1996
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-12334
FORTUNE PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
Doing business in Texas and Louisiana as
FORTUNE NATURAL RESOURCES CORPORATION
Delaware 95-4114732
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
515 W. Greens Road, Suite 720
Houston, Texas 77067
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (281) 872-1170
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of exchange on which registered
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Common Stock, $.01 par value American Stock Exchange
Common Stock Purchase Warrants American Stock Exchange
Securities registered pursuant to section 12(g) of the Act:
10 1/2% Convertible Debentures Due December 31, 1997, $1,000 Face Amount
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No ___
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ x ]
State the aggregate market value of the voting stock held by
non-affiliates of the registrant. The aggregate market value shall be computed
by reference to the price at which the stock was sold, or the average bid and
asked price of such stock, as of a specified date within 60 days prior to the
date of filing.
The aggregate market value of voting stock held by non-affiliates at
February 28, 1997: $31,407,999
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Shares of common stock outstanding as of February 28, 1997: 12,154,961
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and
the Part of Form 10-K into which the document is incorporated: (1) Any annual
report to security holders; (2) Any proxy or information statement; and (3) Any
Prospectus filed pursuant to Rule 424(b) or (c) of the Securities Act of 1933.
The listed documents should be clearly described for identification purposes
(e.g., annual report to security holders for fiscal year ended December 24,
1980).
None
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PART I
ITEMS 1 AND 2. BUSINESS AND PROPERTIES
GENERAL
Fortune Petroleum Corporation ("Fortune" or the "Company") 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, 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 does business in Texas and Louisiana as Fortune Natural Resources
Corporation.
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, 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 a
joint venture with Zydeco Exploration, Inc. ("Zydeco") described below and a
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.
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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 ventures, enabling Fortune to acquire expert technical
assistance in its target geographic areas while avoiding the overhead associated
with a larger number of permanent employees.
Currently, Fortune employs the services of Interpretation3, 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 Item 10. Directors and Executive Officers of
the Registrant.) 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 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.
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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.
SOUTH LAKE ARTHUR, JEFFERSON DAVIS PARISH, LOUISIANA
In November 1996, the Company entered into a 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 identified
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 is
planned to be drilled to a depth of approximately 17,500 feet under a turnkey
drilling contract for $2.6 million. The Company expects that the well will reach
the proposed total depth in April 1997. Fortune's working interest in the well
is 12.5% before payout and 10% after payout. Fortune expects the total cost of
acquiring the interest and its share of the drilling to total approximately
$360,000. National Energy Group is the operator for the drilling phase. If the
well is successful, Mobil Oil Exploration & Producing Southeast, Inc., which has
a 50% working interest in the well, will be the operator for the completion and
production stages of the well.
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
Interpretation3.
Fortune will pay 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, and 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 its pro-rata share
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, over which Fortune expects to commence its
proprietary 3-D seismic acquisition program beginning in April 1997. 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 is
being made in exchange for the assumption of Neumin's future obligation to plug
and abandon the field. The cost of such abandonment is not estimated to be
material to the Company. The transaction is scheduled to close April 15, 1997.
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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 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.
JOINT VENTURE WITH ZYDECO
Fortune owns a 50% interest in 20 oil and gas exploration projects in a
joint venture with Zydeco (the "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. As of the date hereof, 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.
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 farmout 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 farmout 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 farmout 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 farmout 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
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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 farmout 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 farmout 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 farmout 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.
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. Unless the Company is
able to identify additional exploration sites using such 3D seismic data, it
expects to abandon the leases on this prospect before substantial delay rental
payments become due in May 1997
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 4.17% 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.
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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. On April 7,
1997, Fortune was advised by the operator that it believed the source of the
leak had been located and that repairs were underway. Fortune was also told
that, assuming the cause of the leak was successfully diagnosed and the repairs
are completed as projected, the well can be expected back on production by April
17, 1997, at a total cost somewhat below the $395,000 to Fortune's working
interest share originally estimated. Both the cost and duration of the workover
are estimates. No assurance can be given that it will not be either more or less
expensive than the operator now anticipates or that the well will be shut-in for
a longer or shorter period of time. Fortune has consented to participate in this
workover.
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 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 approximate 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.
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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. 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
on this field. (See "- Exploration Activities - La Rosa Proprietary 3D Seismic
Exploration Program.")
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.
9
<PAGE>
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.
10
<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:
<TABLE>
WELL DRILLING ACTIVITY
<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 "Forward
Looking Statements - Uncertainty of Estimates of Proved Reserves and Future Net
Revenues.")
11
<PAGE>
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.
<TABLE>
ESTIMATED NET RESERVE QUANTITIES
<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.
<TABLE>
DISCOUNTED PRESENT VALUE OF FUTURE NET REVENUES
<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.
12
<PAGE>
PRODUCTION
The approximate net production data related to the Company's properties for
the periods ended December 31, 1994, 1995 and 1996 are set forth below:
<TABLE>
NET PRODUCTION DATA
<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:
<TABLE>
AVERAGE SALES PRICES AND PRODUCTION COSTS
<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:
<TABLE>
PRODUCING WELLS
<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
13
<PAGE>
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.
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:
<TABLE>
LEASEHOLD ACREAGE
<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)
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,
14
<PAGE>
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.
ITEM 3. 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.
15
<PAGE>
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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None during the fourth quarter of 1996.
PART II
ITEM 5 . MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
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 American
Stock Exchange ("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 5/6 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.
16
<PAGE>
ITEM 6. SELECTED FINANCIAL 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 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 in Item 7. 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>
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 Items 1 and 2. Business and Properties - Oil
and Gas Operations - Oil and Gas Reserves.)
17
<PAGE>
ITEM 7. 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 strategy and now concentrates in exploration
projects onshore and offshore Louisiana and Texas and in the related transition
zone. 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 strategy, current and future results of operations may not be
comparable to historical performance.
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 to participate in
additional exploration opportunities and to purchase geological and geophysical
data.
On February 28, 1997, the Company filed a registration statement with the
Securities and Exchange Commission for an offering of 2,000,000 shares of Common
Stock by the Company. Paulson Investment Company, Inc. has been engaged as the
lead underwriter. No assurance can be given that such offering will be
completed. If completed, the net proceeds of the offering would be used for
further development of the Company's existing properties, acquisition of
additional properties and geological and geophysical data and general corporate
purposes, including possible debt reduction.
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. 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
18
<PAGE>
properties are generally accounted for as adjustments of capitalized
costs, with no gain or 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. (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 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.)
19
<PAGE>
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 funds which may be raised in connection with the public offering
discussed under "Overview" above. 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 Items 1 and
2. 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 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.
20
<PAGE>
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 Items 1 and 2.
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 the offering discussed under "Overview" above. 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, farmout 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 Items 1 and 2. Business
and 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 Items 1 and 2.
Business and Properties - Exploration Activities - Joint Venture with Zydeco.)
OUTSTANDING DEBT AND DEBT REDUCTION
As of March 10, 1997, the Company had $2.0 million of debt outstanding,
all of which is due in 1997. Outstanding debt is currently comprised of $1.0
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.
21
<PAGE>
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 March 10, 1997 was
$1,025,000. 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 the public offering described herein to retire the
remaining balance.
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.
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 "Forward Looking Statements -
Volatility 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.
22
<PAGE>
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 Items 1 and 2. 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.)
FORWARD LOOKING STATEMENTS
This annual report 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 Items 1 and 2. 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 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 factors set
forth below and elsewhere in this annual report:
EXPLORATION RISKS. The business of exploring for and, to a lesser extent,
of acquiring and developing oil and gas properties is an inherently speculative
activity that involves a high degree of business and financial risk. 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.
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 is currently shut-in for repairs
and was shut-in for over two months during 1996 as the result of a mechanical
failure. 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.
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. 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 prices represent declines
from December 1996 and January 1997 prices and the Company expects further price
declines through the spring and summer of 1997.
23
<PAGE>
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 annual report 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.
OPERATING AND WEATHER HAZARDS. The cost and timing 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, accidents, adverse weather
conditions, encountering unexpected formations or pressures in drilling and
completion operations, corrosive or hazardous substances, mechanical failure of
equipment, blowouts, cratering and fires, which 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.
In April 1996, the Company experienced a mechanical failure of downhole
equipment at the Company's South Timbalier Block 76 well. As a result of this
equipment failure, the well was shut in from April 29, 1996 to July 6, 1996, and
the Company incurred significant costs to repair it. 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. The Company carries insurance for some of these casualties;
however, the Company is not insured against all risks. Furthermore, any such
insurance is subject to coverage limits and cancellation.
ADDITIONAL FACTORS. Additional factors that could cause actual events to
vary from those discussed above and elsewhere in this annual report include,
among others: loss of key company personnel; adverse change in governmental
regulation; inability to obtain critical supplies and equipment, personnel and
consultants; and inability to access capital to pursue the Company's plans.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted beginning at page 35.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON AUDITING AND
FINANCIAL DISCLOSURE
None.
24
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
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.
25
<PAGE>
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 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 Interpretation3, a company which specializes in interpretation
of 2D and 3D seismic data. His firm provides consultation services to Fortune.
Prior to organizing Interpretation3, 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.
26
<PAGE>
ITEM 11. 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 $100,000):
<TABLE>
SUMMARY COMPENSATION TABLE
<CAPTION>
Long Term Compensation
------------------------
Annual Compensation Awards Payouts
--------------------------- ------------------------ -------
Restricted Securities
Stock Underlying LTIP All Other
Name and Principal Salary Bonus Other(1) Awards Options/Warrants Payouts Compensation
Position Year ($) ($) ($) ($) (#) ($) ($)
- -------------------------- ---- ------- ------ ------ --------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks ...... 1996 150,000 -- 20,934 -- 80,000 -- $ 3,000
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) -- 1,972
Executive Vice President
J. Michael Urban ......... 1996 97,308 -- -- -- 55,000(3) -- 4,750
Chief Financial Officer
John L. Collins .......... 1996 96,000 2,000 -- -- 80,000 -- 4,090
Vice President, ........ 1995 56,738 1,600 -- -- 25,000(4) -- --
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 $36,000 as
Chief Executive Officer.
The following table lists the outstanding options held on December 31,
1996 by the Company's executive officers under Company's Stock Option Plans:
<TABLE>
<CAPTION>
Number of Value of Unexercised
Unexercised Options/ in the Money Options
Warrants at FY-End at FY-End (1)
Shares Acquired Exercisable/ Exercisable/
Name on Exercise Value Realized ($) Unexercisable 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 preceding table.
27
<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 582,500 shares at $3.00 per share granted in 1997. The exercise
prices of all options granted in 1993, 1994 and 1995 were reduced to $2.75 on
January 12, 1995.
The 1998 Plan will be substantially identical to the 1993 plan.
28
<PAGE>
The following table shows the grants of stock options during 1996 to each
of the executives named in the Summary Compensation Table.
<TABLE>
OPTION/WARRANT GRANTS IN 1996(1)
<CAPTION>
Individual Grants
------------------------------------------------------------------
Number of % of Total Potential Realizable Value At
Securities Options/Warrants Assumed Annual Rates Of
Underlying Granted to Stock Price Appreciation
Options/Warrants Employees in Exercise or Base Expiration For Option Term
---------------------
Name Granted Fiscal Year Price ($/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
20,000(2) 3.2 2.75 October 16, 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 commencement 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.
29
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
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 Percent
Name Of Beneficial Ownership Of Class
---- ----------------------- --------
<S> <C> <C>
Barry Blank
5353 N. 16th St., Phoenix, AZ(4)............... 911,313 7.3%
William D. Forster
237 Park Ave, New York (1)(2).................. 715,000 5.8%
BSR Investments, Inc.
Paris, France(1)(3)............................ 715,000 5.8%
Klein Ventures, Inc.
1307 E. Pine St., Lodi, CA(5).................. 640,017 5.3%
Tyrone J. Fairbanks
(Director, President and CEO)
515 W. Greens Rd., Houston, TX(6).............. 438,440 3.6%
John L. Collins
(Vice President)
515 W. Greens Rd., Houston TX(6)............... 272,000 2.2%
William T. Walker, Jr.
(Director)
515 W. Greens Rd., Houston TX(6)............... 226,278 1.9%
Dean W. Drulias
(Director, Executive Vice-President,
General Counsel and Corporate Secretary)
515 W. Greens Rd., Houston, TX(6) ............. 181,241 1.5%
J. Michael Urban
(Vice President and CFO)
515 W. Greens Rd., Houston, TX(6).............. 155,000 1.3%
Graham S. Folsom
(Director)
515 W. Greens Rd., Houston, TX(6)(7)........... 135,522 1.1%
Gary Gelman
(Director)
515 W. Greens Rd., Houston, TX(6).............. 94,083 *
Barry Feiner
(Director)
515 W. Greens Rd., Houston, TX(6) (8).......... 87,862 *
Daniel R. Shaughnessy
(Director)
515 W. Greens Rd., Houston, TX(6).............. 10,000 *
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 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:
30
<PAGE>
<TABLE>
<CAPTION>
Amount and Nature of Percent
Beneficial 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).
31
<PAGE>
ITEM 13. 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.
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
Interpretation3, of which Daniel Shaughnessy is the owner and president. Mr.
Shaughnessy was elected to the Company's board of directors in January 1997.
32
<PAGE>
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, (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.
33
<PAGE>
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of the report:
(1) Financial Statements
Page
----
Independent Auditors' Report--KPMG Peat Marwick LLP............. 36
Balance Sheets--December 31, 1995 and December 31, 1996....... 37-38
Statements of Operations for the years ended
December 31, 1994, 1995 and 1996............................ 39
Statements of Stockholders' Equity for the years ended
December 31, 1994, 1995 and 1996............................ 40
Statements of Cash Flows for the years ended December 31,
1994, 1995 and 1996......................................... 41
Notes to Financial Statements.................................. 42
(2) Financial Statement Schedules
None
(3) Exhibits
Number Description
------ -----------
3.1 February 26, 1997 amendment to Bylaws of Fortune
Petroleum Corporation
4.1 Form of Shareholder Rights Plan (incorporated by
reference to Fortune's Registration Statement on
Form S-2, Registration No. 333-22599 filed
on February 28, 1997)
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
(incorporated by reference to Fortune's Registration
Statement on Form S-2, Registration No. 333-22599
filed on February 28, 1997)
10.2 Employment Agreement dated August 1, 1996 by and
between Fortune and Dean W. Drulias (incorporated by
reference to Fortune's Registration Statement on
Form S-2, Registration No. 333-22599 filed on
February 28, 1997)
18.1 Letter from KPMG Peat Marwick LLP re change in
accounting method (incorporated by reference to
Fortune's Registration Statement on Form S-2,
Registration No. 333-22599 filed on February 28, 1997)
23.1* Consent of KPMG Peat Marwick LLP
23.2 Consent of Huddleston & Co., Inc.
23.3 Consent of Sherwin D. Yoelin
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None
- ----------
* Filed herewith
34
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report - KPMG Peat Marwick LLP................. 36
Balance Sheets - December 31, 1995 and December 31, 1996............. 37-38
Statements of Operations for the years ended
December 31, 1994, 1995 and 1996.................................. 39
Statements of Stockholders' Equity for the years ended
December 31, 1994, 1995 and 1996................................... 40
Statements of Cash Flows for the years ended
December 31, 1994, 1995 and 1996................................... 41
Notes to Financial Statements........................................ 42
35
<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.
/s/ KPMG PEAT MARWICK LLP
- -------------------------
Houston, Texas
February 27, 1997
36
<PAGE>
<TABLE>
FORTUNE PETROLEUM CORPORATION
BALANCE SHEETS
ASSETS
<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.
37
<PAGE>
<TABLE>
FORTUNE PETROLEUM CORPORATION
BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
<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.
38
<PAGE>
<TABLE>
FORTUNE PETROLEUM CORPORATION
STATEMENTS OF OPERATIONS
<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.
39
<PAGE>
<TABLE>
FORTUNE PETROLEUM CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
<CAPTION>
Capital in Stock-
Common Stock Excess of Accumulated holders'
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.
40
<PAGE>
<TABLE>
FORTUNE PETROLEUM CORPORATION
STATEMENTS OF CASH FLOWS
<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.
41
<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 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.
42
<PAGE>
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) 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.
43
<PAGE>
(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.
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:
For the Year
Ended
December 31, 1995
-----------------
Revenues........................................ $ 4,451,000
===========
Net Loss........................................ $(5,316,000)
===========
Net Loss Per Common Share....................... $ (0.59)
===========
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
44
<PAGE>
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).
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 farmout 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 farmout 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 farmout 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.
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>
45
<PAGE>
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>
(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. Subsequent 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 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
46
<PAGE>
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 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:
1995 1996
---------- ----------
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 ......................... $ -- $ --
========== ==========
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 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.
47
<PAGE>
(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:
Year ending December 31,
------------------------
1997................................ $ 84,000
1998................................ 84,000
1999................................ 84,000
2000................................ 84,000
2001................................ 35,000
---------
$ 371,000
=========
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.
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
48
<PAGE>
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.
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 principal stockholder and formerly a 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 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.
49
<PAGE>
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.
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 Interpretation3, 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 $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.
50
<PAGE>
Stock option transactions were:
Weighted Average
Common Stock Of Exercise Price of
Options Exercisable(a) Shares Under Plans
------------------- --------------------
Balance, December 31, 1993 ....... 54,438 $2.69
Granted .......................... 356,000 2.71
Exercised ........................ (4,688) 2.60
Forfeited ........................ -- --
-------- -----
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
======== =====
- ----------
(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.
The following table summarizes information concerning currently
outstanding and exercisable options:
Options Outstanding and Exercisable
-----------------------------------------------------
Weighted
Average Weighted
Range of Remaining Average
Exercise Number Contractual Exercise
Price Outstanding Life Price
--------------------------------------------------------------------------
$2.60 to $3.13 934,709 3.5 years $2.93
51
<PAGE>
At December 31, 1996 the Company's outstanding warrants to purchase Common
Stock consisted of (d):
Number of Warrants Exercise Price Expiration Date
------------------ -------------- ---------------
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
=========
- ----------
(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.
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
52
<PAGE>
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.
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:
CRUDE OIL (Barrels)
------------------------------
Year Year Year
1994 1995 1996
------ ------ ----
(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
====== ====== ====
53
<PAGE>
NATURAL GAS (Mcf)
-------------------------------
Year Year Year
1994 1995 1996
------ ------ ------
(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
====== ====== ======
- ----------
* 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 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.
54
<PAGE>
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.
1994 1995 1996
-------- -------- --------
(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 measure of
discounted net cash flows ................ $ 8,148 $ 8,942 $ 10,820
======== ======== ========
55
<PAGE>
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 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.
1994 1995 1996
------- ------- --------
(in thousands)
Standardized 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
======= ======= ========
- ----------
*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.
56
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
caused this Report to be signed on its behalf by the undersigned, thereunto duly
authorized, in the city of Houston, State of Texas, on April 11, 1997.
FORTUNE PETROLEUM CORPORATION
By: /s/ Tyrone J. Fairbanks
------------------------
Tyrone J. Fairbanks
President, Chief Executive Officer
and Director
By: /s/ J. Michael Urban
------------------------
J. Michael Urban
Vice President, Chief Financial Officer
and Chief Accounting Officer
In accordance with the Exchange Act, this report has been signed by the
following persons on behalf of the Registrant and in the capacities and on the
dates stated.
Signature Title Date
--------- ----- ----
/s/ Tyrone J. Fairbanks
- -------------------------
Tyrone J. Fairbanks President, Chief Executive Officer April 11, 1997
and Director
/s/ Dean W. Drulias
- -------------------------
Dean W. Drulias Executive Vice President, General April 11, 1997
Counsel, Corporate Secretary
and Director
/s/ Graham S. Folsom
- -------------------------
Graham S. Folsom Director April 11, 1997
/s/ William T. Walker, Jr.
- -------------------------
William T. Walker, Jr. Director April 11, 1997
/s/ Barry Feiner
- -------------------------
Barry Feiner Director April 11, 1997
/s/ Gary Gelman
- -------------------------
Gary Gelman Director April 11, 1997
/s/ D. R. Shaughnessy
- -------------------------
D. R. Shaughnessy Director April 11, 1997
57
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Fortune Petroleum Corporation:
We consent to incorporation by reference in registration statement No.
33-58790 on Form S-8 of Fortune Petroleum Corporation of our report dated
February 27, 1997, relating to the balance sheets of Fortune Petroleum
Corporation as of December 31, 1996 and 1995, and the related statements of
operations, stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1996, which report appears in the December
31, 1996 annual report on Form 10-K/A of Fortune Petroleum Corporation.
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.
/s/ KPMG Peat Marwick LLP
Houston, Texas
April 9, 1997
Exhibit 23.1
