................ 4,688 -- 12,000 -- 12,000
Common stock issued for directors'
fees................................... 5,953 -- 14,000 -- 14,000
Net loss*................................ -- -- -- (4,453,000) (4,453,000)
----------- -------------- ------------ ------------- ------------
BALANCE, December 31, 1994*.............. 2,644,032 $ 26,000 $ 11,253,000 $ (9,149,000) $2,130,000
----------- -------------- ------------ ------------- ------------
----------- -------------- ------------ ------------- ------------
Common stock returned to treasury........ (12) -- -- --
Common stock issued for exercise of stock
options................................ 202,481 2,000 500,000 -- 502,000
Common stock issued for directors fees... 14,445 -- 39,000 -- 39,000
Common stock issued for stock
offerings.............................. 6,569,117 65,000 11,729,000 -- 11,794,000
Common stock issued for merger........... 1,200,000 12,000 2,480,000 -- 2,492,000
Common stock and warrants issued for
payment of investment banking
services............................... 100,000 2,000 263,000 -- 265,000
Common stock issued for warrant
conversion............................. 115,479 1,000 392,000 -- 393,000
Common stock issued for note
conversion............................. 294,167 3,000 572,000 -- 575,000
Net loss*................................ -- -- -- (5,876,000) (5,876,000)
----------- -------------- ------------ ------------- ------------
BALANCE, December 31, 1995*.............. 11,139,709 $ 111,000 $ 27,228,000 $ (15,025,000) $12,314,000
----------- -------------- ------------ ------------- ------------
----------- -------------- ------------ ------------- ------------
Common stock issued for exercise of stock
options................................ 46,150 1,000 114,000 -- 115,000
Common stock issued for exercise of
warrants............................... 255,638 3,000 813,000 -- 816,000
Common stock issued for directors' fees.. 1,395 -- 4,000 -- 4,000
Common stock canceled and stock issuance
cost................................... (1,227) -- (31,000) -- (31,000)
Common stock issued for stock
offerings.............................. 412,000 4,000 1,145,000 -- 1,149,000
Common stock returned to treasury........ (2) -- -- -- --
Net loss................................. -- -- -- (1,330,000) (1,330,000)
----------- -------------- ------------ ------------- ------------
BALANCE, December 31, 1996............... 11,853,663 $ 119,000 $ 29,273,000 $ (16,355,000) $13,037,000
----------- -------------- ------------ ------------- ------------
----------- -------------- ------------ ------------- ------------
</TABLE>
- --------------------------
*Restated.
See accompanying notes to financial statements.
F-6
<PAGE>
FORTUNE PETROLEUM CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1994* 1995* 1996
----------- ------------ -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.............................................................. $(4,453,000) $ (5,876,000) $(1,330,000)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Common stock issued for directors' fees, compensation and
consulting fees................................................. 14,000 39,000 4,000
Depletion, depreciation and amortization.......................... 1,708,000 1,816,000 1,623,000
Amortization of deferred financing cost........................... -- 172,000 74,000
Impairment to oil and gas properties.............................. 3,347,000 -- --
Loss on sale of oil and gas properties............................ -- 3,607,000 --
Provision for executive severance................................. 225,000 (17,000) --
Non-cash compensation expense..................................... -- -- 20,000
Changes in assets and liabilities:
Accounts receivable............................................... 24,000 (485,000) 340,000
Prepaids and oil inventory........................................ (45,000) (13,000) 102,000
Accounts payable and accrued expenses............................. (202,000) (95,000) (215,000)
Payment of executive severance.................................... (66,000) (111,000) --
Royalties and working interest payable............................ (13,000) 41,000 9,000
Accrued interest.................................................. 31,000 (11,000) (18,000)
Materials, supplies and other..................................... (79,000) 189,000 (2,000)
----------- ------------ -----------
Net cash provided by (used in) operating activities................... 491,000 (744,000) 607,000
----------- ------------ -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties............................... (4,265,000) (5,654,000) (3,232,000)
(Increase) decrease in restricted cash................................ -- (3,230,000) 937,000
Proceeds from sale of properties and equipment........................ 8,000 -- 2,197,000
Expenditures for other property and equipment......................... (30,000) 16,000 (297,000)
----------- ------------ -----------
Net cash used in investing activities................................. (4,287,000) (8,868,000) (395,000)
----------- ------------ -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt.............................. 4,680,000 -- --
Proceeds from notes to stockholders................................... 750,000 -- --
Repayment of long term debt........................................... (1,326,000) (1,651,000) (1,979,000)
Proceeds from issuance of common stock................................ 12,000 15,220,000 2,168,000
Expenditures for offering costs....................................... (29,000) (2,467,000) (115,000)
Common stock repurchase............................................... (2,000) -- --
----------- ------------ -----------
Net cash provided by financing activities............................. 4,085,000 11,102,000 74,000
----------- ------------ -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS............................... 289,000 1,490,000 286,000
----------- ------------ -----------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR............................ 109,000 398,000 1,888,000
----------- ------------ -----------
CASH AND CASH EQUIVALENTS, END OF YEAR.................................. $ 398,000 $ 1,888,000 $ 2,174,000
----------- ------------ -----------
----------- ------------ -----------
Supplemental information:
Interest paid in cash................................................. $ 400,000 $ 692,000 $ 361,000
Common stock issued or issuable as directors' fees.................... 14,000 39,000 4,000
Common stock issued for payment of executive severance................ -- 43,000 --
Common stock issued to acquire LEX.................................... -- 2,492,000 --
Common stock and warrants issued for payment of investment banking
fees................................................................ -- 265,000 --
Common stock issued for conversion of debt............................ -- 575,000 --
Value of California assets transferred to oil and gas properties held
for sale............................................................ -- 1,180,000 --
</TABLE>
- --------------------------
*Restated.
See accompanying notes to financial statements.
F-7
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS
(1) GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fortune Petroleum Corporation (Fortune or the Company), which does business
in Texas and Louisiana as Fortune Natural Resources Corporation, is an
independent energy company engaged in the acquisition, production and
exploration of oil and gas, primarily offshore Louisiana and the Texas and
Louisiana Gulf Coast.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates, judgments
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the financial statements and revenues and expenses during the
reported period. Actual results could differ from those estimates.
CASH EQUIVALENTS
The Company considers all highly liquid instruments with original maturities
of three months or less to be cash equivalents.
OIL INVENTORY
Oil inventory is stated at approximate fair market value. Market value is
determined based on current well head price of oil less selling and delivery
costs.
PROPERTY AND EQUIPMENT
During the fourth quarter of 1996, the Company changed its method of
accounting for oil and gas operations from the successful efforts method to the
full cost method (see Note 2). Under the full cost method, all costs associated
with the acquisition, exploration and development of oil and gas reserves,
including non-productive costs, are capitalized as incurred. Internal overhead,
which is directly identified with acquisition, exploration and development is
capitalized. Such overhead has not been material through December 31, 1996.
The capitalized costs of oil and gas properties are accumulated in cost
centers on a country-by-country basis and are amortized using the
unit-of-production method based on proved reserves. All of the Company's
properties are located in the United States. Estimated future development and
abandonment costs are included in the amortization base. Depreciation, depletion
and amortization expense per equivalent MCF was $1.00, $1.22, and $1.14 for the
years ended December 31, 1994, 1995, and 1996, respectively. Capitalized costs
and estimated future development costs associated with unevaluated properties
are excluded from amortization until the quantity of proved reserves
attributable to the property has been determined or impairment has occurred. At
December 31, 1994, 1995, and 1996, the Company excluded $1.0 million, $5.9
million, and $4.9 million, respectively, of capitalized costs from amortization.
These costs will be included in the amortization base as the properties are
evaluated.
Dispositions of oil and gas properties are recorded as adjustments to
capitalized costs, with no gain or loss recognized unless such adjustments would
significantly alter the relationship between capitalized costs and proved
reserves. See Note 4 regarding the disposition of the California Properties.
The unamortized cost of oil and gas properties less related deferred income
tax may not exceed an amount equal to the tax-effected net present value
discounted at 10% of proved oil and gas reserves plus
F-8
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(1) GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the lower of cost or estimated fair market value of unevaluated properties. To
the extent the Company's unamortized cost of oil and gas properties exceeded the
ceiling amount, a provision for additional depreciation, depletion and
amortization would be required as an impairment reserve. During 1994, an
impairment of $3.3 million was recorded.
Automotive, office and other property and equipment are stated at cost.
Depreciation is provided using the straight-line method over an estimated future
service life of five years.
MATERIALS AND SUPPLIES
Materials and supplies are stated at the lower of identified actual cost or
replacement cost.
INCOME TAXES
The Company utilizes the asset and liability method for recognition of
deferred tax assets and liabilities. Deferred taxes are recognized for future
tax consequences attributable to differences between financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. The effect on deferred
taxes of a change in tax rates is recognized in income in the period the change
occurs.
BOND ISSUANCE COSTS
Bond issuance costs are being amortized using the straight line method over
the 5 year life of the related debt.
STOCK OPTION PLANS
Prior to January 1, 1996, the Company accounted for its stock option plan in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations.
As such, compensation expense would be recorded on the date of grant only if the
current market price of the underlying stock exceeded the exercise price. On
January 1, 1996, the Company adopted SFAS No. 123, ACCOUNTING FOR STOCK-BASED
COMPENSATION, which permits entities to recognize as expense over the vesting
period the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net income and pro forma
earnings per share disclosures to employee stock option grants made in 1995 and
future years as if the fair-value-based method defined in SFAS No. 123 had been
applied. The Company has elected to continue to apply the provisions of APB
Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123.
(2) CHANGE IN ACCOUNTING PRINCIPLE
During the fourth quarter of 1996, the Company changed its method of
accounting for oil and gas operations from the successful efforts method to the
full cost method. All prior years' financial statements presented herein have
been restated to reflect the change.
The cumulative effect of the change through December 31, 1993 was not
significant. As a result of the change in accounting method, net loss for the
year ended December 31, 1994 increased $1.5 million ($0.57 per share), and for
the years ended December 31, 1995, and 1996 decreased $0.3 million ($0.05 per
share)
F-9
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(2) CHANGE IN ACCOUNTING PRINCIPLE (CONTINUED)
and $2.0 million ($0.18 per share) respectively. The cumulative effect through
December 31, 1996 is to increase both net oil and gas property and shareholders'
equity by $0.8 million.
Management believes the full cost method of accounting is preferable because
it will more accurately reflect the results of the Company's future operations.
In connection with the Company's change in strategy from primarily an
acquisition and production company to an exploration and production company, it
is now focusing its efforts in a single geological basin, the Gulf Coast. The
Company seeks to allocate its capital resources over a diversified portfolio of
exploration and development projects within that basin. It seeks to achieve a
balance between the risks of exploratory drilling and the return on investment
by investing in projects with large potential. Dry holes and abandoned
properties and projects are an inherent part of the exploration process.
However, management believes that it is through disciplined, consistent
application of this balanced portfolio strategy that the desired return on its
entire investment will be achieved. Management believes that the full cost
method of accounting is the method used by many independent oil and gas
companies of comparable size to Fortune and allows investors to better measure
the performance of the Company. Management further believes that advanced three
dimensional seismic and computer-aided exploration technology has become a much
more significant factor in the success of an exploration program than in the
past. Management believes that expensing these costs when incurred, as is
required under successful efforts, is inconsistent with the value they add to
the exploration process.
(3) RESTRICTED CASH
Under the terms of the Company's exploration agreement with Zydeco
Exploration, Inc., Fortune contributed $4.8 million in cash during 1995 for
future lease acquisition and maintenance, seismic acquisition and seismic
processing costs. At December 31, 1996, approximately $2.5 million had been
expended, leaving $2.3 million of restricted cash available for future
expenditures. The Company has joint signature authority with Zydeco on the bank
account containing approximately one-half of these funds, has certain approval
authority over the remainder of the funds and is the recipient of interest
earned on all of the funds. (See Note 4)
(4) ACQUISITIONS AND DISPOSITION OF ASSETS
SOUTH TIMBALIER BLOCK 76
On December 11, 1995, Fortune acquired, for $2.2 million, a 16.67% working
interest (12.5% net revenue interest) in a 5,000 acre producing oil and gas
property offshore Louisiana from Petrofina, Inc. The property, South Timbalier
Block 76 (and referred to herein as the "South Timbalier Block"), includes a
producing well, drilling and production platform and transmission line. In
connection with the acquisition, Fortune granted a third party the option,
exercisable until March 11, 1996, to acquire a 4.167% working interest in the
South Timbalier Block for $790,000 and the retention by Fortune of the option
holder's deposit of $150,000. The option was exercised on March 8, 1996 for the
$940,000 consideration discussed above, reducing the Company's interest in the
block to a 12.5% working interest. The proceeds received on this sale were
credited to oil and gas properties in 1996.
F-10
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(4) ACQUISITIONS AND DISPOSITION OF ASSETS (CONTINUED)
The following pro forma unaudited results reflect the year ended December
31, 1995 as if the South Timbalier Block 76 acquisition had occurred, the option
had been exercised, and the common stock issued in the acquisition of LEX was
issued (See below and Note 10), as of January 1, 1995:
<TABLE>
<CAPTION>
FOR THE YEAR
ENDED
DECEMBER 31,
1995
-------------
<S> <C>
Revenues....................................................................... $ 4,451,000
-------------
-------------
Net Loss....................................................................... $ (5,316,000)
-------------
-------------
Net Loss Per Common Share...................................................... $ (0.59)
-------------
-------------
</TABLE>
DISPOSITION OF CALIFORNIA PROPERTIES
During 1995, the Company offered for sale all of its California properties.
In December 1995, the Company entered into a purchase and sale agreement to sell
all but one of its California properties to a private oil and gas producer group
for a price of $840,000. The sale closed in February 1996, with an effective
date of December 31, 1995. The sale of the Company's remaining California
property closed in April 1996, with an effective date of December 1, 1995. The
Company received net proceeds in this transaction of $300,000 after deducting
closing adjustments, primarily consisting of net cash flow received by the
Company between the effective date and the closing date. At December 31, 1995,
the Company classified the $1.2 million of estimated net proceeds to be received
from both of these transactions as oil and gas properties held for sale. The
sale of these properties significantly altered the relationship between
capitalized costs and proved reserves because the properties sold comprised
approximately 53% of the Company's proved reserves at the time of the sales.
Accordingly, the Company recognized a loss in 1995 of $3.6 million, which
represents the excess of 53% of the oil and gas property balance subject to
depreciation, depletion and amortization over the $1.2 million estimated net
sales proceeds to be received from the sale of the properties. During 1994, 1995
and 1996 the operation of these properties did not have a significant impact on
net income.
LAGNIAPPE EXPLORATION CORPORATION/ZYDECO EXPLORATION
On May 12, 1995, Fortune acquired Lagniappe Exploration, Inc. ("LEX") which
had previously entered into an exploration agreement with Zydeco. The Company
acquired 100% of LEX in exchange for 1.2 million shares of Fortune Petroleum
Common Stock and 1.2 million warrants. The acquisition has been recorded using
the purchase method of accounting, effective May 12, 1995. The market value of
the shares, when issued, was $2,572,000. At the time of the acquisition, the
only material asset owned by LEX was its right to participate in the Zydeco
exploration agreement in exchange for funding a budget of $4.8 million for
leasehold acquisition and seismic costs. Subsequent to closing the acquisition,
LEX was liquidated and its assets were merged into Fortune. Under the
exploration agreement, Fortune has acquired a 50% interest in each of
approximately 20 seismically defined oil and gas projects identified using
advanced 3D and 2D seismic imaging, visualization and comprehensive well log
analyses and has incurred $2.5 million of the $4.8 million budget. (See Notes 3
and 10)
F-11
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(4) ACQUISITIONS AND DISPOSITION OF ASSETS (CONTINUED)
The Company does not currently expect to retain a working interest of more
than 25%, except in certain circumstances, in wells drilled on the projects and
intends to farm out its remaining interest to other oil companies. Fortune may
retain larger or smaller working interests in certain projects depending upon
capital availability and other factors. Under a farmout arrangement, the Company
would be relieved of its obligation to pay, or could recover already paid,
acquisition and exploration costs while generally retaining a smaller, and
sometimes non-operating, interest in the prospect. The Company also has a right
under the exploration agreement to farm out a portion or all of its interest in
each prospect to Zydeco under a put arrangement in the exploration agreement.
Zydeco has an identical right to farm out to Fortune.
ENRE CORPORATION
On June 24, 1994, the Company acquired a 25% interest in EnRe-1 LLC, a
company formed to develop and explore for oil and gas lands held under certain
Jicarilla Apache mineral development agreements in Rio Arriba County, New
Mexico. The net acquisition price was $1,674,000, and the effective date of the
transaction using the purchase method of accounting was June 1, 1994. As a
result of the acquisition, the Company has effective non-operating working
interests ranging from 21.5625% to 25% in approximately 50,000 producing,
development and exploratory acres.
LAROCO, LLP
On February 8, 1994, the Company completed an acquisition of a 50% working
interest in a 3,689 acre lease in the La Rosa Natural Gas Field in Refugio
County, Texas from Brooklyn Union Exploration Company, Inc. for $760,000. The
effective date of the transaction using the purchase method of accounting was
February 1, 1994.
(5) OIL AND GAS PROPERTIES AND OPERATIONS
Capitalized costs relating to oil and gas producing activities and related
accumulated depletion, depreciation and amortization at December 31, 1994, 1995
and 1996 were as follows:
<TABLE>
<CAPTION>
1994 1995 1996
------------- ------------- -------------
<S> <C> <C> <C>
Capitalized costs of oil and gas properties............... $ 18,394,000 $ 20,864,000 $ 23,079,000
Less accumulated depletion, depreciation and
amortization............................................ (9,210,000) (10,730,000) (12,308,000)
------------- ------------- -------------
$ 9,184,000 $ 10,134,000 $ 10,771,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
Of the above capitalized costs, the amount representing unproved properties
was $1.0 million, $5.9 million, and $5.5 million in 1994, 1995 and 1996,
respectively.
F-12
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS
(5) OIL AND GAS PROPERTIES AND OPERATIONS (CONTINUED)
Costs incurred in oil and gas producing activities were as follows:
<TABLE>
<CAPTION>
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Property acquisition
Unproved.................................................... $ 755,000 $ 4,596,000 $ 77,000
Proved...................................................... 2,738,000 2,192,000 --
Exploration................................................... 231,000 576,000 2,317,000
Development................................................... 541,000 498,000 838,000
------------ ------------ ------------
$ 4,265,000 $ 7,862,000 $ 3,232,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The results of operations from oil and gas producing activities for the
years ended December 31, 1994, 1995 and 1996, are as follows:
<TABLE>
<CAPTION>
1994 1995 1996
--------- --------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Revenues from oil and gas producing activities:
Sales to unaffiliated parties......................................... $ 3,339 $ 2,959 $ 3,825
--------- --------- ---------
Production and other taxes.............................................. 1,090 1,514 1,172
Depreciation, depletion and amortization................................ 1,542 1,781 1,576
Loss on sale of oil and gas properties.................................. -- 3,607 --
Impairment to oil and gas reserves...................................... 3,347 -- --
--------- --------- ---------
Total expenses.......................................................... 5,979 6,902 2,748
--------- --------- ---------
Pretax loss from producing activities................................... (2,640) (3,943) 1,077
Income tax (expense) benefit............................................ -- -- --
--------- --------- ---------
Results of oil and gas producing activities (excluding corporate
overhead and interest costs).......................................... $ (2,640) $ (3,943) $ 1,077
--------- --------- ---------
--------- --------- ---------
</TABLE>
F-13
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(6) LONG TERM DEBT
A summary of long-term debt follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1995 1996
------------ ------------
<S> <C> <C>
Convertible Subordinated Debentures of $1,725,000 (net of discount of $57,000 and
$42,000 at December 31, 1995 and 1996, respectively) due December 31, 1997,
including interest of 10 1/2% per annum paid semi-annually.......................... $ 1,668,000 $ 1,683,000
Bank One credit facility due October 1, 1997 including interest at 1 1/2% over Bank
One, Texas, NA's prime rate payable monthly......................................... 3,200,000 1,250,000
Other debt with interest ranging from 0% to 9 1/4% per annum due through 1998......... 29,000 --
------------ ------------
Total long-term debt.................................................................. 4,897,000 2,933,000
Less current installments............................................................. 3,208,000 2,253,000
------------ ------------
Long-term debt, excluding current installments........................................ $ 1,689,000 $ 680,000
------------ ------------
------------ ------------
</TABLE>
The 10 1/2% Convertible Subordinated Debentures due December 31, 1997 bear
an effective interest rate of 12.13% and are convertible into shares of the
Company's Common Stock, after April 1, 1994, at a conversion price of $6.32 per
share or 158 shares per Debenture. On, February 26, 1997, the Company closed an
Exchange Offer for these Debentures which resulted in $697,000 ($680,000 net of
discount) principal amount of Debentures being converted to 218,858 shares of
Common Stock. The Company also issued 174,250 Common Stock Warrants to the
Debentureholders who exchanged their Debentures in connection with the Exchange
Offer. The Common Stock Warrants are exercisable for a period of three years,
one-half at $4.00 per share and one-half at $5.00 per share. Susbsequent to the
conversion, the remaining balance due on the Debentures at December 31, 1997 is
$1,028,000. Furthermore, the Company will record a non-cash debt conversion
expense of approximately $316,000 during the first quarter of 1997. The non-cash
debt conversion expense represents the difference between the fair market value
of all of the Common Stock, and Common Stock Warrants issued in connection with
the Exchange Offer and the fair market value of the lower number of Common Stock
that could have been issued upon the conversion of the Debentures under the
Indenture prior to the Exchange Offer. For purposes of calculating the non-cash
debt conversion expense, the Company valued the 218,858 shares of Common Stock
issued in connection with the Exchange Offer at $547,502 ($2.625 per share)
based on the closing price of the Common Stock on the American Stock Exchange on
February 26, 1997. The Company estimated the value of the Common Stock Warrants
issued to the Debentureholders at $8,713 ($0.05 per Warrant). As of December 31,
1996, the Company classified, as long term liabilities, the portion, net of
discount, of the the Debentures that were converted to common stock in the
Exchange Offer.
Under the Bank One, Texas, N.A. (the Bank) credit facility, the Company has
the ability to borrow amounts up to an available borrowing base as defined in
the credit agreement. The amount the Company may borrow under the credit
facility is determined by the borrowing base as calculated by the Bank semi-
annually on the basis of the Company's oil and gas reserves. The credit facility
contains various financial covenants, is secured by all of the Company's oil and
gas producing properties and currently requires monthly principal payments of
$75,000. At December 31, 1995, the Company was not in compliance with its cash
flow coverage ratio covenant in the credit agreement. Under the terms of credit
agreement, the bank has the right to demand repayment of the entire loan balance
in the event of covenant defaults. The
F-14
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(6) LONG TERM DEBT (CONTINUED)
Company obtained a waiver of this covenant from the Bank as of December 31,
1995; however, the Company is not able to borrow additional amounts under the
credit facility because the Bank has set the borrowing base equal to the loan
balance, which declines by $75,000 per month. The Company has determined that it
is in compliance with the cash flow coverage ratio for the quarter ended
December 31, 1996. At February 18, 1997, the remaining balance owed on the
credit facility was $1,100,000.
All of the Company's debt that was not converted to Common Stock in the
Debenture Exchange Offer is due in 1997.
(7) INCOME TAXES
No provision for income taxes was required for the years ended December 31,
1994, 1995 and 1996. Deferred taxes consist of the following:
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards.......................................... $ 2,976,000 $ 4,354,000
Oil and Gas Properties difference in accumulated depletion................ 1,544,000 586,000
------------ ------------
4,520,000 4,940,000
Less valuation allowance (100%)........................................... 4,520,000 4,940,000
------------ ------------
Net deferred taxes........................................................ $ -- $ --
------------ ------------
------------ ------------
</TABLE>
At December 31, 1996, the Company estimates it had cumulative net operating
loss carryforwards for Federal income tax purposes of $12.8 million which is
significantly restricted under I.R.C. 382 and which is available to offset
future federal taxable income, if any, with various expirations through 2011.
The Company is uncertain as to the recoverability of the above deferred tax
assets and has therefore applied a 100% valuation allowance.
The Company has available IRC Section 29 Tax Credits that may be used to
reduce or eliminate any corporate income tax through the year 2001. It is
uncertain at this time to what extent the Company will be able to utilize these
federal tax credits, as their utilization is dependent upon the amount, if any,
of future federal income tax incurred, after application of the Company's net
operating loss carryforwards.
(8) STOCK OFFERINGS
In December 1996, the Company sold 412,000 shares of Common Stock at a price
of $3.00 per share in a private placement. Net proceeds of approximately $1.1
million were received for the sale of these shares. In addition, the Company
issued to the acquiring shareholders one Common Stock Warrant for every two
Common Stock shares acquired. The 206,000 warrants are exercisable for a period
of two years at a price of $3.50 per share.
In June and July 1995, the Company sold 4.6 million shares of the Company's
Common Stock at $2.00 per share in a public offering. Proceeds of approximately
$8.1 million, net of offering fees and expenses were received from the sale of
the shares.
On December 15, 1995, the Company closed a private placement of 1,321,117
shares of Common Stock at a price of $3.22 per share. Net proceeds of
approximately $3.3 million were received for the sale of these shares. The
shares were sold subject to certain "reset" provisions pursuant to which the
purchasers
F-15
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(8) STOCK OFFERINGS (CONTINUED)
could receive additional shares if the price of the Common Stock were to drop
below the purchase price during certain calculation periods. The Company's
Common Stock price did fall to a level that would have required the Company to
issue approximately 1,266,000 additional Common Stock shares to the purchasers;
however, the Company is currently investigating certain alleged irregularities
in the trading in its Common Stock and is uncertain whether it will be required
to issue additional shares. (See Note 9) In February 1995, the Company closed a
previous private placement of 648,000 shares of Common Stock. The proceeds were
used to fund the initial contribution to the Zydeco venture.
(9) COMMITMENTS AND CONTINGENCIES
The Company has an employment agreement with its President and Chief
Executive Officer (the "CEO") that provides for an annual salary of $150,000
through December 31, 1997, and is subject to renewal upon expiration. Upon
termination of the employment agreement, the CEO has a two-year consulting
agreement at 40% of his annual salary. In the event of a termination of
employment after a change of control, and under certain circumstances, the CEO
is entitled to a lump sum payment of two years salary. The Company also has an
employment agreement with its Executive Vice President and General Counsel that
provides for an annual salary of $125,000 through December 31, 1998, and is
subject to renewal upon expiration. In the event of a termination of employment
after a change of control, and under certain circumstances, the Executive Vice
President and General Counsel is also entitled to a lump sum payment of two
years salary.
The Company leases certain office space under non-cancelable operating
leases. Rental expense under the office lease for the years ended December 31,
1994, 1995 and 1996 was $45,000, $53,000 and $75,000, respectively.
Minimum future lease payments under the non-cancelable operating leases are
as follows:
<TABLE>
<S> <C>
Year ending December 31,
1997.................................................... $ 84,000
1998.................................................... 84,000
1999.................................................... 84,000
2000.................................................... 84,000
2001.................................................... 35,000
---------
$ 371,000
---------
---------
</TABLE>
On June 13, 1996, the lawsuit between Fortune and EnRe was settled with an
agreement by each party to drop all of their respective claims. On March 14,
1995, Fortune was served with the lawsuit, filed in the District Court of Bexar
County, Texas by EnRe Corporation, in which EnRe, as operator of the Company's
New Mexico properties at that time, sought recovery of approximately $438,000
allegedly owed by Fortune for the drilling of certain wells on such properties.
On March 24, 1995, Fortune answered EnRe's lawsuit and filed a counterclaim
against EnRe for an indeterminable amount for damages suffered by Fortune for
EnRe's actions in operating the New Mexico properties. On March 30, 1995, a
partial settlement was reached as to payment by Fortune of undisputed well
development costs in the amount of $174,499 in exchange for EnRe's cooperation
in complying with provisions of the operating agreement to report operating
information to Fortune on a timely basis.
F-16
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS
(9) COMMITMENTS AND CONTINGENCIES (CONTINUED)
In July 1996, the Company received invoices from AMPOLEX (USA), Inc., the
current operator of the Company's New Mexico properties, billing Fortune for
$232,805 of outstanding accounts receivable attributable to two other working
interest owners in the properties which the operator failed to collect from such
owners. The Company has reviewed this matter and does not believe that it owes
any portion of such amounts.
On March 26, 1996, Fortune was served with a lawsuit which had been filed in
the Federal District Court in Delaware by one of the purchasers of Fortune
Common Stock in an offering in December 1995 under Regulation S. Under the terms
of the subscription agreement pursuant to which the plaintiff acquired his
shares, he was entitled to receive additional shares of Fortune stock if the
market price fell below a stated level during a specified period following the
40-day holding period prescribed by Regulation S. Fortune vigorously contested
this action, believing that plaintiff either participated in a scheme to
unlawfully manipulate the market price of the Common Stock or benefited from
such manipulation by others. On February 3, 1997, the plaintiff voluntarily
dismissed the complaint without prejudice, and the court ordered the return to
Fortune of shares of Common Stock which had been voluntarily placed in escrow by
Fortune. Management does not anticipate that the action will be refiled.
On April 16, 1996, Fortune was advised that similar suits had been filed in
Federal District Court in New York by two other buyers in the same offering.
Fortune responded to the suits, admitting that the stock price declined but
alleged that suspicious trading activity in Fortune stock occurred immediately
prior to and during the time period in which the additional-share allocation was
computed. Fortune believes that it has discovered evidence of active market
manipulation in the Common Stock by these plaintiffs; accordingly, it has
commenced a countersuit for damages suffered by the Company and its shareholders
as a result of these acts. Fortune intends to continue to vigorously defend the
remaining litigation.
(10) RELATED PARTY TRANSACTIONS
As part of the relocation of Fortune's headquarters to Houston, Texas, the
Company provided Tyrone J. Fairbanks, its President and Chief Executive Officer,
with an incentive relocation package to facilitate his move to Texas. The
package consisted of a payment by the Company of Mr. Fairbanks' moving expenses,
a non-recourse, unsecured loan in the amount of $80,000 bearing interest at the
rate of 6% per annum, with $20,000 of such loan forgiven in each of four
consecutive years beginning in 1996, provided Mr. Fairbanks is still employed by
the Company or has been terminated by the Company without cause, and a secured
recourse loan in the amount of $70,000 also bearing interest at the rate of 6%
per annum, payable interest only for two years with a $35,000 principal payment
due on the second anniversary of the loan and all remaining principal and
interest due on the third anniversary of the loan. The Company also extended the
term of Mr. Fairbanks' employment contract through December 31, 1997.
In connection with the acquisition of LEX, Fortune paid William D. Forster
and BSR Investments, the LEX stockholders, an aggregate of 1,200,000 shares of
Common Stock and 1,200,000 five year stock purchase warrants exercisable at
$4.75 per share. One-third of such shares and warrants were placed in escrow
pending the resolution of a dispute which has arisen among the former LEX
stockholders and others regarding who is entitled to the shares of Common Stock
and stock purchase warrants issued by Fortune at the closing of the LEX
acquisition.
F-17
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(10) RELATED PARTY TRANSACTIONS (CONTINUED)
On May 11, 1995, Baytree Associates, Inc. (Baytree) and Ensign commenced
litigation in the Supreme Court of New York against Forster, BSR, Souki (the son
of Samyr Souki, president of BSR), LEX and Fortune seeking to enjoin the closing
of the LEX acquisition by Fortune on the grounds that Ensign was entitled to a
one-third interest in the proceeds of the transaction, namely the Common Stock
and warrants to be issued by Fortune. On May 22, 1995, the New York court
granted the Company's motion for summary judgment and dismissed Fortune and LEX
from the suit with prejudice based on an agreement of all parties. Forster, BSR
and Souki are now the only remaining defendants in the action.
On April 24, 1995, the Company obtained a $300,000 "bridge" loan to enable
it to pay certain expenses, including $100,000 on its credit facility. The loan
was obtained from LEX, which in turn had borrowed the funds from several
individuals. Upon the consummation of the Company's acquisition of LEX, it
became liable on such loans. The loans were repaid out of the proceeds of the
Company's June 1995 Common Stock offering. Among the individuals who loaned
funds to LEX were Mrs. William H. Forster, mother of William D. Forster, a
principal of LEX and formerly a director and principal stockholder of Fortune,
and John E. McConnaughy, Jr., formerly a principal stockholder of the Company.
Each of Mrs. Forster and Mr. McConnaughy loaned LEX $100,000 and received from
LEX, as an inducement to make the loan, 33,333 shares of Common Stock and 33,333
stock purchase warrants out of 1,200,000 shares and 1,200,000 warrants issued to
LEX in conjunction with the acquisition. W. Forster & Co., Inc., a corporation
wholly owned by William D. Forster, received a $30,000 placement fee from the
Company for assistance in arranging the $300,000 bridge loan.
In order to provide additional capital for development activities, on
December 19 and 20, 1994, the Company borrowed an aggregate of $750,000 from
certain principal stockholders and from each of its directors then serving
(Messrs. Champion, Drulias, Fairbanks, Folsom and Walker). The directors loaned
$175,000 to the Company in the aggregate; $375,000 was obtained from Klein
Ventures, Inc.; and $200,000 was obtained from Jack Farber. The notes were
unsecured, bearing interest at 11% per annum (1.5% above the Bank One, Texas,
prime rate), payable monthly, and the notes were due six months from their
respective dates of issue.
Both the Klein Ventures, Inc. and Farber notes permitted the holder to elect
to exchange their notes for shares of Common Stock at the price on the date the
notes were issued ($2.00 and $1.875 per share, respectively), and Fortune
reserved 294,166 shares of Common Stock for such purpose. On or about June 30,
1995, the estate of Mr. Farber converted its note into 106,667 shares of Common
Stock. As additional consideration for making the loan, Klein Ventures, Inc.
received 10,000 stock purchase warrants with an exercise price of $2.40 per
share, and Mr. Farber received 35,000 stock purchase warrants with an exercise
price of $1.875 per share. The Company also agreed to name two individuals
nominated by Mr. Farber to fill vacancies on the Board of Directors. Barry
Feiner, Esq., who served as counsel to Mr. Farber prior to the latter's death on
May 5, 1995 and to Barry Blank, another principal stockholder of the Company,
and Mr. Gary Gelman, Mr. Farber's grandson, were elected to the Board of
Directors in January 1995 pursuant to this agreement. Both Mr. Feiner and Mr.
Gelman were re-elected to the board by the stockholders at the 1995 annual
meeting.
At maturity, on December 21, 1995, Klein Ventures, Inc. opted for conversion
of its notes to Fortune Common Stock. The balance of the notes to the directors
were repaid in full.
F-18
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(10) RELATED PARTY TRANSACTIONS (CONTINUED)
No future transaction will be entered into between the Company and members
of management or principal stockholders unless such transactions are approved by
a majority of the directors who are not members of management or principal
stockholders.
In January 1995, Daniel E. Pasquini, the former president of the Company,
agreed to a modification of a previous severance package. He accepted $85,000 in
cash, the exercise price of 45,000 stock options held by him was reduced to
$.575 per share and the Company issued him warrants to purchase 45,000 shares of
common stock at $2.75 per share. Compensation expense related to this severance
package was recognized in 1994.
Until his employment by the Company effective October 16, 1996, Mr. Dean W.
Drulias was a stockholder of and a practicing attorney at the law firm of
Burris, Drulias & Gartenberg, a Professional Corporation, which has served as
counsel to the Company since its incorporation in May 1987. Mr. Drulias has
served as a director since 1990 and as Secretary since July 1994. During 1994,
1995 and 1996, his firm billed the Company a total of $110,000, $183,000 and
$152,000, respectively, for legal fees and costs.
On January 22, 1997, the Company's board of directors appointed Daniel R.
Shaughnessy as a director of the Company. Mr. Shaughnessy is a petroleum
geophysicist and geologist and is president and owner of Interpretation(3), an
integrated 3D geophysical interpretation which does geological and geophysical
consulting work for the Company. During 1995 and 1996, Mr. Shaughnessy's firm
billed the Company a total of $1,500, and $45,000, respectively, for geological
and geophysical consulting.
As compensation to outside directors, the Company pays directors' fees of
$2,500 per quarter. Inside directors do not receive such compensation.
(11) STOCKHOLDERS' EQUITY
On January 20, 1995, the Company amended its Certificate of Incorporation to
increase the number of authorized shares of Common Stock from 10,000,000 shares
to 40,000,000 and the number of authorized preferred shares from 100,000 to
2,000,000.
Fortune has three non-compensatory Stock Option Plans. The plans cover all
officers and employees of the Company. Three plans also provide for options for
directors of the Company. Awards are made by the Board of Directors upon
recommendations of its Compensation Committee. There is no performance formula
or measure. Options granted under the 1987 and 1988 plan must be exercised
within ten years of the date of grant or are forfeited. Options granted under
the 1993 plan must be exercised within five years of the date of grant or they
are forfeited. The Company's 1991 Stock Option Plan terminated in 1996 with all
options having been granted.
The Company follows the intrinsic value method for stock options granted to
employees. In October 1995, the FASB issued Statement of Financial Accounting
Standard No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). The
Company has not adopted the fair value method for stock-based compensation plans
which is an optional provision of FAS 123. Accordingly, no compensation expense
has been recognized for its stock based compensation plans. Had compensation
cost for the Company's stock option plans been determined based upon the fair
value at the grant date for awards under these plans consistent with the
methodology prescribed under FAS 123, the Company's net loss and loss per share
would have been increased by approximately $0.1 million ($0.02 per share) and
$0.5 million ($0.03 per share) for 1995 and 1996, respectively. The fair value
of the options granted during 1996 is estimated as
F-19
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(11) STOCKHOLDERS' EQUITY (CONTINUED)
$1.11 per common stock option on the date of grant using the Black-Scholes
option pricing model with the following assumptions: dividend yield 0%,
volatility of 65%, risk-free interest rate of 6.14% assumed forfeiture rate of
5%, and an expected life of 2.5 years. For the purposes of calculating estimated
1995 compensation expense, the following assumptions were used: dividend yield
of 0%, volatility of 65%, risk-free interest rate of 7.80% assumed forfeiture
rate of 5%, and an expected life of 2.5 years.
Stock option transactions were:
<TABLE>
<CAPTION>
COMMON STOCK WEIGHTED AVERAGE
OPTIONS OF EXERCISE PRICE OF
EXERCISABLE(A) SHARES UNDER PLANS
--------------------- ---------------------
<S> <C> <C>
Balance, December 31, 1993................................... 54,438 $ 2.69
Granted...................................................... 356,000 2.71
Exercised.................................................... (4,688) 2.60
Forfeited.................................................... -- 2.60
-------- -----
Balance, December 31, 1994................................... 405,750 2.71
Granted...................................................... 289,000 2.46
Exercised.................................................... (202,481) 2.26
Forfeited.................................................... -- --
-------- -----
Balance, December 31, 1995................................... 492,269 2.75
Granted...................................................... 505,000 3.07
Exercised.................................................... (46,150) 2.47
Forfeited.................................................... (16,410) 2.75
-------- -----
Balance, December 31, 1996................................... 934,709 $ 2.93
-------- -----
-------- -----
</TABLE>
- ------------------------
(a) Table includes 80,000 Common Stock warrants which were issued to employees
in 1995 and 1996 in lieu of Common Stock options.
All options are immediately exercisable upon grant. At December 31, 1996,
the Company had 16,400 Common Stock options available for grant under the 1993
Stock Option Plan. All options under all other plans have been granted. In
January 1995, the Company reduced the exercise price on 45,000 common stock
options held by Daniel E. Pasquini, the former president of the Company, from
$2.75 per share to $0.58 per share. (See Note 10) On January 12, 1995, the
prices of the options granted in 1991, 1993, 1994, and 1995 were reduced from
$6.00, $5.00, $5.48, $6.03 per share, respectively, to $2.75 per share for all
optionholders who were employees of the Company on that date. Such price
reduction is reflected in the year the options were originally granted in the
above table.
F-20
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(11) STOCKHOLDERS' EQUITY (CONTINUED)
The following table summarizes information concerning currently outstanding
and exercisable options:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING AND EXERCISABLE
-------------------------------------
WEIGHTED
AVERAGE WEIGHTED
RANGE OF REMAINING AVERAGE
EXERCISE NUMBER CONTRACTUAL EXERCISE
PRICE OUTSTANDING LIFE PRICE
- ------------------- ----------- ----------- -----------
<S> <C> <C> <C>
$2.60 to $3.13 934,709 3.5 years $ 2.93
</TABLE>
At December 31, 1996 the Company's outstanding warrants to purchase Common
Stock consisted of (d):
<TABLE>
<CAPTION>
NUMBER OF WARRANTS EXERCISE PRICE EXPIRATION DATE
- ------------------- -------------- ---------------
<S> <C> <C>
45,000 $ 1.88 - 2.40 1/15/97
150,000 $ 4.63 - 6.00 12/11/97
45,000 $ 3.00 2/15/98
75,000 $ 2.68 8/29/98
138,888 $ 3.89 9/28/98
64,015 $ 4.41 9/28/98(a)
1,982,750 $ 3.75 9/28/98(b)
31,500 $ 11.14 10/05/98(c)
206,000 $ 3.50 12/3/98
35,000 $ 2.75 1/06/00
1,200,000 $ 4.75 5/12/00
400,000 $ 2.40 6/25/00
100,000 $ 4.75 8/01/00
60,000 $ 3.63 9/06/00
30,000 $ 2.44 8/29/01
----------
4,563,153
----------
----------
</TABLE>
- ------------------------
(a) Warrants permit the holder to purchase 88,289 total shares of Common Stock.
(b) Warrants permit the holders to purchase 2,841,610 total shares of Common
Stock.
(c) Each warrant permits the holder to purchase 3.3 shares of Common Stock plus
two stock purchase warrants, expiring September 28, 1998. Each stock
purchase warrant permits the holder to purchase 1.43 additional share of
Common Stock at an exercise price of $3.75.
(d) Table excludes warrants which have been issued to employees in lieu of stock
options.
(12) MAJOR CUSTOMER
The Company sold oil representing 54% of its oil production under contracts
to one customer for the year ended December 31, 1996. 86% of the Company's gas
production was sold to four customers (26%, 23%, 20% and 17%, respectively) for
the year ended December 31, 1996.
F-21
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(12) MAJOR CUSTOMER (CONTINUED)
The Company sold oil representing 56% of its oil production under contracts
to one customer for the year ended December 31, 1995. 71% of the Company's gas
production was sold under contracts to three customers (29%, 26% and 16%,
respectively) for the year ended December 31, 1995.
The Company sold oil representing 72% of its oil production under contracts
to one customer for the year ended December 31, 1994. 88% of the Company's gas
production was sold to three customers (48%, 25% and 15%, respectively) for the
year ended December 31, 1994.
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents, accounts receivable,
accounts payable, debt and other financial assets and liabilities approximate
their fair value.
(14) RETIREMENT PLAN
During 1996, the Company adopted the Fortune Petroleum Corporation 401(k)
Profit Sharing Plan for its eligible employees. Under the plan, all employees on
the Company's payroll as of November 1, 1996, and all employees hired after that
date who have attained age 21 and three months of service, are permitted to make
salary deferrals up to the lesser of 15% of their annual compensation or $9,500.
Salary deferrals will be matched 50% by the Company and are 100% vested after
two years of service with the Company. Salary deferrals are 100% vested at all
times. The Company does not make profit sharing contributions to the plan. For
1996, the Company's matching contribution was $14,000, all of which will be paid
in shares of Common Stock.
(15) SUBSEQUENT EVENTS
On February 26, 1997, the Company closed an Exchange Offer which resulted in
a portion of its 10 1/2% Convertible Subordinated Debentures being converted
into Common Stock and Common Stock Warrants. (See Note 6.)
(16) UNAUDITED OIL AND GAS PRODUCING ACTIVITIES AND OIL AND GAS COST INFORMATION
All of the Company's reserves are located within the United States. Proved
reserves represent estimated quantities of crude oil and natural gas which
geological and engineering data demonstrate to be reasonably certain to be
recoverable in the future from known reservoirs under existing economic and
operating conditions Proved developed oil and gas reserves are reserves that can
be expected to be recovered through existing wells using existing equipment and
operating methods.
For the year ended December 31, 1994, the oil and gas reserve estimates were
reviewed by Huddleston & Co., Inc., ("Huddleston") Houston, Texas independent
petroleum engineers and Sherwin D. Yoelin, independent petroleum engineer, and
for the years ended December 31, 1995 and 1996, by Huddleston, in accordance
with guidelines established by the Securities and Exchange Commission. Such
estimates are subject to numerous uncertainties inherent in the estimation of
quantities of proved reserves and in the projection of future rates of
production, prices and the timing of development expenditures. The future cash
inflow, as reflected in the "Standardized Measure of Discounted Future Net Cash
Flows Relating to Proved Oil and Gas Reserves", determined from such reserve
data are estimates only, and the present values thereof should not be construed
to be the current market values of the Company's oil and gas reserves or the
costs that would be incurred to obtain equivalent reserves.
F-22
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS
(16) UNAUDITED OIL AND GAS PRODUCING ACTIVITIES AND OIL AND GAS COST INFORMATION
(CONTINUED)
CHANGES IN ESTIMATED RESERVE QUANTITIES
The Company's net interests in estimated quantities of proved developed and
undeveloped reserves of crude oil and natural gas at December 31, 1994, 1995,
and 1996, and changes in such quantities during the years, 1994, 1995 and 1996,
were as follows:
<TABLE>
<CAPTION>
CRUDE OIL (BARRELS)
-------------------------------
YEAR 1994 YEAR 1995 YEAR 1996
--------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS)
BEGINNING OF PERIOD............................................................ 813 1,647 347
Revisions of previous estimates.............................................. 866 (160) 6
Extensions and discoveries................................................... -- -- 106
Production................................................................... (88) (92) (57)
Purchase of minerals in place................................................ 56 174 --
Sales of minerals in place*.................................................. -- (1,222) (153)
--------- --------- ---
END OF PERIOD.................................................................. 1,647 347 249
--------- --------- ---
--------- --------- ---
Proved developed reserves
Beginning of period........................................................ 666 675 324
--------- --------- ---
--------- --------- ---
End of period.............................................................. 675 324 160
--------- --------- ---
--------- --------- ---
</TABLE>
<TABLE>
<CAPTION>
NATURAL GAS (MCF)
-------------------------------
YEAR 1994 YEAR 1995 YEAR 1996
--------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS)
BEGINNING OF PERIOD 5,562 5,911 5,938
Revisions of previous estimates........................................... 533 (388) (753)
Extensions and discoveries................................................ -- -- 85
Production................................................................ (1,017) (909) (1,038)
Purchase of minerals in place............................................. 833 2,934 --
Sales of minerals in place*............................................... -- (1,610) (751)
--------- --------- ---------
END OF PERIOD............................................................... 5,911 5,938 3,481
--------- --------- ---------
--------- --------- ---------
Proved developed reserves
Beginning of period..................................................... 4,221 3,317 4,686
--------- --------- ---------
--------- --------- ---------
End of period........................................................... 3,317 4,686 1,749
--------- --------- ---------
--------- --------- ---------
</TABLE>
- ------------------------
* During 1995, the Company's interests in its California properties, which were
sold in February 1996, were transferred to oil and gas properties held for
sale.
NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVES
This statement attempts to present future net cash flows related to proved
oil and gas reserves without the subjectivity inherent in either direct
estimation of market value or entity specific discounted net cash
F-23
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(16) UNAUDITED OIL AND GAS PRODUCING ACTIVITIES AND OIL AND GAS COST INFORMATION
(CONTINUED)
flow. This measure is not a measure of fair market value nor a measure of the
present value of future cash flows, but rather a rough estimation of such.
This measure should be responsive to some of the key variables that affect
fair market value, such as changes in reserve quantities, selling prices,
production costs and tax rates.
The future net cash inflows are developed as follows:
(1) Estimates are made of quantities of proved reserves and the future
periods during which they are expected to be produced based on period-end
economic conditions.
(2) The estimated future production of proved reserves is priced on the
basis of period-end prices except for fixed and determinable escalation
provisions in existing contracts.
(3) The resulting future gross revenue streams are reduced by estimated
future costs to develop and to produce the proved reserves, based on
period-end cost estimates.
(4) The resulting future net revenue streams are reduced to present value
amounts by applying a 10 percent discount factor.
STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL
AND GAS RESERVES
Disclosure of the principal component of the standardized measure of
discounted future net cash flows provides information concerning the factors
involved in making the calculation. In addition, the disclosure of both
undiscounted and discounted net flows provides a measure of comparing proved oil
and gas reserves both with and without an estimate of production timing. The
standardized measure of discounted future net cash flows relating to proved
reserves reflects income taxes.
<TABLE>
<CAPTION>
1994 1995 1996
---------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS)
Future cash inflows............................................................. $ 32,898 $ 19,531 $ 19,751
Future costs:
Production.................................................................... (11,283) (6,050) (4,026)
Development................................................................... (5,683) (881) (1,613)
---------- --------- ---------
Future net inflows before income taxes.......................................... 15,932 12,600 14,112
Future income taxes............................................................. -- -- --
---------- --------- ---------
Future net cash flows........................................................... 15,932 12,600 14,112
10% discount factor............................................................. (7,784) (3,658) (3,292)
---------- --------- ---------
Standardized mesure of discounted net cash flows................................ $ 8,148 $ 8,942 $ 10,820
---------- --------- ---------
---------- --------- ---------
</TABLE>
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS FROM PROVEN
RESERVE QUANTITIES
This statement discloses the sources of changes in the standardized measure
from period to period. The amount reported as "Net change in sales and transfer
prices net of production costs" represents the approximate effect of increasing
the evaluation of reserves proved in prior periods to reflect higher prices in
effect in the following years. The "Accretion of discount" was computed by
applying the 10 percent discount factor to the valuation of the proved reserves
as of the beginning of the period before income tax
F-24
<PAGE>
FORTUNE PETROLEUM CORPORATION
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
(16) UNAUDITED OIL AND GAS PRODUCING ACTIVITIES AND OIL AND GAS COST INFORMATION
(CONTINUED)
effects. "Changes in estimated future development costs" arise from: (1)
revisions of previous estimates for both development costs actually incurred in
the current period and for development costs estimated to be incurred in
succeeding periods and (2) new discoveries from which future development must be
performed. The "Sales and transfers, net of production costs" are expressed in
actual dollar amounts. "Revisions of quantity estimates" are expressed at
period-end prices. The "Net change in income taxes" is computed as the change in
present value of future income taxes. The "Changes in production rates (timing)
and other" reflects all other changes, such as changes in timing, and includes
the residual from estimation errors in computing other elements of change. The
average gas prices received by the Company were $1.39, $2.32 and $4.04 per Mcf
at year end 1994, 1995 and 1996, respectively. The average oil prices received
by the Company were $14.62, $16.10 and $22.79 per Bbl at year end 1994, 1995 and
1996, respectively. At February 26, 1997, the Company was receiving an average
of approximately $2.96 per Mcf for its gas production and $20.62 per Bbl for its
oil production. These current prices represent declines from December 1996 and
January 1997 prices, and the Company expects further price declines through the
spring and summer of 1997.
<TABLE>
<CAPTION>
1994 1995 1996
--------- --------- ---------
<S> <C> <C> <C>
(IN THOUSANDS)
Standarized Measure:
Beginning of period............................................................... $ 8,554 $ 8,148 $ 8,942
Increases (decreases):
Sales and transfers, net of production costs...................................... (2,249) (1,445) (2,653)
Extensions and discoveries........................................................ -- -- 1,532
Net change in sales and transfer prices, net of production costs.................. (1,635) 460 5,233
Changes in estimated future development costs..................................... (4,315) 500 (332)
Revisions of quantity estimates................................................... 6,385 (871) (1,473)
Accretion of discount............................................................. 855 814 894
Net change in income taxes........................................................ -- -- --
Purchases of reserves in place.................................................... 1,464 5,329 --
Sales of reserves in place*....................................................... -- (3,024) (1,612)
Changes in production rates (timing) and other.................................... (911) (969) 289
--------- --------- ---------
Standardized Measure:
End of period..................................................................... $ 8,148 $ 8,942 $ 10,820
--------- --------- ---------
--------- --------- ---------
</TABLE>
- ------------------------
*During 1995, the Company's interests in its California properties, which
were sold in February 1996, were transferred to oil and gas properties held for
sale.
F-25
<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES
OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY
JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
Prospectus Summary............................. 3
Risk Factors................................... 7
Use of Proceeds................................ 13
Dilution....................................... 13
Capitalization................................. 14
Dividend Policy................................ 15
Price Range of Common Stock.................... 15
Selected Financial and Operating Data.......... 16
Management's Discussion and Analysis of
Financial Condition and Results of
Operations.................................... 17
Business and Properties........................ 23
Management..................................... 37
Certain Relationships and Related
Transactions.................................. 41
Principal Stockholders......................... 44
Description of Securities...................... 46
Underwriting................................... 50
Legal Matters.................................. 51
Experts........................................ 51
Available Information.......................... 51
Glossary....................................... 52
Index to Financial Statements.................. F-1
</TABLE>
2,000,000 SHARES
[LOGO]
FORTUNE PETROLEUM CORPORATION
COMMON STOCK
---------------------
PROSPECTUS
---------------------
PAULSON INVESTMENT
COMPANY, INC.
, 1997
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The Registrant estimates that expenses in connection with the offering
described in the Registration Statement will be as follows:
<TABLE>
<S> <C>
Securities and Exchange Commission Registration Fee............... $ 1,784
Accountants' Fees and Expenses.................................... $ 15,000
Legal Fees and Expenses........................................... $ 50,000
American Stock Exchange fees...................................... $ 17,500
Underwriting Expense Allowance (1)................................ $ 165,000
Printing and Engraving Expenses................................... $ 75,000
Miscellaneous..................................................... $ 15,716
---------
Total......................................................... $ 340,000
---------
---------
</TABLE>
- ------------------------
(1) $189,750 if the over-allotment option is exercised.
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law permits the
indemnification of officers, directors, employees and agents of Delaware
corporations. The Certificate of Incorporation and Bylaws of the Company provide
that the corporation shall, to the fullest extent permitted by Section 145 of
the General Corporation Law of the State of Delaware as it may be amended from
time to time, indemnify and hold harmless each person who was or is a party or
is threatened to be made a party to or is involved in any action, suit or
proceeding, whether civil, criminal, administrative or investigative
(hereinafter a "proceeding"), by reason of the fact that he or she, or a person
whom he or she is a legal representative, is or was a director or officer of the
Company or is or was serving at the request of the Company as director, officer,
employee or agent of another corporation or of a partnership, joint venture,
trust or other enterprise, including service with respect to employee benefit
plans, whether the basis of such proceeding is alleged action or inaction in an
official capacity or in any other capacity while serving as a director, officer,
employee or agent, against all costs, charges, expenses, liabilities and losses
(including attorney's fees, judgments, fines, ERISA excise taxes or penalties
and amounts paid or to be paid in settlement) reasonably incurred or suffered by
such person in connection therewith, and such indemnification shall continue as
to person who has ceased to be a director, officer, employee or agent and shall
inure to the benefit of his or her heirs, executors and administrators.
ITEM 16. EXHIBITS
(a) Exhibits
<TABLE>
<CAPTION>
NUMBER DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
1.1 Underwriting Agreement between Registrant and Paulson Investment Company, Inc.
2.1 Letter agreement dated February 13, 1995, between Registrant and Lagniappe Exploration, Inc. and related
Exploration Agreement, as amended (incorporated by reference to Fortune's Registration Statement on Form
SB-2, Regiatration No. 33-88452)
2.2 Agreement of Reorganization and Merger, dated May 12, 1995, among Registrant, Lanacorp, Inc., Lagniappe
Exploration, Inc., William D. Forster and BSR Investments Limited (incorporated by reference to
Fortune's Registration Statement on Form SB-2, Registration No. 33-88452)
</TABLE>
II-1
<PAGE>
<TABLE>
<C> <S>
3.1 Certificate of Incorporation of Fortune Petroleum Corporation (incorporated by reference to Fortune's
Registration Statement Form 10, File No. 0-16370)
3.2 Bylaws of Fortune Petroleum Corporation (incorporated by reference to Fortune's Registration Statement
Form 10, File No. 0-16370)
3.3 Certificate of Amendment to Certificate of Incorporation of Registrant increasing authorized capital
stock (incorporated by reference to Fortune's Registration Statement on Form SB-2, Registration No.
33-88452)
4.1 Indenture, dated October 30, 1992, by and between Fortune Petroleum Corporation and IBJ Schroeder Bank &
Trust Company, Trustee, as amended (incorporated by reference to Fortune's Registration Statement on
Form S-1, Registration No. 33-49190)
4.2 Form of Representative Warrant Agreement
4.3 Form of shareholder Rights Plan
5.1 Opinion of Reish & Luftman regarding legality of securities
10.1 Participation Agreement by and between Fortune and Smith Management Company, Inc. et al. to acquire a
12.5% working interest in Espiritu Santo Bay.
10.2 Employment Agreement dated August 1, 1996 by and between Fortune and Dean W. Drulias
18.1 Letter from KPMG Peak Marwick LLP re change in accounting method.
23.1* Consent of KPMG Peat Marwick LLP
23.2 Consent of Huddleston & Co., Inc.
23.3 Consent of Sherwin D. Yoelin
23.4 Consent of Reish & Luftman (included in Exhibit 5.1)
25.1 Power of Attorney (included on signature page)
</TABLE>
- ------------------------
* Filed herewith.
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file during any period in which offers or sales are being made, a
post effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933
(ii) To reflect in the prospectus any facts or events arising after the
effective date of the registration statement (or the most recent post
effective amendment thereof) which, individually or in the aggregate
represent fundamental change in the information set forth in the
registration statement;
(iii) To include any material information with respect to the plan of
distribution not previously disclosed in the registration statement or any
material change to such information in the registration statement;
Provided however, that paragraphs (1)(i) and (1)(ii) do not apply if the
information required to be included in a post-effective amendment by those
paragraphs is contained in periodic reports filed by the registrant pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934 that are incorporated
by reference in the registration statement.
(2) That, for the purpose of determining any liability under the Securities
Act of 1933, each such post-effective amendment shall be deemed to be a new
registration statement relating to the securities
II-2
<PAGE>
offered therein, and the offering of such securities at that time shall be
deemed to be initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
(4) For purposes of determining any liability under the Securities Act of
1933, the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(5) For the purpose of determining any liability under the Securities Act of
1933, each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed to be
the initial bona fide offering there.
(6) Insofar as indemnification for liabilities arising under the Securities
Act of 1933 may be permitted to directors, officers, and controlling persons of
the registrant pursuant to the foregoing provisions, or otherwise, the
registrant has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer of controlling person of the registrant
in the successful defense of any action, suit of proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by a controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
ITEM 18. FINANCIAL STATEMENTS AND SCHEDULES
Not applicable.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly authorized this Pre-Effective
Amendment No. 2 to the Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Houston, State of Texas,
on April 23, 1997.
FORTUNE PETROLEUM CORPORATION
By: /s/ TYRONE J. FAIRBANKS
-----------------------------------------
Tyrone J. Fairbanks
PRESIDENT AND CHIEF EXECUTIVE OFFICER
By: /s/ J. MICHAEL URBAN
-----------------------------------------
J. Michael Urban
VICE PRESIDENT AND CHIEF FINANCIAL
AND ACCOUNTING OFFICER
In accordance with the requirements of the Securities Act of 1933, this
Pre-Effective Amendment No. 2 to the Registration Statement has been signed by
the following person in the capacities and on the dates stated.
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
/s/ TYRONE J. FAIRBANKS
- ------------------------------ Chief Executive Officer April 23, 1997
Tyrone J. Fairbanks and Director
Executive Vice President,
/s/ DEAN W. DRULIAS General Counsel,
- ------------------------------ Corporate Secretary and April 23, 1997
Dean W. Drulias Director
GRAHAM S. FOLSOM*
- ------------------------------ Director April 23, 1997
Graham S. Folsom
II-4
<PAGE>
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
WILLIAM T. WALKER, JR.*
- ------------------------------ Director April 23, 1997
William T. Walker, Jr.
BARRY FEINER*
- ------------------------------ Director April 23, 1997
Barry Feiner
GARY GELMAN*
- ------------------------------ Director April 23, 1997
Gary Gelman
D.R. SHAUGHNESSY*
- ------------------------------ Director April 23, 1997
D.R. Shaughnessy
*By: /s/ DEAN W. DRULIAS
--------------------------------------
Dean W. Drulias
(ATTORNEY-IN-FACT)
II-5
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Fortune Petroleum Corporation:
We consent to the use of our report on the financial statements of the
Company included herein and to the reference to our firm under the heading
"Experts" in the Prospectus.
Our report dated February 27, 1997, refers to a change from the successful
efforts method to the full cost method of accounting for oil and gas properties.
KPMG Peat Marwick LLP
/s/ KPMG PEAT MARWICK LLP
Houston, Texas
April 22, 1997
