Registration Statement No. 333-45469
Rule 424(b) (1)
COMMON STOCK PURCHASE WARRANTS
EXCHANGE OFFER
The Exchange Offer and withdrawal rights will expire at 5:00 p.m., New York
City time, on March 31, 1998 (as such date may be extended, the "Expiration
Date").
Fortune Natural Resources Corporation ("Fortune" or the "Company") hereby
offers to exchange (the "Exchange Offer") each Common Stock Purchase Warrant
issued to the public in connection with the Company's 1993 public Unit offering
and each identical warrant issued prior to the Expiration Date upon exercise of
the unit purchase warrants issued to the representative of the underwriters of
such offering (collectively "Old Public Warrants") for one new Common Stock
Purchase Warrant ("New Warrant"). The Exchange Offer will be conducted upon the
terms and subject to the conditions set forth in this Prospectus and the
accompanying letter of transmittal (the "Letter of Transmittal"). (See "The
Exchange Offer" and "Description of Securities.")
Each holder of Old Public Warrants participating in the Exchange Offer will
receive one New Warrant exercisable for 1.4375 shares of Common Stock, $.01 par
value ("Common Stock"), of the Company for each of the Old Public Warrants,
which are currently exercisable for the same number of shares of Common Stock.
All of the New Warrants are exercisable on or prior to September 28, 1999 (the
Old Public Warrants expire September 28, 1998). Each share of Common Stock will
be purchasable under the New Warrants at a price of approximately $2.61 per
share, the same current exercise price as the Old Public Warrants. The New
Warrants will be callable by the Company at any time after the closing price of
the Common Stock on the American Stock Exchange, Inc. ("AMEX") equals or exceeds
$5.50 for twenty consecutive trading days (the same call price as the Old Public
Warrants). (See "Description of Securities - Warrants.")
The Common Stock and Old Public Warrants issued to the public are listed
and trade on the AMEX under the symbols FPX and FPXW, respectively. On February
10, 1998, the last reported sales price of the Common Stock on the AMEX was
$1.75 per share and the last reported sale price of the Old Public Warrants was
$0.19 per warrant. The Company has filed a listing application with the AMEX for
the shares of Common Stock issuable upon exercise of any of the New Warrants.
The New Warrants will not be listed on the AMEX or any other exchange or
otherwise admitted for trading privileges AND SUCH WARRANTS WILL NOT BE
TRANSFERABLE EXCEPT UPON THE PRIOR WRITTEN CONSENT OF THE COMPANY. Therefore, it
is highly unlikely that any market will ever develop for any of the New
Warrants. (See "Price Range of Securities.")
The Exchange Offer is not conditioned upon any minimum number of Old Public
Warrants being tendered for exchange, and the Company will accept for exchange
any and all Old Public Warrants that are validly tendered prior to 5:00 p.m.,
New York City time, on the Expiration Date. Tenders of Old Public Warrants may
be withdrawn at any time prior to 5:00 p.m., New York City time, on the
Expiration Date. U.S. Stock Transfer Corporation (the "Exchange Agent") will act
as exchange agent in connection with this offering. Holders of Old Public
Warrants will have until the Expiration Date to elect to convert their Old
Public Warrants into New Warrants. The Expiration Date may be extended by the
Company. (See "The Exchange Offer.")
No assurance can be given that any of the Old Public Warrants will be
exchanged in the Exchange Offer. Further, no assurance can be given that any of
the New Warrants will be exercised. If all of the New Warrants were issued and
exercised, the Company would receive gross proceeds of $7,425,000. The Company
will pay all costs and expenses of the Exchange Offer, estimated to be $28,000,
whether or not the Exchange Offer is successful.
THESE SECURITIES INVOLVE A HIGH DEGREE OF RISK. (SEE "RISK FACTORS"
BEGINNING ON PAGE 9.)
------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
THE DATE OF THIS PROSPECTUS IS FEBRUARY 12, 1998
<PAGE>
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed by the Company with the Securities and
Exchange Commission (the "Commission") pursuant to the Securities Exchange Act
of 1934 (the "Exchange Act") (File No. 1-12334) are incorporated in this
Prospectus by reference and are made a part hereof:
1. Annual Report on Form 10-K/A for the year ended December 31, 1996,
filed on April 11, 1997.
2. Current report on Form 8-K filed March 24, 1997.
3. Current report on Form 8-K filed on April 7, 1997.
4. Current report on Form 8-K filed on April 18, 1997.
5. Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1997, filed on May 14, 1997.
6. Current report on Form 8-K filed June 16, 1997.
7. Quarterly Report on Form 10-Q for the quarterly period ended
June 30, 1997, filed on July 29, 1997.
8. Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 1997, filed on November 14, 1997.
9. Current Report on Form 8-K filed on December 15, 1997.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon oral or written request, a copy of any or all of
the documents incorporated herein by reference (other than exhibits to such
documents, unless such exhibits are specifically incorporated by reference in
such documents). Written or telephone requests should be directed to Fortune
Natural Resources Corporation, 515 West Greens Road, Suite 720, Houston, Texas
77067. Attention: Dean W. Drulias, General Counsel (telephone (281) 872-1170).
2
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and financial statements and notes thereto appearing elsewhere in
this Prospectus. Capitalized terms not otherwise defined are used as defined in
the Glossary included elsewhere in this Prospectus.
The Company
Fortune Natural Resources Corporation ("Fortune" or the "Company") is an
independent oil and gas company whose primary focus is exploration for and
development of domestic oil and gas. Fortune's principal areas of interest
include onshore and offshore Louisiana and Texas, including the relatively
shallow transition zone where the use of modern geophysical technology and
advanced interpretation techniques offers the opportunity for new discoveries in
areas of proven historical production.
Fortune seeks to participate, generally as a minority, non-operating
interest holder, in a variety of exploration and development projects developed
with industry partners using state-of-the-art technologies including, where
appropriate, three dimensional ("3D") seismic and computer-aided exploration
("CAEX") technology. Fortune believes that these techniques have undergone
important technological advances in recent years and that their use can provide
Fortune and its project partners with a more accurate and complete prospect
evaluation, materially increasing the likelihood of finding commercial
quantities of oil and gas at lower average reserve finding costs.
Although Fortune does not currently operate properties or originate oil and
gas exploration prospects, it actively participates in the evaluation of the
opportunities presented to it, both at the time of its initial investment in a
prospect and thereafter during the evaluation and selection of drilling
projects. In order to use state-of-the-art technology while controlling fixed
operating costs, Fortune relies heavily on industry consultants for its project
evaluations.
Fortune's strategy is to invest in a diversified portfolio of oil and gas
exploration and development properties within the Company's area of interest.
Fortune seeks to mitigate the risks of exploration drilling by generally taking
minority interests in projects with large potential reserves and additional
development potential. In furtherance of this strategy, Fortune has developed
working relationships with other independent resource companies operating in its
area of interest and has acquired interests in exploration projects, which are
currently in various stages of evaluation, acquisition and preparation for
drilling. (See "Business and Properties - Exploration Activities.")
Fortune has an approximate 12.9% before-payout working interest in the East
Bayou Sorrel Field, Iberville Parish, Louisiana. The discovery well in the
Field, the Schwing #1, 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. A second well at East Bayou Sorrel, in which the Company
has an approximate 12.9% before-payout working interest, began producing on June
22, 1997. Production from this well averaged approximately 523 BOPD and 445 MCFD
in January 1998. The producing wells on this property account for about 40% of
the Company's current production and cash flow. A third well in the field was
recently completed and is currently undergoing testing.
Fortune has a 12.5% working interest in the producing 5,000 acre South
Timbalier Block 76. The producing well on this property which is located
offshore Louisiana accounts for about one-third of the Company's current
production and cash flow. The well was shut in on March 24, 1997 for a workover
to repair a failed packer. The repair was completed and the well was put back on
production on April 19, 1997. The South Timbalier well is producing
approximately 670 BOPD and 8,600 MCFD as of February 3, 1998.
The Company has a 37.5% interest in the La Rosa Field in Refugio County,
Texas, and an 18.75% interest in a 24 square mile proprietary 3D seismic survey
which has been shot on acreage in and adjacent to this field. The 3D seismic
survey is currently being processed and interpreted and two wells have been
drilled relying on the data obtained to date. The first of these wells is
currently producing; the second was abandoned as a dry hole. The Company
believes that this 3D seismic survey will identify several additional
development and exploration opportunities in the field, although there can be no
assurance that any such opportunities will be identified or pursued
successfully.
3
<PAGE>
In addition, the Company has entered into a multi-year proprietary 3D
seismic joint venture to evaluate and identify exploration prospects in a 166.5
square mile AMI in and around the Texas transition zone including the
intracoastal waters at Espiritu Santo Bay in Calhoun County, and certain
surrounding areas. Fortune owns a 12.5% working interest in the joint venture
which has undertaken a 135 square mile proprietary 3D seismic survey. The 3D
seismic survey has been acquired and processed and is currently being
interpreted. The Company believes that this 3D seismic survey will also identify
several development and exploration opportunities in the area, although there
can be no assurance that any opportunities will be identified or pursued
successfully.
In February 1995, Fortune formed a joint venture with Zydeco Exploration,
Inc. ("Zydeco") to evaluate and explore oil and gas prospects in the Louisiana
transition zone and Timbalier Trench. The joint venture holds an interest in
various projects in the shallow Gulf Coast waters offshore Louisiana (the "Joint
Venture Projects"). To date, non-commercial wells have been drilled on two of
the Joint Venture Projects and certain others have been farmed out or sold to
third parties. The remaining projects are being evaluated for drilling, farmout
or resale opportunities.
Under its exploration agreement with Zydeco, Fortune contributed $4,800,000
to the venture in 1995. The funds were to be used to pay 100% of the budgeted
leasehold acquisition and seismic costs on the projects, entitling Fortune to a
50% working interest in each project. As of June 4, 1997, $2,154,000 of the
funds remained unspent and this amount was returned to Fortune in June 1997. The
Company's 50% working interest in the projects that have not been farmed out is
subject to proportionate reduction in the event that Zydeco expends additional
funds on the projects. In keeping with its strategy of balancing risk and
return, the Company does not currently expect to retain a working interest of
more than 25% in any well drilled on the Joint Venture Projects, as a general
rule, and intends to farm out its remaining interest to other oil and gas
companies. Fortune recorded an impairment expense in 1997 attributable to a
significant portion of its investment in the Joint Venture Projects.
Prior to mid-1994, the Company focused its efforts on the acquisition of
producing properties in an effort to take advantage of competitive prices for
proved reserves with development potential in relation to the cost of reserves
discovered through exploration activities. In mid-1994, the Company made a
strategic decision to shift its emphasis from the acquisition of producing
properties to exploration for oil and natural gas reserves, although the Company
continues to examine attractive acquisition opportunities. This decision was
prompted by increasing price competition for attractive producing properties as
well as the recent important advances in exploration technology. To help
facilitate its exploration strategy and focus its efforts, the Company sold all
of its California producing properties and prospects in early 1996. The Company
relocated its headquarters from Los Angeles, California to Houston, Texas in
February 1996.
All of the Company's current and proposed exploration activities involve a
high degree of risk, including the risk that the Company will make substantial
investments in properties and wells without achieving commercial production.
While the Company attempts to manage exploration risk through careful evaluation
of potential investments and diversification, there is no assurance that the
Company's efforts will result in successful development of oil or gas wells.
The Company's principal executive offices are located at 515 West Greens
Road, Suite 720, Houston, Texas 77067. Its telephone number at that address is
(281) 872-1170. In 1997 the Company changed its name from Fortune Petroleum
Corporation to "Fortune Natural Resources Corporation," the name under which
Fortune previously operated in Louisiana and Texas.
4
<PAGE>
Risk Factors
The securities offered hereby involve a high degree of risk and investors
should carefully consider the information set forth under "Risk Factors," as
well as the other information and data in this Prospectus.
THE EXCHANGE OFFER
<TABLE>
<CAPTION>
<S> <C>
THE OFFER.................................. The Company is offering upon the terms and subject to the conditions
set forth herein and in the accompanying Letter of Transmittal,
one New Warrant for each Old Public Warrant.
EXPIRATION OF EXCHANGE OFFER.............. This Exchange Offer will expire on 5:00 p. m. New York
City time on March 31, 1998, unless extended by the
Company.
CONDITIONS TO EXCHANGE OFFER.............. The Registration Statement of which this Prospectus
constitutes a part must be effective and the
Warrantholder must comply with the terms and
conditions set forth in the Letter of Transmittal.
(See "The Exchange Offer - Conditions of the Exchange
Offer.")
TERMS OF NEW WARRANTS(1).................. Each New Warrant will be exercisable on or prior to
September 28, 1999 (the Old Public Warrants expire
September 28, 1998), for 1.4375 shares of Common
Stock, at an exercise price of $3.75 per warrant (the
same current exercise price as the Old Public
Warrants). The New Warrants will be callable by the
Company at any time after the closing price of the
Common Stock on AMEX equals or exceeds $5.50 for
twenty consecutive trading days (the same call price as
the Old Public Warrants). (See "Description of Securities -
New Warrants.")
MARKET FOR COMMON STOCK
AND WARRANTS........................... The Common Stock and Old Public Warrants issued to the
public are listed and trade on the AMEX under the
symbols FPX and FPXW, respectively. The shares of
Common Stock issuable upon exercise of any of the New
Warrants have been approved for listing upon notice of
issuance on the AMEX. The New Warrants will not be
listed on AMEX or any other exchange or otherwise
admitted for trading privileges or otherwise
authorized for inclusion on any recognized securities
market and SUCH WARRANTS WILL NOT BE TRANSFERABLE
EXCEPT UPON THE PRIOR WRITTEN CONSENT OF THE COMPANY.
5
<PAGE>
PROCEDURES FOR TENDERING
OLD PUBLIC WARRANTS.................... Unless a tender of Old Public Warrants is effected
pursuant to the procedures for book-entry transfer as
provided herein, each holder desiring to accept the
Exchange Offer must complete and sign the Letter of
Transmittal, have the signature thereon guaranteed if
required by the Letter of Transmittal, and mail or
deliver the Letter of Transmittal, together with the
Old Public Warrants or a Notice of Guaranteed Delivery
and any other required documents (such as evidence of
authority to act, if the Letter of Transmittal is
signed by someone acting in a fiduciary or
representative capacity), to the Exchange Agent (as
defined) at the address set forth under "The Exchange
Offer - The Exchange Agent; Assistance" prior to 5:00 p.m.,
New York City time, on the Expiration Date. Any Beneficial
Owner (as defined) of the Old Public Warrants whose
Old Public Warrants are registered in the name of a
nominee, (such as a broker, dealer, commercial bank or
trust company) and who wishes to tender Old Public
Warrants in the Exchange Offer, should instruct such
entity or person to promptly tender on such Beneficial
Owner's behalf. (See "The Exchange Offer - Procedures
for Tendering Old Public Warrants.")
GUARANTEED DELIVERY PROCEDURES............ Holders of Old Public Warrants who wish to tender
their Old Public Warrants and (i) whose Old Public
Warrants are not immediately available or (ii) who
cannot deliver their Old Public Warrants or any other
documents required by the Letter of Transmittal to the
Exchange Agent prior to the Expiration Date (or
complete the procedure for book-entry transfer on a
timely basis), may tender their Old Public Warrants
according to the guaranteed delivery procedures set
forth in the Letter of Transmittal. (See "The
Exchange Offer - Guaranteed Delivery Procedures.")
ACCEPTANCE OF OLD PUBLIC WARRANTS AND
DELIVERY OF NEW WARRANTS.............. Upon effectiveness of the Registration Statement of
which this Prospectus constitutes a part, the Company
will accept any and all Old Public Warrants that are
properly tendered in the Exchange Offer prior to 5:00
p.m., New York City time, on the Expiration Date. The
New Warrants issued pursuant to the Exchange Offer
will be delivered promptly after acceptance of the Old
Public Warrants. (See "The Exchange Offer -
Acceptance of Old Public Warrants for Exchange;
Delivery of New Warrants.)
WITHDRAWAL RIGHTS......................... Tenders of Old Public Warrants may be withdrawn at any
time prior to 5:00 p.m., New York City time, on the
Expiration Date. (See "The Exchange Offer -
Withdrawal Rights.")
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<PAGE>
EXCHANGE AGENT............................ U.S. Stock Transfer Corporation, the Warrant Agent
for all of the Old and New Warrants will serve as
Exchange Agent. The address and telephone number of
the Exchange Agent are set forth in "The Exchange
Offer - The Exchange Agent; Assistance."
FEES AND EXPENSES......................... All expenses incident to the consummation of the
Exchange Offer will be paid by the Company. (See "The
Exchange Offer - Fees and Expenses.")
USE OF PROCEEDS........................... No proceeds will be received by the Company in
connection with this exchange. Proceeds received by
the Company in the event of any warrant exercise,
which would total $7,425,000 if the maximum number of
New Warrants potentially issuable are actually issued
and exercised, will be used for further development of
the Company's existing properties; acquisition of
additional properties and/or geological and
geophysical data; and general corporate purposes,
including possible reduction of outstanding debt.
FEDERAL INCOME TAX CONSEQUENCES........... For information regarding the federal income tax
consequences of acceptance of New Warrants in exchange
for Old Public Warrants, see "Certain Federal
Income Tax Consequences."
</TABLE>
(1) The New Warrants do not contain the provisions contained in the Old Public
Warrants providing the holders of such warrants protection against dilution
from certain issuances of Common Stock or other securities below the
current market value. (See "Risk Factors" and "Description of
Securities-Warrants.")
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<PAGE>
SUMMARY FINANCIAL AND OPERATING DATA
The following Summary Condensed Financial Data for each of the years in the
three-year period ended December 31, 1996 and the unaudited financial
information for the nine months ended September 30, 1996 and 1997, are derived
from, and qualified by reference to, the Company's audited and unaudited
financial statements, appearing elsewhere herein. The Summary Condensed
Financial Data should be read in conjunction with the audited and unaudited
financial statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing elsewhere herein. The data for
years ending prior to 1996 have been restated to reflect the change in the
Company's method of accounting for oil and gas operations to the full cost
method of accounting. (See note 2 to December 31, 1996 Financial Statements.)
The results for the nine months ended September 30, 1997 are not necessarily
indicative of results for the full year.
SUMMARY CONDENSED FINANCIAL DATA
(dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
NINE MONTHS
YEARS ENDED DECEMBER 31, ENDED SEPTEMBER 30,
------------------------------------- ---------------------
1994* 1995* 1996 1996* 1997
---------- ---------- ----------- ----------- --------
(unaudited)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................................... $ 3,397 $ 3,143 $ 4,040 $ 2,990 $ 3,007
Loss on sale of oil and gas properties........... - 3,607 - - -
Impairment to oil and gas properties............. 3,347 - - - 3,200
Net loss......................................... $ (4,453) $ (5,876) $ (1,330) $ (1,052) $ (5,084)
Net loss per share............................... $ (1.69) $ (0.90) $ (0.12) $ (0.09) $ (0.42)
Net weighted average shares outstanding.......... 2,639 6,556 11,351 11,285 12,075
OPERATING DATA:
Net Production:
Crude oil, condensate and gas liquids (Bbl).... 88,000 92,000 57,000 43,000 64,000
Natural gas (Mcf).............................. 1,017,000 909,000 1,038,000 796,000 643,000
Gas equivalent (MCFE).......................... 1,542,000 1,461,000 1,383,000 1,057,000 1,026,000
Average Sales Price:.............................
Crude oil, condensate and gas liquids ($ per Bbl) $ 14.14 $ 14.66 $ 20.24 $ 19.61 $ 19.20
Natural gas ($ per Mcf)........................ $ 2.09 $ 1.77 $ 2.56 $ 2.49 $ 2.56
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1994* 1995* 1996 1996* 1997
---------- ---------- ----------- ----------- --------
(unaudited)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets..................................... $ 10,066 $ 17,800 $ 16,335 $ 15,729 $ 11,831
Total debt....................................... $ 7,123 $ 4,897 $ 2,933 $ 3,155 $ 1,887
Net stockholders' equity......................... $ 2,130 $ 12,314 $ 13,037 $ 12,207 $ 8,965
RESERVES:
Estimated Net Proved Reserves (1):
Crude oil and condensate (MBbls)............... 1,647 347 249
Natural gas (Bcf).............................. 5.9 5.9 3.5
Estimated future net revenues
before income taxes............................ $ 15,932 $ 12,600 $ 14,112
Present value of estimated future net revenues
before income taxes (discounted at
10% per annum)............................... $ 8,148 $ 8,942 $ 10,820
</TABLE>
* Restated
(1) Estimates of oil and gas reserves in future years are based in part on the
sales price at December 31 of the respective year. To the extent that the
cost of producing the oil and gas, plus applicable taxes, from any
particular property exceeds the sales price, the quantity of proved
reserves is reduced. (See "Business and Properties - Oil and Gas Operations
- Oil and Gas Reserves")
8
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RISK FACTORS
This Prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 (the "Securities Act"). Such
forward-looking statements may be found in this section and under "Prospectus
Summary," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business and Properties." Forward-looking statements
include, but are not limited to, statements regarding: future oil and gas
production and prices, future exploration and development spending, future
drilling and operating plans, reserve and production potential of the Company's
properties and prospects and the Company's business strategy. Actual events or
results could differ materially from those discussed in the forward-looking
statements as a result of various factors including, without limitation, the
risk factors set forth below and elsewhere in this Prospectus. An investment in
the Company's New Warrants or Common Stock involves a high degree of risk. The
New Warrants or Common Stock should not be acquired by persons who cannot afford
the loss of their entire investment. Prospective investors should carefully
consider all of the information contained in this Prospectus, including the
following risk factors:
RISKS ASSOCIATED WITH THE COMPANY
EXPLORATION RISKS. The business of exploring for and, to a lesser extent,
of developing oil and gas properties is an inherently speculative activity that
involves a high degree of business and financial risk. Property acquisition
decisions generally are based on various assumptions and subjective judgments
that are speculative. Although available geological and geophysical information
can provide information with respect to a potential oil or gas property, it is
impossible to determine accurately the ultimate production potential, if any, of
a particular property or well. Moreover, the successful completion of an oil or
gas well does not ensure a profit on the Company's investment therein. The
Company's current investments are primarily in exploration projects. Drilling
for oil and natural gas involves numerous risks, including the risk that no
commercially productive hydrocarbon reservoirs will be encountered. These risks
are substantially greater in the case of exploratory drilling than in the case
of wells drilled into producing formations. The Company's future drilling
activities may not be successful. Participation in certain recent prospects by
the Company has resulted in less than anticipated success, and it is to be
expected that a substantial number of the projects in which the Company invests
will fail to achieve commercial production or to justify the investment made in
them.
CHANGE IN STRATEGY. In mid-1994, Fortune changed its strategy from the
acquisition of producing oil and gas properties with anticipated development
potential to a strategy that primarily stresses exploratory drilling for oil and
gas. In furtherance of this change in strategy, Fortune made substantial changes
in management and personnel and, in 1996, sold all of its California properties,
which accounted for a significant portion of the Company's oil and gas reserve
volumes at the time of the sale, and relocated its offices to Houston, Texas. It
has also developed a new area of interest and new working relationships, and
invested in new prospects, the operating results of which are too preliminary to
support meaningful evaluation of their potential. Because of these changes in
business strategy, current and future results of operations may not be
comparable to historical performance.
NET LOSSES INCURRED BY COMPANY. The Company has incurred substantial net
losses in each of the last three years and during the nine months ended
September 30, 1997. The losses equaled $4,453,000, $5,876,000 and $1,330,000 for
1994, 1995 and 1996, respectively and $5,084,000 for the nine months ended
September 30, 1997. There is no assurance that losses will not continue for the
remainder of 1997 and thereafter. (See "Management's Discussion and Analysis of
Financial Condition and Results of Operations.")
NEED TO REPLACE DECLINING RESERVES. The Company's future oil and natural
gas reserves and production, and thus cash flow and income, are highly dependent
on the Company's ability to find or acquire additional reserves. Without adding
new reserves in the future, the Company's oil and gas reserves and production
will decline. There is no assurance that the Company will be able to find and
develop or acquire additional reserves.
DEPENDENCE ON LIMITED NUMBER OF WELLS. Over 70% of the Company's oil and
gas revenues, cash flow and proved oil and gas reserves is currently accounted
for by three wells, the South Timbalier Block 76 well and the two East Bayou
Sorrel wells. The short production history from the East Bayou Sorrel wells
increases the uncertainty of assuring or estimating future production from such
wells. The South Timbalier Block 76 well was shut-in for repairs for one month
in 1997 and for over two months during 1996 as the result of mechanical
failures. (See "Risks Associated with the Oil and Gas Industry - Operating
Hazards" and "Business and Properties - Property Acquisition Activity - South
Timbalier Block 76 Acquisition.") A significant curtailment or loss of
production from any 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.
9
<PAGE>
WORKING CAPITAL; NEED FOR ADDITIONAL FINANCING. Investment in oil and gas
exploration requires the commitment of substantial amounts of capital over
significant periods of time. For the three-year period ended December 31, 1996,
the Company incurred over $15 million of capital costs in its oil and gas
exploration and development activities. The Company estimates that it made
additional capital investments of approximately $4.9 in 1997. While the Company
believes it will have sufficient capital or cash flow to meet its projected
capital needs over the short-term, the Company may not have sufficient liquid
capital resources to participate at its existing working interest level or at
all if the operators of the properties in which the Company has invested propose
an accelerated drilling schedule, or if capital requirements otherwise exceed,
or capital resources fall short of, expectation. If the Company declines to
participate in making capital expenditures with respect to any project, its
interest in the project may be substantially reduced.
DEPENDENCE ON OPERATORS, CONSULTANTS AND OTHERS. Fortune currently
participates in exploration projects but does not operate any such projects.
Accordingly, it is dependent on other oil and gas companies to conduct
operations in a prudent and competent manner. Although it expects to be actively
involved in project evaluations, Fortune may have little or no control over the
way in which such operations are conducted or the timing of exploitation of
particular projects. If the entity selected to act as operator proves
incompetent, Fortune could be forced to incur additional costs to conduct
remedial procedures and could lose its investment in a property altogether.
Because Fortune employs a variety of technological approaches to its evaluation
of properties and projects, it relies heavily on outside consultants for the
required technological expertise. The Company has no long-term agreements with
such consultants, all of whom are available to other natural resource companies,
including the Company's competitors.
ACCOUNTING RISKS. The Company reports its operations using the full cost
method of accounting for oil and gas properties. Under full cost accounting
rules, all productive and non-productive costs incurred in connection with the
exploration for and development of oil and gas reserves are capitalized.
Dispositions of oil and gas properties are generally accounted for as
adjustments of capitalized costs, with no gain or loss recognized, unless such
disposition is deemed to be significant. (See note 1 to the December 31, 1996
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 or when previously
unevaluated properties carried at cost are disposed of below that cost or
abandoned. For example, the Company recognized a $3.3 million impairment to its
oil and gas properties in 1994 and a $3.2 million impairment for the nine-month
period ended September 30, 1997.
PROPERTIES PLEDGED TO SECURE DEBT. All of the Company's producing
properties are pledged to secure its bank credit facility. A failure to pay the
principal or interest or breaches of financial covenants under the credit
facility could cause the Company to lose all or part of its interest in its
principal producing properties. The entire $550,000 principal balance of the
credit facility is due July 11, 1999. If Fortune's operating activities are
significantly curtailed or Fortune's financial position weakens significantly
and the Company is unable to repay such debt when it comes due, it is possible
that Fortune's productive properties could be seized by the bank through a
foreclosure. (See "Management's Discussion and Analysis of Financial Condition
and Results of Operations.")
UNINSURED RISKS. Under the terms of operating agreements entered into with
the operator of wells in which the Company has an interest, it is anticipated
that the operators will carry insurance against certain risks of oil and gas
operations. The Company would normally be required to pay its proportionate
share of the premiums for such insurance and be named as an additional insured
under the policy. In addition to such insurance, the Company also carries
insurance against certain oil and gas operating risks. However, the Company may
not be fully insured against all risks because such insurance is not available,
is not affordable, or losses exceed policy limits.
DEPENDENCE ON KEY OFFICER. The Company depends to a large extent on the
abilities and continued participation of its key employee, Tyrone J. Fairbanks,
President and Chief Executive Officer. The loss of Mr. Fairbanks could have a
material adverse effect on the Company. In an effort to reduce the risk, the
Company has entered into an employment agreement with Mr. Fairbanks which
expires May 31, 2000. (See "Management.") The Company also has obtained $500,000
of key man life insurance on the life of Mr. Fairbanks.
10
<PAGE>
RISKS ASSOCIATED WITH THE OIL AND GAS INDUSTRY
VOLATILITY OF OIL AND GAS PRICES. The Company's revenues, profitability and
future rate of growth are substantially dependent upon prevailing market prices
for oil and gas, which can be extremely volatile. 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 oil
and gas. There is no assurance that current price levels can be sustained or
that the Company will be able to produce oil or gas on an economic basis in
light of prevailing market prices. Any substantial or extended decline in the
price of oil and/or gas would have a material adverse effect on the Company's
financial condition and results of operations, including reduced cash flow and
borrowing capacity, and could reduce both the value and the amount of the
Company's oil and gas reserves. The average gas prices received by the Company
were $2.09, $1.77 and $2.56 per Mcf in 1994, 1995 and 1996, respectively. The
average oil prices received by the Company were $14.14, $14.66 and $20.24 per
Bbl in 1994, 1995 and 1996, respectively. During the nine months ended September
30, 1997, the Company received $2.56 per MCF for its gas and $19.20 per Bbl for
its oil production. At December 31, 1997, the Company was receiving an average
of approximately $2.60 per Mcf for its gas and $16.90 per Bbl for its oil
production. These current prices represent declines from earlier prices and the
Company expects further declines in the price of gas through the spring and
summer of 1998.
UNCERTAINTY OF ESTIMATES OF PROVED RESERVES AND FUTURE NET REVENUES. There
are numerous uncertainties inherent in estimating quantities of proved reserves
and in projecting future rates of production and timing of development
expenditures, including many factors beyond the control of the producer. The
reserve data set forth in this Prospectus represent only estimates. Estimating
quantities of proved reserves is inherently imprecise. Such estimates are based
upon certain assumptions about future production levels, future oil and gas
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 oil and gas 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. Estimates
of the economically recoverable oil and gas reserves attributable to any
particular group of properties, classifications of such reserves based on risk
of recovery and estimates of future net cash flows expected therefrom, prepared
by different engineers or by the same engineers at different times, may very
substantially. The rate of production from oil and gas properties declines as
reserves are depleted. Except to the extent the Company acquires additional
properties containing proved reserves, conducts successful exploration and
development activities or, through engineering studies, identifies additional
behind-pipe zones or secondary recovery reserves, the proved reserves of the
Company will decline as oil and gas are produced. Future oil and gas production
is, therefore, highly dependent upon the Company's level of success in acquiring
or finding additional reserves. (See "Business and Properties - Oil and Gas
Operations - Oil and Gas Reserves.")
OIL AND GAS LEASES. The Company's right to explore and produce oil and gas
from its properties derives from its oil and gas leases with the owners of the
properties. There are many versions of oil and gas leases in use. The oil and
gas leases in which the Company has an interest were, in most cases, acquired
from other companies who first entered into the leases with the landowners. Oil
and gas leases generally call for annual rental payments and the payment of a
percentage royalty on the oil and gas produced. Courts in many states have
interpreted oil and gas leases to include various implied covenants, including
the lessee's implied obligation to develop the lease diligently, to prevent
drainage of oil and gas by wells on adjacent land, to seek diligently a market
for production, and to operate prudently according to industry standards. Oil
and gas leases with similar language may be interpreted quite differently
depending on the state in which the property is located. The Company believes it
(or the operator of its properties) has followed industry standards in
interpreting its oil and gas leases in the states where it operates. However,
there is no assurance that the leases will be free from litigation concerning
the proper interpretation of the lease terms. Adverse decisions could result in
material costs to the Company or possibly the loss of one or more leases.
11
<PAGE>
Oil and gas leases typically have a primary term of three to ten years.
During that time the lessee has the obligation to drill a productive well or the
lease expires. If a productive well is drilled, the lease is extended for the
life of the production. All of the non-producing leases in the Company's
exploration projects will expire over the next two to five years if not extended
by operations or production. If productive wells are not drilled on these
projects before that time, the leases will terminate and the Company would lose
its entire investment in the leases. There is no assurance that the Company and
its industry partners will be able to drill or farm out all of the existing
exploration projects prior to expiration of the leases in those prospects or
that the Company will be able to renew those existing leases.
OPERATING HAZARDS. The cost of drilling, completing and operating wells is
often uncertain, and drilling operations may be curtailed, delayed or canceled
as a result of a variety of factors, including unexpected drilling conditions,
equipment failures or accidents and adverse weather conditions. The Company's
operations are subject to all of the risks normally incident to the operation
and development of oil and gas properties and the drilling of oil and gas wells,
including encountering unexpected formations or pressures, corrosive or
hazardous substances, mechanical failure of equipment, blowouts, cratering and
fires, which could result in damage or injury to, or destruction of, formations,
producing facilities or other property, or could result in personal injuries,
loss of life or pollution of the environment. Any such event could result in
substantial loss to the Company that could have a material adverse effect on the
Company's financial condition. In 1996 and 1997, the Company experienced
mechanical failures of downhole equipment at the Company's South Timbalier Block
76 well. As a result of these equipment failures, the well was shut in for
approximately two months in 1996 and one month in 1997, and the Company incurred
significant repair costs. (See "Business and Properties -- Property Acquisition
Activities -- South Timbalier Block 76 Acquisition.") Although such operational
risks and hazards may to some extent be minimized, no combination of experience,
knowledge and scientific evaluation can eliminate the risk of investment or
assure a profit to any company engaged in oil and gas operations.
WEATHER HAZARDS. Weather conditions, including severe rains and winter
conditions, have adversely impacted the Company's oil and gas operations in the
past. Furthermore, weather conditions in the future, including hurricanes in the
Gulf of Mexico, could interrupt or prevent production and drilling operations in
the Gulf of Mexico and the coastal counties and parishes, and could result in
damage to equipment or facilities.
ENVIRONMENTAL HAZARDS. Oil and gas operations present risks of
environmental contamination from drilling operations and leakage from oil field
storage or transportation facilities. The Company has never experienced a
significant environmental mishap, but spills of oil could occur which could
create material liability to the Company for clean-up expenses. The Company is
not currently a party to any judicial or administrative proceedings that involve
environmental regulations or requirements and believes that it is in substantial
compliance with all applicable environmental regulations. The Company believes
that it is reasonably likely that the trend in environmental legislation and
regulations will continue toward stricter standards. The Company is unaware of
future environmental standards that are reasonably likely to be adopted that
will have a material effect on the Company's financial position or results of
operations, but cannot rule out the possibility. (See "Business and Properties -
Governmental Regulation.")
COMPETITION. The oil and gas exploration, production and acquisition
business is highly competitive. A large number of companies and individuals
engage in acquiring properties or drilling for oil and gas, and there is a high
degree of competition for desirable oil and gas prospects and properties. There
is also competition between the oil and gas industries and other industry in
supplying the energy and fuel requirements of industrial, commercial,
residential and other consumers. Many of the Company's competitors have greater
financial and other resources than does the Company, and there is no assurance
that the Company will be able to compete successfully in acquiring desirable
opportunities.
GOVERNMENT REGULATION. The Company's business is regulated by certain
federal, state and local laws and regulations relating to the development,
production, marketing and transmission of oil and gas, as well as environmental
and safety matters. State conservation laws regulate the rates of production
from oil and gas wells for the purpose of ensuring maximum production of the
resource. Such regulations may require the Company to produce certain wells at
less than their maximum flow rate. For example, production from the East Bayou
Sorrel Schwing #1 well is currently restricted to approximately 1,400 Bbl. of
oil per day because of such a state mandated restriction. (See "Business and
Properties - Exploration Activities - East Bayou Sorrel Field, Iberville Parish,
Louisiana.") State law also governs the apportionment of production among
property owners and producers where numerous wells may be producing from a
single reservoir (referred to as unitization proceedings). Rulings in
unitization proceedings may allocate production in a particular reservoir in a
manner that decreases the Company's share of production. Other such regulations
prevent the Company from freely conducting operations at all times during the
year, such as those which protect the whooping crane habitat which forms a
portion of the Company's Espiritu Santo Bay prospect. There is no assurance that
laws and regulations enacted in the
12
<PAGE>
future will not adversely affect the Company's exploration for or production and
marketing of oil and gas. From time to time, proposals are introduced in
Congress or by the Administration that could affect the Company's oil and gas
operations. (See "Business and Properties - Governmental Regulation.")
SHORTAGES OF SUPPLIES AND EQUIPMENT. The Company's ability to conduct its
operations in a timely and cost effective manner is subject to the availability
of oil and gas operations equipment, supplies, and service crews. The industry
is currently experiencing a shortage of certain types of drilling rigs and work
boats in the Gulf of Mexico. This shortage could result in delays in the
Company's operations as well as higher operating and capital costs. Shortages of
other drilling equipment, tubular goods, drilling service crews and seismic
crews could occur from time to time, further hindering the Company's ability to
conduct its operations as planned.
RISKS ASSOCIATED WITH INVESTMENT IN THE SECURITIES
RISK OF CONVERSION OF OLD PUBLIC WARRANTS. The Old Public Warrants
currently trade on the AMEX. The New Warrants will not be listed on any exchange
or otherwise eligible for trading in a recognized securities market. In
addition, none of the New Warrants will be transferable without the prior
written consent of the Company. Therefore, it is unlikely that there will ever
be any public or private market for any of the New Warrants. In addition, if any
significant portion of the Old Public Warrants are exchanged, it is likely that
the existing market for the Old Public Warrants on the AMEX will be adversely
affected or possibly eliminated. AMEX guidelines provide for the delisting of
warrants in the event less than 200,000 warrants are outstanding or fewer than
300 holders are involved in the issuance. There can be no assurance that fewer
holders or Old Public Warrants will remain outstanding and that the AMEX will
not, on that basis, order the Old Public Warrants delisted. All of the Old
Public Warrants also contain anti-dilution provisions which require the Company
to issue additional shares of Common Stock upon exercise of such warrants to the
extent that there have been prior issuances of Common Stock at prices that
trigger the anti-dilution provisions of such warrants. The New Warrants do not
contain such anti-dilution provisions. Therefore, the New Warrants will be
illiquid compared to the Old Public Warrants and will not be entitled to such
anti-dilution protection. (See "Prospectus Summary" and "Description of
Securities-Warrants.")
SHARES ELIGIBLE FOR FUTURE SALE/POTENTIAL DILUTION. At January 30, 1998,
12,129,167 shares of Common Stock were outstanding, of which 11,585,186 shares
were freely tradeable and 543,981 shares were "restricted securities" as that
term is defined in Rule 144 adopted by the Commission under the Act. At that
date, the Company also had outstanding options and private warrants to acquire
an aggregate of 4,513,665 shares of Common Stock, effectively all of which are
currently exercisable. Sales of substantial amounts of the Common Stock in the
public market could adversely affect the market price of the Common Stock. (See
"Description of Securities.")
Two purchasers of Common Stock pursuant to a 1995 offering under Regulation
S of the Securities Act have filed suit to require the issuance to them of
additional shares of Common Stock under certain "reset" provisions which
required the Company to issue additional shares if the market price of the
Common Stock declined during certain recalculation periods. ("Business and
Properties - Legal Proceedings.") While the Company believes that it is not
obligated to issue any additional shares, any such issuance would be dilutive to
the other shareholders. If successful, the plaintiffs would be entitled to the
issuance of approximately 580,000 additional shares of Common Stock or, in the
alternative and if proven to the satisfaction of the court, to the market value
of those shares at the time of the breach. The exercise price and number of
shares to be acquired upon exercise of the Old Public Warrants may require
adjustment if the Company is required to issue the "reset" shares in the
above-described lawsuit or for other reasons. No such adjustment would be
required under the terms of the New Warrants.
DIVIDEND POLICY
The Company has not paid dividends on its Common Stock and does not intend
to pay such dividends in the foreseeable future. Under the Company's line of
credit, the Company may not pay dividends on its capital stock without the prior
written consent of its lending bank.
13
<PAGE>
PRICE RANGE OF SECURITIES
The following table sets forth the high and the low closing prices of the
Common Stock and the Old Public Warrants of the Company on the AMEX for the
periods indicated.
<TABLE>
<CAPTION>
Common Stock Old Public 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 5/16 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....... 2 7/16 1 5/8 1 7/16
Third quarter........ 2 1/2 1 9/16 3/4 1/2
Fourth Quarter....... 3 3/16 2 3/8 1 3/8 1/2
1998
First quarter (through
February 10)......... 2 5/8 1 3/4 7/16 3/16
</TABLE>
At February 10, 1998, the closing price of the Common Stock was $1.75 per
share and the Old Public Warrants was $0.19. At December 31, 1997, there were
12,129,167 shares of Common Stock outstanding held of record by approximately
3,000 stockholders and Old Public Warrants exercisable for 2,755,688 shares of
Common Stock.
14
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following Summary Condensed Financial Data for each of the years in the
five-year period ended December 31, 1996 and the unaudited financial information
for the nine months ended September 30, 1996 and 1997, are derived from, and
qualified by reference to, the Company's audited and unaudited financial
statements, appearing elsewhere herein. The Summary Selected Financial Data
should be read in conjunction with the audited and unaudited financial
statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" appearing elsewhere herein. The data for years ending
prior to 1996 have been restated to reflect the change in the Company's method
of accounting for oil and gas operations to the full cost method of accounting.
(See note 2 to December 31, 1996 Financial Statements.) The results for the nine
months ended September 30, 1997 are not necessarily indicative of results for
the full year.
(dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
---------------------------------------------------------- ---------------------
1992* 1993* 1994* 1995* 1996 1996* 1997
--------- --------- --------- --------- --------- --------- ---------
(unaudited
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Total revenues ......................... $ 2,160 $ 2,834 $ 3,397 $ 3,143 $ 4,040 $ 2,990 $ 3,007
Loss on sale of oil and gas properties . -- -- -- 3,607 -- -- --
Impairment to oil and gas properties ... -- 2,993 3,347 -- -- -- 3,200
Net loss ............................... $ (174) $ (3,703) $ (4,453) $ (5,876) $ (1,330) $ (1,052) $ (5,084)
Net loss per share ..................... $ (0.24) $ (2.09) $ (1.69) $ (0.90) $ (0.12) $ (0.09) $ (0.42)
Net weighted average shares outstanding. 714 1,773 2,639 6,556 11,351 11,285 12,075
OPERATING DATA:
Net Production:
Crude oil, condensate and
gas liquids (Bbl) .................. 87,000 79,000 88,000 92,000 57,000 43,000 64,000
Natural gas (Mcf) .................... 234,000 724,000 1,017,000 909,000 1,038,000 796,000 643,000
Gas equivalent (MCFE) ................ 758,000 1,196,000 1,542,000 1,461,000 1,383,000 1,057,000 1,026,000
Average Sales Price:
Crude oil, condensate and gas
liquids ($ per Bbl) ................ $ 17.57 $ 14.33 $ 14.14 $ 14.66 $ 20.24 $ 19.61 $ 19.20
Natural gas ($ per Mcf) .............. 2.39 2.28 2.09 1.77 2.56 2.49 2.56
</TABLE>
<TABLE>
<CAPTION>
December 31, September 30,
---------------------------------------------------------- ---------------------
1992* 1993* 1994* 1995* 1996 1996* 1997
--------- --------- --------- --------- --------- --------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets.......................... $ 8,199 $ 10,429 $ 10,066 $ 17,800 $ 16,335 $ 15,729 $ 11,831
Total debt............................ $ 3,574 $ 3,003 $ 7,123 $ 4,897 $ 2,933 $ 3,155 $ 1,887
Net stockholders' equity.............. $ 4,177 $ 6,588 $ 2,130 $ 12,314 $ 13,037 $ 12,207 $ 8,965
RESERVES:
Estimated net proved reserves(1):
Crude oil and condensate (MBbl)..... 2,066 813 1,647 347 249
Natural gas (Bcf)................... 4.8 5.6 5.9 5.9 3.5
Estimated future net revenues
before income taxes............... $ 20,358 $ 12,835 $ 15,932 $ 12,600 $ 14,112
Present value of estimated future
net revenues before income taxes
(discounted at 10% per annum)....... $ 8,555 $ 8,554 $ 8,148 $ 8,942 $ 10,820
</TABLE>
- ------------
*Restated.
(1) Estimates of oil and gas reserves in future years are based in part on the
sales price at December 31 of the respective year. To the extent that the
cost of producing the oil and gas, plus applicable taxes, from any
particular property exceeds the sales price, the quantity of proved
reserves is reduced. (See "Business and Properties - Oil and Gas Operations
- Oil and Gas Reserves")
15
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
All of the Company's operating revenues are derived from the production of
oil and gas. Prior to mid-1994, the Company was principally engaged in the
purchase and production of oil and gas reserves, primarily in California. In
mid-1994, the Company changed its business strategy and now concentrates on
exploration projects onshore and offshore Louisiana and Texas and in the related
transition zone.
From 1994 to 1995, operating revenues decreased, primarily as a result of
lower gas prices and weather related production curtailments. In 1996 the
Company sold its California properties, but revenues increased as production
from an offshore Louisiana well acquired in late 1995 contributed to revenues
for a full year. The Company expects that 1997 revenues will be comparable to
1996 revenues as the East Bayou Sorrel wells offset natural depletion on other
properties and the effect of the sale of a portion of South Timbalier in early
1996.
Operating results in 1994 and the first nine months of 1997 were
substantially affected by impairments to oil and gas properties 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 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 expand in
future years.
The Company experienced substantial operating and net losses in 1994, 1995,
1996 and in the first nine months of 1997 primarily attributed to the
impairments and loss on sale expenses described above. Operations contributed
cash in 1994, 1996 and the first nine months of 1997, primarily due to
relatively high gas prices and increases in production, but consumed cash in
1995 because of low 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. In the first nine months of 1997, net
investment in oil and gas properties included acquisition, exploration and
development expenditures.
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, although operating revenues and financial resources should be
sufficient to sustain capital and operating obligations through 1998, additional
funds will need to be raised in order to fully participate in currently planned
projects. In the event the Company is not able to raise such additional funds,
it will be forced to reduce the size of its participation in certain ventures or
forego other opportunities completely. In June 1997, the Company received
$2,154,000 of cash from the joint venture with Zydeco. This cash was previously
reported on the Company's balance sheet as restricted cash in "Other Assets." In
July 1997 the Company refinanced its bank credit facility with a new bank and
extended the maturity of the facility to July 1999. In December 1997, the
Company closed a private placement of $3,225,000 of 12% Convertible Subordinated
Notes due 2007 (the "Notes") and realized $2,815,000 net of offering costs. The
funds were used to repay the Company's Debentures due December 31, 1997, to
reduce bank debt and for general corporate purposes.
Substantial sales of equity securities in 1995 resulted in significant
increases in the weighted average shares outstanding in both 1995 and 1996. Net
loss per share decreased in 1995 despite an increase in the net loss from
operations and also decreased in 1996 as a result of a decrease in the net loss
from operations and an increase in the weighted average shares outstanding.
In the fourth quarter of 1996, the Company elected to change to the full
cost method of accounting. Management of the Company believes that full cost
accounting is preferable because it will more accurately reflect the results of
the Company's future operations. (See notes 1 and 2 to the December 31, 1996
Financial Statements for a further discussion of the reasons for and impact of
this change in accounting method.)
16
<PAGE>
RESULTS OF OPERATIONS
Nine Months ended September 30, 1997 and 1996
During the nine months ended September 30, 1997, Fortune had a net loss of
$5.1 million compared to a net loss of $1.1 million for the same 1996 period.
The increase in loss in 1997 is primarily attributable to the $316,000 non-cash
debt conversion expense incurred in connection with closing the Company's
Exchange Offer on February 26, 1997, the $323,000 of stock offering costs
incurred in 1997 for the public offering which was withdrawn in April 1997, the
$3,200,000 non-cash impairments to oil and gas properties recorded in 1997 and
increased depreciation, depletion and amortization expense in 1997. (See notes
2, 6 and 7 to the September 30, 1997 unaudited financial statements included
herein.)
Net oil and gas revenues in the first nine months of 1997 were comparable
to revenues for the same 1996 period. 1996 revenues included revenues from the
Company's California properties that were sold in February and March 1996 and a
higher ownership interest at South Timbalier Block 76 through March 1996. On
March 8, 1996, the Company sold 25% of its interest in the South Timbalier Block
76 for $940,000 pursuant to a preexisting arrangement. Both 1996 and 1997
revenues were adversely affected by the workovers at South Timbalier Block 76.
Offsetting the above decreases was the commencement of production from the
discovery well at East Bayou Sorrel as discussed above. The Company has a 12.9%
before-payout working interest in this field. Oil production increased 47%
during the first nine months of 1997 versus 1996 as a result of this discovery.
Gas production decreased 19% during the first nine months of 1997 versus 1996,
primarily because of depletion on the Company's properties and the sale of a
portion of South Timbalier Block 76, as discussed above.
For the first nine months of 1997, the Company's gas prices averaged $2.56
per Mcf as compared to $2.49 per Mcf for the same 1996 period. Oil prices
averaged $19.20 per Bbl for the first nine months of 1997 compared to $19.61 per
Bbl for the same 1996 period. At December 31, 1997, the Company was receiving an
average of approximately $2.60 per Mcf for its gas and $16.90 per Bbl for its
oil production. These current prices represent declines from earlier prices and
the Company expects further declines in the price of gas through the spring and
summer of 1998.
The Company incurred non-recurring office relocation and severance cost of
$207,000 in the first nine months of 1996 in connection with the Company's move
to Houston. In the first nine months of 1997, the Company expensed $323,000 of
costs associated with a public offering that the Company withdrew on April 25,
1997 and $316,000 of debt conversion expense associated with the Debenture
exchange offer discussed in note 2 to the September 30, 1997 unaudited financial
statements included herein.
Interest expense decreased by $116,000 (34%) for the first nine months of
1997 versus 1996 due to the lower debt balances. Interest expense is expected to
increase in future periods as a result of the Company's convertible debt
offering which closed in the fourth quarter of 1997. (See "Capital Resources -
Convertible Subordinated Notes due December 31, 2007".) The Company's provision
for depletion, depreciation and amortization (DD&A) increased by $530,000 (49%)
in the first nine months of 1997 as compared to 1996 because of higher property
costs and lower proved reserves in 1997. See note 7 to the September 30, 1997
unaudited financial statements included herein for a discussion of the $3.2
million impairment to oil and gas properties in 1997.
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 gas prices and a full year of production from 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.
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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 Bbl in 1996
compared to $14.66 per Bbl 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 notes 1 and 2 to the December 31, 1996
Financial Statements.)
Net revenues from sales of oil and gas decreased $380,000 (11%) in 1995,
compared to 1994. The decrease resulted primarily from lower 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. Gas prices averaged $1.77 per Mcf for
1995, compared to $2.09 per Mcf for 1994. Oil prices averaged $14.66 per Bbl for
1995 as compared to $14.14 per Bbl 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 the
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.
LIQUIDITY
Cash Flows from Operating Activities
Fortune's cash flow provided by operating activities increased for the
first nine months of 1997 to $816,000 as compared to $418,000 for 1996. Before
considering the effect of changes in assets and liabilities, operating cash flow
was $483,000 for 1997 as compared to $87,000 for 1996. Lower production and
operating expense and interest expense and the absence of office relocation
costs in 1997, as discussed above, contributed to the increase. The Company's
working capital of $240,000 at September 30, 1997 was comparable to December 31,
1996. Working capital at September 30, 1997 is net of $1,022,000 of Debentures
that were due December 31, 1997. The Company repaid these Debentures on December
5, 1997 with a portion of the proceeds from the private placement of the Notes
thereby converting short-term debt to long-term.
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Fortune's internal liquidity and capital resources in the near term will
consist of working capital and cash flow from its oil and gas operations, a
portion of the net proceeds from the private placement of the Notes and its
unused borrowing capacity under its new credit facility.
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 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 gas
prices, the shut-in of the Company's Hopper Canyon Field and higher operating
costs.
The Company's 1996 discovery well at East Bayou Sorrel, Iberville Parish,
Louisiana, which began producing on December 20, 1996, had no impact on the
Company's revenues in 1996. Its impact on 1997 production through September 30
as compared to the same 1996 period was offset by the items discussed in the
1997 operating results section above. The second well at East Bayou Sorrel was
completed and placed on permanent production facilities on June 1997. A third
well in this field has been completed and is currently being tested. The Company
believes that the Bayou Sorrel wells will have a positive impact on its cash
flow from operations 1998.
CAPITAL RESOURCES
Cash Used in Investing Activities - Capital Expenditures
Cash expenditures for oil and gas properties for the first nine months of
1997 were $3.4 million as compared to $1.1 million for 1996. The 1997
expenditures include primarily the acquisition of an additional interest at East
Bayou Sorrel, an exploratory well at South Lake Arthur, a development well at
East Bayou Sorrel and seismic and land acquisition at Espiritu Santo Bay. A
significant portion of the Company's 1997 expenditures were funded with the
funds returned by Zydeco under the terms of the Fortune/Zydeco joint venture. In
June 1997, Zydeco returned to the Company $2.2 million of exploration venture
cash under the terms of the venture agreement. The cash was previously reported
on the Company's balance sheet as restricted cash in other assets. Fortune's net
capital expenditures for all of 1997 were approximately $4.9 million.
The Company has been involved in two significant proprietary 3D seismic
projects along the Texas coast. The La Rosa project, a 24 square mile
proprietary 3D survey over one of the Company's existing producing fields in
Refugio County, Texas has been shot and is currently being interpreted. The
Company sold one-half of its interest in the non-producing portion of this field
in exchange for the acquiring parties paying all of the Company's 3D seismic
costs. The Company has drilled two wells utilizing this new data and expects to
drill additional projects during 1998. The first well was completed and is
currently producing; the second was abandoned as a dry hole. The Company holds a
37.5% working interest in the producing wells and an 18.75% working interest in
the prospective projects covered by this 3D survey.
The second project is offshore Texas in the intracoastal waters of Espiritu
Santo Bay, Calhoun County. This involves a 135 square mile proprietary 3D
seismic survey in which the Company owns a 12.5% working interest. The area
covered by the survey also includes producing fields. This survey has also been
completed and is being interpreted. The Company is encouraged by the results
thus far and expects to begin identifying drillable projects by early 1998.
The Company is currently participating in a third well at East Bayou Sorrel
and expects to see additional drilling on this project in 1998. This well was
spuded on October 8, 1997 and was completed in early January 1998. It is
currently being tested. The 3D seismic projects and the East Bayou Sorrel
project are expected to be multi-year projects which, if successful, could have
a significant positive impact on the Company's cash flow and results of
operations.
The Company intends to fund these expenditures with its available cash and
its cash flow from operations or from outside sources. Should funds not be
available to the Company as required for participation in the projects, the
Company can reduce its working interest share of the projects. Should the
Company's working interest in exploration projects be reduced, the Company would
not derive as great a benefit in the event of an exploration success.
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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 acquisitions offshore Louisiana. The Company also
received $2.2 million of proceeds from the sale of oil and gas properties in
1996, including $1.2 million for the sale of the California properties, that was
used to retire debt in February 1996. The Company also received $940,000 for the
sale of 25% of its interest in South Timbalier Block 76. (See "Business and
Properties - Exploration Activities" and " -- Property Acquisition Activities.")
Cash Flows from Financing Activities - Cash Provided from Equity Transactions
Fortune's primary source of capital during 1995 and 1996 was stock
offerings and the exercise of warrants and options. In December 1996, the
Company sold 412,000 shares of common stock at a price of $3.00 per share in a
private placement. Net proceeds of approximately $1.1 million were received from
the sale of these shares. On December 11, 1995, the Company closed a private
placement of 1,321,117 shares to acquire a producing property and raise
additional capital. From this sale, the Company netted approximately $3.3
million after payment of expenses of the offering. (See "Description of Business
- - Property Acquisition Activities - South Timbalier Block 76 Acquisition.")
On June 30, 1995, the Company closed an underwriting of 4,100,000 shares of
Common Stock at a price of $2.00 per share. On July 5, 1995, the underwriters
exercised their over-allotment option for an additional 500,000 shares. The
Company netted approximately $8.1 million after deduction of underwriting
discounts and costs of the offering. In February 1995, the Company netted
$795,000 in a private placement of Common Stock. The proceeds were used to fund
the initial contribution to the joint venture with Zydeco. (See "Business and
Properties - Exploration Activities - Joint Venture with Zydeco.")
- Outstanding Debt and Debt Reduction
As of December 31, 1997, the Company had $3,775,000 of debt outstanding.
Outstanding debt is currently comprised of $550,000 of bank debt which is due
July 11, 1999 and $3,225,000 of outstanding convertible subordinated notes due
December 31, 2007.
- Convertible Subordinated Notes due 2007
In December, 1997, the Company closed its private placement of the Notes.
An aggregate of $3,225,000 principal amount of Convertible Notes was sold, and
the Company received $2,815,000 of net proceeds after the offering expenses and
commissions. The net proceeds of the private placement were used to refinance
existing debt and for general corporate purposes. On December 5, 1997, the
Company redeemed the remaining outstanding balance of $1,028,000 of the
Company's Convertible Subordinated Debentures due December 31, 1997 (the
"Debentures"). In addition, $315,000 of net proceeds were used to reduce
borrowings under the Company's credit facility with Credit Lyonnais.
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- Credit Facility
Prior to July 1997, the Company's bank debt was incurred under a $10
million secured master revolving credit facility with Bank One, Texas, N.A.
("Bank One") which had been in place since January 14, 1994. The Bank One credit
facility was a reserve-base borrowing facility secured by substantially all of
the Company's oil and gas reserves. The Bank One facility contained various
financial covenants, was due October 1, 1997, bore interest at 1.5% over Bank
One's prime rate and required monthly principal payments of $75,000. On July 11,
1997, the Company refinanced its debt under the Bank One credit facility by
entering into a $20 million credit facility with Credit Lyonnais New York Branch
("Credit Lyonnais"). The Credit Lyonnais facility is due July 11, 1999, and can
be extended for one year upon mutual consent. Under the new credit facility, the
Company may initially borrow up to a pre-determined borrowing base, for general
corporate purposes at either 1.25% above Credit Lyonnais' base rate or 4% above
LIBOR. The borrowing base, currently set at $2.0 million, was calculated based
upon the Company's July 1, 1997 oil and gas reserves and is subject to
semi-annual review. The unused portion of the borrowing base, which is currently
approximately $1.4 million, is to be used only for acquisitions of producing
properties or development projects approved in advance by Credit Lyonnais. The
Company is also required to pay a commitment fee of 0.5% on the unused portion
of the borrowing base. The Credit Lyonnais facility is secured by a mortgage on
all of the Company's existing proved oil and gas properties.
- Retirement of Debentures
On February 26, 1997, the Company closed an exchange offer for the
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 was $1,028,000. This remaining
balance was repaid on December 5, 1997 with a portion of the net proceeds from
the Notes offering discussed above.
In connection with the February 1997 exchange of Debentures for common
stock and common stock warrants, the Company recorded 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 1992
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 December 31, 1997, the Company
was receiving approximately $16.90 per Bbl as an average price for its oil
production and $2.60 per Mcf as an average price for its gas production. At
December 31, 1996, the Company received approximately $4.04 per Mcf for its gas
production and $22.79 per Bbl for its oil production. At December 31, 1995, the
Company received approximately $2.32 per Mcf for its gas production and $16.10
per Bbl for its oil production. At December 31, 1994, the Company received
approximately $14.62 per Bbl for its oil production and $1.39 per Mcf as an
average price for its gas production. (See "Risk Factors - Risks Associated with
the Oil and Gas Industry - 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.
Total net proved recoverable reserves at December 31, 1996 decreased to
249,000 Bbls of oil and 3.5 Bcf of gas from 347,000 Bbls of oil and 5.9 Bcf of
gas at December 31, 1995. The increase in the present value of the reserves is
attributable to the higher oil and gas prices at year end 1996 vs. 1995. The
decrease in proved reserves was primarily attributable to the sale of 25% of the
Company's interest in South Timbalier Block 76 in March 1996, the sale of the
one remaining California property and a West Texas property in 1996 and natural
depletion, offset by the reserve addition at East Bayou Sorrel. (See "Business
and Properties - Property Acquisition Activities.")
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RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 changes the
calculation and financial statement presentation of earnings per share. SFAS 128
requires the restatement of prior period earnings per share amounts. The
statement will be effective for financial statements issued for periods
beginning after December 15, 1997. The Company does not believe that the
adoption of SFAS 128 will have an impact on the loss per share information
presented herein.
Effective December 1997, the Company is required to adopt Statement of
Financial Accounting Standards No. 129, "Disclosure of Information about Capital
Structure" ("SFAS 129"). SFAS 129 requires that all entities disclose in summary
form within the financial statement the pertinent rights and privileges of the
various securities outstanding. An entity is to disclose within the financial
statement the number of shares issued upon conversion, exercise, or satisfaction
of required conditions during at least the most recent annual fiscal period and
any subsequent interim period presented. Other special provisions apply to
preferred and redeemable stock. The Company will adopt SFAS 129 in the fourth
quarter of 1997.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes
standards for reporting and display of comprehensive income and its components.
The components of comprehensive income refer to revenues, expenses, gains and
losses that are excluded from net income under current accounting standards,
including foreign currency translation items, minimum pension liability
adjustments and unrealized gains and losses on certain investments in debt and
equity securities. SFAS 130 requires that all items that are recognized under
accounting standards as components of comprehensive income be reported in a
financial statement displayed in equal prominence with the other financial
statements; the total of other comprehensive income for a period is required to
be transferred to a component of equity that is separately displayed in a
statement of financial position at the end of an accounting period. SFAS 130 is
effective for both interim and annual periods beginning after December 15, 1997.
The Company does not believe that this SFAS will have any significant impact on
its financial statements.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"). SFAS 131 establishes standards for the way public enterprises are
to report information about operating segments in annual financial statements
and requires the reporting of selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. SFAS 131 is effective for periods beginning after December 15, 1997.
The Company does not believe that this SFAS will currently result in any
significant disclosures in its financial statements.
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BUSINESS AND PROPERTIES
GENERAL
Fortune is an independent public oil and gas company whose primary focus is
on exploration for and development of domestic oil and gas properties. The
Company's principal properties are located onshore and offshore Louisiana and
Texas.
During 1995, the Company implemented a program of exploration for
significant oil and 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 oil and gas
prospects on the Gulf Coast of Texas and Louisiana 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 invest in a diversified portfolio of oil and gas
exploration and development properties within its area of interest. It seeks to
mitigate the risks of exploration drilling by generally taking minority
interests in projects with large potential reserves and additional development
potential. Together with other industry partners, Fortune has invested in
seismic exploration programs to identify new exploration prospects, in
exploration prospects ready to drill, and in producing properties believed to
have additional development potential, each described in more detail below.
Fortune seeks to participate, generally as a minority, non-operating
interest holder, in a variety of exploration and development projects with
industry partners. The Company's approach to prospect acquisition is twofold. It
seeks prospects on an opportunistic basis, evaluating individual prospect
opportunities presented to it by other oil and gas companies or consultants. It
also seeks to develop prospects through multi-year strategic joint ventures
designed to evaluate a wide area for potential drilling prospects, such as the
recently commenced venture along the Texas intracoastal waters and Matagorda
Island at Espiritu Santo Bay.
Fortune and its partners use state-of-the-art technologies including, where
appropriate, 3D seismic and CAEX technology in defining and evaluating drilling
prospects. Fortune believes that these techniques have undergone important
technological advances in recent years and that their use can provide Fortune
and its project partners with a more accurate and complete prospect evaluation,
materially increasing the likelihood of finding commercial quantities of oil and
gas at lower average reserve finding costs.
Although Fortune does not currently operate properties or originate
exploration prospects, it actively participates in the evaluation of
opportunities presented by its industry partners, both at the time of its
initial investment in a prospect and thereafter during the evaluation and
selection of drilling locations. In order to maintain the ability to employ
state-of-the-art technology while controlling fixed operating costs, Fortune
relies heavily on industry consultants for its project evaluations. With
aggressive downsizing by major oil companies in recent years and the
reorganization of many independent oil companies, Fortune has found that highly
qualified prospect originators and technical advisors are available as
consultants and joint venturers, enabling Fortune to acquire expert technical
assistance in its target geographic areas while avoiding the overhead associated
with a larger number of permanent employees.
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 is a
director of Fortune. (See "Management.") The Company employs Huddleston & Co.,
Inc., Houston, Texas, independent petroleum engineers, to estimate reserves in
successful wells and in properties being evaluated for acquisition. The Company
does not have contracts with these consultants that obligate the consultants to
continue their availability to the Company. However, the Company has no reason
to believe that these consultants will cease providing services in the
foreseeable future.
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EXPLORATION ACTIVITIES
Fortune participates in 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-operating
position in such projects, the Company gains opportunities to participate in
significant discoveries while minimizing its losses if the exploration wells are
unproductive.
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 a 166.5
square mile AMI 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 joint venture which has undertaken
a 135 square mile proprietary 3D seismic venture. Fortune and its working
interest partners currently own 17,794 leasehold acres and hold options to
acquire leases on an additional 14,326 acres within the area of the seismic
survey.
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 elect whether to participate in drilling an
initial well or farm out all or part of its interest to other joint venture
partners or third parties. Seismic acquisition activities commenced in April
1997 and were completed in September 1997. The seismic data is currently being
processed and interpreted, and it is not expected that any exploration drilling
activities will begin until early 1998. No assurance can be given that any
exploration prospects will be identified or that any commercial quantities of
hydrocarbons will be discovered.
On March 13, 1997, each of the Espiritu Santo Bay 3-D Seismic Project joint
venture partners, including Fortune, elected to acquire their pro-rata shares of
the Steamboat Pass Field, Calhoun County, Texas from Neumin Production Company
("Neumin"). The Steamboat Pass Field is adjacent to Matagorda Island and beneath
Espiritu Santo Bay. The field is currently producing approximately 550 Mcf of
natural gas per day from four shallow gas wells. The acquisition also entitles
Fortune to its pro-rata share of the existing facilities located on site.
Fortune acquired a 12.5% working interest in the 5,766 acres held by production
in the field. The acquisition was made in exchange for the assumption of
Neumin's future obligation to plug and abandon the field. The cost of such
abandonment is not expected to be material to the Company. The transaction
closed on April 18, 1997.
La Rosa Proprietary 3D Seismic Exploration Program
The Company acquired an undivided 50% interest in the LaRosa field in 1994,
which was subsequently reduced to a 37.5% working interest as the result of an
after-payout back-in negotiated at the time of purchase. (See "Property
Acquisition Activities - Refugio County, Texas - La Rosa Field.") The Company
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 all of Fortune's costs of such survey and, therefore, currently owns an
undivided 18.75% working interest in all newly-generated prospects. Fortune
maintains its 37.5% working interest in all production from existing wellbores.
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 was completed in
mid-1997. Fortune and its working interest partners currently own 3,689 acres in
the field and hold seismic options to acquire up to an additional 4,000 acres.
The first well was spudded December 2, 1997 and the second on January 12, 1998.
The first is currently producing approximately 700 MCFD and 20 BOPD. The second
was plugged and abandoned as a dry hole.
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East Bayou Sorrel Field, Iberville Parish, Louisiana
On December 15, 1995, the Company entered into a Participation Agreement 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. Fortune's
share of the initial costs to acquire, evaluate and drill the first well on 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 first well on the prospect, the
Schwing #1, 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. There is currently no limitation on gas production from
this reservoir. This well is in an AMI totaling approximately 3,500 acres.
The Schwing #1 is now producing from the lowest of seven potential oil
and/or gas zones which were encountered when drilling. The remaining zones in
the well have not been tested in the first well. Based on this limited data, at
December 31, 1996, the Company's reserve engineers estimated 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 project as the field is developed.
The second well at East Bayou Sorrel, the Schwing #2, was completed and
placed on permanent production facilities on June 23, 1997. This well was
completed as a dual producer, however, the shallow completion in this well bore
was shut in on September 19, 1997. The Schwing #2 produced at an average rate of
approximately 523 BOPD and 445 MCFD in January 1998. The Company is
participating in a third well in the same area on which drilling commenced on
October 8, 1997. The Schwing #3 was completed and is currently being tested
although there can be no assurance that additional production will be discovered
by this well. The Company's working interests in the East Bayou Sorrel producing
units range from approximately 12.2% to 12.9% working interest (approximately
8.7% to 9.2% net revenue interest) before payout and from approximately 10.7% to
11.3% working interest (approximately 7.6% to 8.1% net revenue interest) after
payout.
Southwest Segno, Liberty County, Texas
On September 24, 1997, the Company entered into a Participation Agreement
to drill a well on the Southwest Segno Prospect in Liberty County, Texas. The
Company paid $36,000 to acquire an undivided 30% before-payout working interest
in this prospect. Drilling on the initial well commenced January 15, 1998.
Dry-hole costs for this well were initially estimated to be $93,000 to Fortune's
share. As of January 30, 1998, operations had been suspended on this well
because of mechanical problems. The operator of this well is attempting to
resolve these problems but there can be no assurance such efforts will be
successful or, if successful, that operations will result in a commercially
productive well. As of January 30, 1998, approximately $98,000 had been expended
on this well to Fortune's interest.
South Lake Arthur, Jefferson Davis Parish, Louisiana
In 1996, the Company participated in an exploratory well on the South Lake
Arthur prospect in Jefferson Davis Parish, Louisiana. The Company had acquired
an interest in approximately 1,900 acres of mineral leases, with rights to
participate in additional leases acquired in an AMI covering approximately 2,800
acres.
The test well on this prospect was commenced on January 9, 1997 and was
temporarily plugged and abandoned in late April 1997 after it was determined
that the well crossed a fault and failed to reach the primary objective target.
Fortune's working interest in the well is 12.5% before payout and 10% after
payout. Fortune estimates its share of the total cost of drilling and
temporarily plugging and abandoning the well to be approximately $440,000.
Although the well encountered hydrocarbons in a shallower reservoir, Fortune did
not believe the hydrocarbons were sufficient to justify a completion attempt.
Accordingly, Fortune sold its interest in the shallow zone to the other parties
who elected to complete the well. Fortune retained its interest in the deeper
primary objective target.
25
<PAGE>
Joint Venture with Zydeco
Fortune owns varying interests in several Joint Venture Projects located in
the transition zone and Timbalier Trench regions offshore Louisiana. Each of
these projects were identified and acquired by a joint venture formed by Fortune
with Zydeco to identify, evaluate and explore oil and gas prospects in this area
offshore Louisiana. Each of these projects was identified using a combination of
advanced 2D and 3D seismic and CAEX technology in conjunction with geological
analysis of existing wells.
Under its exploration agreement with Zydeco, Fortune contributed $4,800,000
to the venture in 1995. The funds were to be used to pay all of the budgeted
leasehold acquisition and seismic costs on the projects, entitling Fortune to a
50% working interest in each project. As of June 4, 1997, $2,154,000 of the
funds remained unspent; this amount was returned to Fortune in June 1997 in
accordance with the terms of the exploration agreement. The Company's 50%
working interest in the projects that have not been farmed out is subject to
proportionate reduction in the event that Zydeco expends additional funds on the
projects. Fortune has farmed out its interest in six of the Joint Venture
Projects to industry partners, retaining overriding royalties and/or the right
to participate as a working interest owner and has a 100% working interest on
one of the projects. It has retained its 50% working interest on each of the
remaining projects.
The Company does not currently expect that wells will be drilled on all of
the Joint Venture Projects or that it will retain a working interest of more
than 25% in wells that are drilled on the Joint Venture Projects, except in
certain circumstances. In keeping with its strategy of balancing risk and
return, Fortune intends to farm out its remaining interest to other oil
companies. Under a farmout arrangement, the Company would be relieved of all or
part its obligation to pay drilling expenses, and could recover its acquisition
and exploration costs but would wind up with a smaller interest in any given
prospect. No assurance can be given that Fortune will be able to farm out any of
the projects or that, if it is successful in doing so, that the farmout will be
on the terms described above.
Each of the parties in the joint venture has a right to farm out a portion
or all of its interest in each prospect to the other under a "put" arrangement
in the exploration agreement. In the event of such a farmout of a 50% working
interest, Fortune or Zydeco would retain either a negotiated overriding royalty
convertible into a working interest or a default arrangement of a one percent
overriding royalty interest in the project. The overriding royalty interest
would be convertible into a 12.5% working interest after Zydeco or Fortune
recouped its drilling costs for the well from production. Should either Fortune
or Zydeco farm out a smaller working interest to the other, the overriding
royalty and after-payout working interests would be proportionately reduced.
The Joint Venture Projects are in various stages of evaluation. 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. To date,
wells have been drilled on two of the Joint Venture Projects, the Aurora and
Polaris Prospects. Hydrocarbons were encountered in both wells, but were of
insufficient quantities to justify completion attempts. A third party drilled
one of the dry holes under a farmout for which Fortune received $66,000 in fees.
The Company incurred approximately $832,000 in costs on the other well. The
remaining projects are being evaluated for drilling, farmout or resale
opportunities. Many of the Joint Venture Projects are in the vicinity of recent
discoveries in the transition zone and Timbalier Trench and, as such, should
represent opportunities to find significant oil and gas production. However,
there can be no assurance that Fortune will have sufficient resources to
participate in any exploration wells proposed, that it will be able to farm out
its interest on favorable terms or that any of the exploration wells will be
drilled or be successful.
Fortune acquired its interest in the joint venture through its acquisition
in May 1995 of Lagniappe Exploration, Inc. ("LEX"), for 1,200,000 shares of
Common Stock and 1,200,000 stock purchase warrants exercisable at $4.75 per
share through May 12, 2000. The interest in the joint venture was the only
significant asset of LEX. A portion of such shares and warrants remain in escrow
pending the resolution of a dispute which has arisen among the former LEX
stockholders and others regarding who is entitled to the shares of Common Stock
and stock purchase warrants issued by Fortune at the closing of the LEX
acquisition. (See "Principal Stockholders.") In connection with the return of
the unexpended funds from the joint venture in June 1997, Fortune reviewed its
$4.3 million remaining unevaluated investment in the Zydeco exploration venture
properties. The $4.3 million investment includes the value of the Fortune Common
Stock that was issued in 1995 to acquire its interest in the exploration venture
as well as the funds that Fortune has expended for leases and seismic in the
exploration venture. As a result of this review, Fortune transferred $2.6
million of costs associated with the Zydeco exploration venture properties to
the evaluated property account in the second quarter of 1997. This was a major
contributing factor to the Company's $3.2 million impairment to oil and gas
properties recorded through September 30, 1997.
26
<PAGE>
PROPERTY ACQUISITION ACTIVITIES
South Timbalier Block 76 Acquisition
On December 11, 1995, Fortune acquired a 16.67% working interest (12.5% net
revenue interest) in a 5,000 acre producing oil and gas property offshore
Louisiana in South Timbalier Block 76. The seller was Petrofina, S.A. This
property ("Block 76") includes a producing well which was completed in 1990,
drilling and production platform and a transmission line. The effective date of
the acquisition was June 1, 1995. Therefore, Fortune received the net cash flow
from the well to its interest from June 1, 1995. The effective date for
financial reporting purposes was November 1, 1995. The Company initially paid
$2.2 million for its interest in Block 76 plus 150,000 common stock purchase
warrants at prices from $4.625 to $6.00 per share, all of which expired
unexercised in December 1997. In the acquisition, Fortune granted an option,
exercisable until March 11, 1996, to a third party to acquire a 4.167% working
interest in the property for $790,000 plus the retention by Fortune of a
$150,000 deposit for a total of $940,000. The option was timely exercised, which
reduced the Company's interest in the block to a 12.5% working interest (9.375%
net revenue interest) effective January 1, 1996.
On April 29, 1996, the Block 76 well was shut in due to a mechanical
failure of downhole equipment. A remedial workover, started June 16, 1996, cost
the Company approximately $300,000. The well was brought back on production July
6, 1997. The well was also shut-in from March 24, 1997 to April 19, 1997 for a
workover to repair a leak that caused the well to lose casing pressure. The
Company's share of the costs of this second workover was approximately $360,000.
Notwithstanding these shut-ins, the well has already returned Fortune's
investment, and the Company is evaluating the possibilities for additional
wells.
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 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 purposes. 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 that it will be required 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 ("MDAs") 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 MDAs, comprising approximately 20,000 acres terminated, and
the acreage reverted to the lessors. In 1997, approximately 14,000 additional
acres reverted to the lessors pursuant to the terms of the MDAs.
Of the seven wells drilled during 1994 and 1995, two were completed as
producing wells. 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. At June 30, 1997, the Company transferred
all of its remaining $1.3 million of unevaluated costs attributable to these
properties to the evaluated property account.
27
<PAGE>
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. The Company participated in the
drilling of a 10,000 foot exploratory test well to the Lobo sand in 1994 which
was determined to be non-commercial. The Company had a 25% working interest in
this well; dry hole costs to the Company were $115,000. The Company has a 20%
interest in a proved undeveloped in-fill location within the Belle Pepper Field.
Fortune paid an adjusted price of $6.5 million in cash and 195,000
three-year common stock purchase warrants which were either exercised or expired
in 1996. Aggregate production from the producing wells acquired by Fortune has
not yet returned the Company's investment in this area.
Refugio County, Texas -La Rosa Field
On February 8, 1994, the Company completed an acquisition of a 50% working
interest in a 3,689 acre lease in the La Rosa Natural Gas Field in Refugio
County, Texas from Brooklyn Union Exploration Company, Inc. for $760,000. The
effective date of the transaction using the purchase method of accounting was
February 1, 1994. The acquisition consisted of 12 producing wells, four
saltwater disposal wells and 35 shut-in wells with total new proved reserves to
the Company of one BCFE and additional probable reserves behind pipe. The lease
includes 2,700 undeveloped acres adjacent to production which was acquired for
future exploration. Since acquiring an interest in the LaRosa Field in February
1994, the Company has participated in over 50 natural gas and oil recompletions
in new zones of shut-in wells, of which a majority have been successful.
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 production from existing
wellbores and an 18.75% working interest in new discoveries that result from the
3D survey. (See "- Exploration Activities - La Rosa Proprietary 3D Seismic
Exploration Program.")
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 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. Production
to date has not returned the Company's investment. The operator is currently
attempting to reduce the landowners' royalty from 35% to 25% before proceeding
with further drilling in the field.
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 Bbls 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.
28
<PAGE>
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 bank debt. Concurrently with the closing of the sale of the non-Sespe
properties, Fortune reduced its bank debt by $1.1 million, representing the
entire indebtedness secured by the Company's California properties. The closing
of the sales 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.
OIL AND GAS OPERATIONS
Drilling Activities
The following table sets forth information regarding development and
exploratory wells drilled by Fortune in the years ended December 31, 1994, 1995
and 1996:
WELL DRILLING ACTIVITY
<TABLE>
<CAPTION>
Year Ended December 31,
----------------------------------
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
Gross Wells
Productive 5 1 3
Dry 3 - 3
-------- -------- --------
Total 8 1 6
======== ======== ========
Net Wells
Productive 1.18 .20 .31
Dry .47 - 1.21
-------- -------- --------
Total 1.65 .20 1.52
======== ======== ========
</TABLE>
Oil and Gas Reserves
The Company's proved reserves are located in Texas and onshore and offshore
Louisiana. Proved reserves represent estimated quantities of oil and 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.
29
<PAGE>
Such estimates are subject to numerous uncertainties inherent in the
estimation of quantities of proved reserves and in the projection of future
rates of production, prices and the timing of development expenditures. The
accuracy of any reserve estimate is a function of available data and of
engineering and geological interpretation and judgment. The future cash inflow,
as reflected in the "Standardized Measure of Discounted Future Net Cash Flows
Relating to Proved Oil and Gas Reserves," determined from such reserve data, are
estimates only, and the present values thereof should not be construed to be the
current market values of the Company's oil and gas reserves or the costs that
would be incurred to obtain equivalent reserves. While the reserve estimates
presented herein are believed to be reasonable, they should be viewed with the
understanding that subsequent production of oil and gas from each reservoir, the
timing and success of future development drilling and changes in pricing
structure or market demand will affect the reserve estimate. (See "Risk Factors
- -- Risks Associated with the Oil and Gas Industry -- Uncertainty of Estimates of
Proved Reserves and Future Net Revenues.")
The following sets forth information with respect to estimated proved oil
and gas reserves as determined by Fortune's independent petroleum engineers
attributable to the Company's interests in oil and gas properties as of December
31, 1994, 1995 and 1996.
ESTIMATED NET RESERVE QUANTITIES
<TABLE>
<CAPTION>
December 31,
--------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Total Proved Reserves (1):
Oil (Bbls).................... 1,647,000 347,000 249,000
Natural Gas (Mcf)............. 5,911,000 5,938,000 3,481,000
------------ ------------ ------------
Equivalent Mcf (MCFE) (2).......... 15,793,000 8,020,000 4,975,000
============ ============ ============
Total Proved Developed Reserves:...
Oil (Bbls).................... 675,000 324,000 160,000
Natural Gas (Mcf)............. 3,317,000 4,686,000 1,749,000
------------ ------------ ------------
Equivalent Mcf (MCFE (2)........... 7,367,000 6,630,000 2,709,000
============ ============ ============
</TABLE>
(1) Estimates of oil and gas reserves are based in part on the price at
which the product was sold as of the end of each year; and if the cost
of producing the oil and gas exceeds the sales price, the quantity of
"recoverable reserves" is reduced. The decrease in proved reserves from
1995 to 1996 was primarily attributable to the sale of 25% of the
Company's interest in South Timbalier Block 76 in March 1996, the sale
of the one remaining California property and a West Texas property in
1996 and natural depletion, offset by the reserve addition at East
Bayou Sorrel. The decrease in reserves from 1994 to 1995 is primarily
due to the transfer to oil and gas properties held for sale of reserves
attributed to the Company's California properties which were sold in
February 1996, and which represented approximately 1.4 MMBbl of oil and
1.5 Bcf of 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 oil to six Mcf of gas.
30
<PAGE>
Discounted Present Value of Future Net Revenues
The following table represents the estimated future net revenues (using
unescalated prices and discounted at 10% per annum) and the present value of the
future estimated net reserves from the proved developed producing, proved
developed non-producing and the proved undeveloped reserves at December 31,
1994, 1995 and 1996.
DISCOUNTED PRESENT VALUE OF FUTURE NET REVENUES
<TABLE>
<CAPTION>
December 31,
------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Cumulative Future Net Revenue (1)...... $ 15,932,000 $ 12,600,000 $ 14,112,000
Less adjustment to give effect
to a 10% annual discount.......... (7,784,000) (3,658,000) (3,292,000)
------------ ------------ ------------
8,148,000 8,942,000 10,820,000
Less discounted present value
of future income taxes............ - - -
------------ ------------ ------------
$ 8,148,000 $ 8,942,000 $ 10,820,000
============ ============ ============
</TABLE>
(1) The increase in the present value of the reserves from 1995 to 1996 is
attributable to the higher prices at year end 1996 of $4.04 per Mcf and
$22.79 per Bbl vs. $2.32 per Mcf and $16.10 per Bbl at December 31,
1995. The increase in 10% discounted value at year end 1995 vs 1996 is
due to the net effect of acquiring the high production rate reserves
offshore Louisiana offset by the exclusion of the longer life
California properties sold in February 1996. The decrease in net
revenues from 1994 to 1995 is primarily due to the significant
reduction in reserve volumes attributable to the exclusion of the
California properties. At December 31, 1997, the Company was receiving
an average of approximately $2.60 per Mcf for its gas and $16.90 per
Bbl for its oil production. These current prices represent declines
from earlier prices and the Company expects further declines in the gas
price through the spring and summer of 1998. The Company expects that
reserves will be lower at year end 1997 compared to 1996 as a result of
these lower prices as well as depletion.
Production
The approximate net production data related to the Company's properties for
the periods ended December 31, 1994, 1995 and 1996 is set forth below:
NET PRODUCTION DATA
<TABLE>
<CAPTION>
December 31,
------------------------------------------
1994 1995 1996
------------ ------------ ------------
<S> <C> <C> <C>
Oil (Bbls)........................ 88,000 92,000 57,000
Gas (Mcf)......................... 1,017,000 909,000 1,038,000
</TABLE>
Prices and Production Costs
The following table sets forth the approximate average sales prices and
production (lifting) costs per Bbl of oil and per Mcf of gas produced and sold
in the United States from the Company's oil and gas leases for the years ended
December 31, 1994, 1995 and 1996:
AVERAGE SALES PRICES AND PRODUCTION COSTS
<TABLE>
<CAPTION>
Year Ended 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>
31
<PAGE>
Producing Wells
The following table lists the total gross and net producing oil and gas
wells in which Fortune had an interest at December 31, 1996:
PRODUCING WELLS
<TABLE>
<CAPTION>
Gross Net
------------------ ------------------
Oil Gas Oil Gas
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Texas.............................. 39 40 3.90 13.40
Louisiana.......................... 1 1 .11 .12
New Mexico......................... 2 - .43 -
-------- -------- -------- --------
Total.......................... 42 41 4.44 13.52
======== ======== ======== ========
</TABLE>
Principal Customers
For the year ended December 31, 1994, 48% of the Company's produced gas was
sold to Michael Gas Marketing Co., Inc., 25% to Tenneco and 15% to Enron, while
72% of the Company's produced oil was sold to Texaco Trading and Transportation
and 8% to Enron. During 1995, 56% of the Company's oil production was sold to
Texaco Trading and Transportation and 10% to Laroco, LLP; 29% of the Company's
gas production was sold to Laroco LLP, 26% to Michael Gas Marketing and 16% to
AWP. During 1996, 54% of the Company's oil production was sold to Scurlock
Permian Corporation; of the Company's gas production 26% was sold to CNG Energy
Services Corporation, 23% to Fina Natural Gas Company, 20% to Texana Pipeline
Joint Venture and 17% to Michael Gas Marketing.
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 oil and gas in the areas in which the Company
operates.
PROPERTIES
Leasehold Acreage
Fortune's holdings of developed and undeveloped leasehold acreage as of
December 31, 1996 were approximately as follows:
LEASEHOLD ACREAGE
<TABLE>
<CAPTION>
Developed Undeveloped
------------------- -------------------
Gross Net Gross Net
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Louisiana........................ 660 81 28,441 10,995
Texas............................ 5,504 1,080 3,960 1,468
New Mexico....................... 1,320 285 48,680 11,231
Oklahoma......................... - - 80 5
-------- -------- -------- --------
Total.......................... 7,484 1,446 81,161 23,699
======== ======== ======== ========
</TABLE>
32
<PAGE>
Title to Properties
Detailed title examinations were performed for many of the Company's
properties in December 1993, January 1994 and June 1997 in conjunction with the
establishment of the Company's bank credit facility, and title opinions were
issued. 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 under the Company's bank credit facility. 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 1999. 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 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. At its present
location, Fortune occupies approximately 5,400 square feet of office space under
a lease agreement with a term of 5 years. (See note 9 of notes to December 31,
1997 Financial Statements.)
COMPETITION
The principal raw materials and resources necessary for the exploration
for, and the acquisition, development, production and sale of, oil and gas are
leasehold prospects under which oil and gas reserves may be discovered, drilling
rigs and related equipment to explore for such reserves, and knowledgeable
personnel to conduct all phases of oil and gas operations. The Company must
compete for such raw materials and resources with both major companies and
independent oil and gas operators. Each of these resources is currently in high
demand. Many of the companies with which Fortune competes for these resources
are better equipped to acquire them. There is no assurance that the Company will
be able to acquire any portion of these resources in a timely and economical
manner.
EMPLOYEES
As of December 31, 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 that 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 regulation 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.
33
<PAGE>
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 insurance against oil spills providing
$11,000,000 of coverage with a $5,000 deductible for such 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 that
are adversely affected by well permitting, spacing regulations or production
limitations.
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 of the
Securities Act. 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 the 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 that 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 two other buyers in the same
offering had filed similar suits in Federal District Court in New York. 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 received leave of court to add third-party defendants
whose actions, Fortune contends, furthered this market manipulation. Fortune
intends to continue to vigorously defend against plaintiffs' actions and
prosecute its own counterclaims. Discovery is continuing in these cases and a
consolidated trial is expected in 1998.
34
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Director
Executive Officer Age Since Title
- --------------------------------- --- ---- ------------------------------------------------
<S> <C> <C> <C>
Tyrone J. Fairbanks.............. 41 1991 President, Chief Executive Officer, and Director
Dean W. Drulias(2)............... 51 1990 Executive Vice President, General Counsel,
Corporate Secretary and Director
J. Michael Urban................. 44 -- Vice President, Chief Financial Officer and
Assistant Secretary
John L. Collins.................. 53 -- Vice President of Investor Relations
Graham S. Folsom(1).............. 40 1992 Director
William T. Walker, Jr.(2)........ 66 1993 Director
Barry Feiner(2).................. 63 1995 Director
Gary Gelman(1)................... 32 1995 Director
Daniel R. Shaughnessy(1)......... 47 1997 Director
</TABLE>
(1) Member of Audit Committee
(2) Member of Compensation Committee
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.
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, Los Angeles,
California, which served as counsel to the Company since its incorporation in
May 1987. He had practiced law in the Los Angeles area since 1977, specializing
in the areas of energy, environmental and real property law. Mr. Drulias is a
member of the State Bars of California and Texas.
J. Michael Urban was hired effective March 11, 1996 as the Company's Vice
President and Chief Financial Officer. Mr. Urban previously 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 is also a director of Community Bank, a private commercial bank located in
the Houston area. 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.
John L. Collins was hired effective May 30, 1995 as the Company's Vice
President of Investor Relations. 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.
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.
35
<PAGE>
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) and Aviation Distributors, Inc. (NMS).
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. Feiner also serves on the
board of directors of Intile Design, Inc. Mr. Feiner represented the placement
agent with respect to certain legal matters relating to the 1997 offering of the
Convertible Subordinated Notes. Furthermore, Mr. Feiner serves as legal counsel
to Mr. Blank, branch manager for the placement agent for the 1997 Notes offering
and a beneficial owner of more than 5% of the Company's stock. (See "Item 13 -
Certain Relationships and Related Transactions.")
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.
Daniel R. Shaughnessy is a geologist and geophysicist. He is the founder
and president of Interpretation3, a company that 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. (See "Business and Properties
- -Strategy.")
Director Compensation
The Company pays outside directors fees of $2,500 per quarter. Inside
directors do not receive any compensation for serving as directors.
36
<PAGE>
EXECUTIVE COMPENSATION
The following table lists the total compensation paid by the Company to
all of its executive officers:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term Compensation
---------------------------------------
Annual Compensation Awards Payouts
----------------------------------- ---------------------------- ---------
Restricted Securities
Stock Underlying LTIP All Other
Name and Principal Salary Bonus Other1 Awards Options/Warrants Payouts Compensation
Position Year ($) ($) ($) ($) (#) ($) ($)
- ------------------------- ----- -------- -------- -------- ---------- ------------- --------- ------------
<S> <C> <C> <C> <C> <S> <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, Investor 1995 56,738 1,600 - - 25,000 (4) - -
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) The figure shown reflects the issuance to Mr. Drulias of 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) The figure shown reflects the issuance to Mr. Urban of 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) The figure shown reflects the issuance to Mr. Collins of 25,000 stock
purchase warrants exercisable at $3.25 per share (the market price of the
Common Stock on May 30, 1995, the date of issue) and expiring May 30, 2000.
The following table lists the outstanding options held on December 31, 1996
by the Company's executive officers under Company's Stock Option Plans:
AGGREGATE OPTION EXERCISE IN LAST FISCAL YEAR
AND FY-END OPTION VALUES
<TABLE>
<CAPTION>
Number of Value of Unexercised
Unexercised Options/ in-the-Money Options/
Warrants at FY-End Warrants at FY-End
Shares Acquired Exercisable/ Exercisable/
Name on Exercise Value Realized ($) Unexercisable(1) Unexercisable
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Tyrone J. Fairbanks - - 296,999 / 0 -
Dean W. Drulias 6,575 - 82,400 / 0 -
J. Michael Urban - - 55,000 / 0 -
John L. Collins - - 105,000 / 0 -
</TABLE>
(1) Includes stock purchase warrants reflected in the preceding table.
37
<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 more than one-third of the Board of Directors
following certain special events), Mr. Fairbanks is entitled to receive a single
payment equal to two year's 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 (2) years of consulting
services upon the completion of the primary term of his contract at forty
percent (40%) of the last compensation thereunder. Mr. Fairbanks' current
employment agreement provides for an annual salary of $160,000 and additional
compensation, in an amount not to exceed his annual salary, based upon the
increase in the value of the Company's stock. The term of Mr. Fairbanks'
employment contract expires May 31, 2000, with a three-year evergreen provision.
As part of the relocation of the Company's headquarters to Houston, Texas,
Fortune provided Mr. Fairbanks with an incentive relocation package to
facilitate his move and with various loans and other benefits. (See "Certain
Relationships and Related Transactions")
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 year's compensation and all shares of Common Stock subject
to stock options then held by him without payment of the exercise price
therefor. The 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. All existing plans cover officers and
employees of the Company; those effective in 1993 and 1998 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 1988 plan must be exercised within
ten years of the date of grant or they are forfeited. Options granted under the
1993 and 1998 plans must be exercised within five years of the date of grant or
they are forfeited.
All options available under the 1988 plan have been granted, and no shares
remain on which options may be granted. Options have been granted as follows:
(1) under the 1988 plan, options for 27,500 shares at $2.60 per share and (2)
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 595,000 shares at $3.00 per
share granted in 1997. The exercise prices of all options granted in 1993, 1994
and 1995 were reduced to $2.75 on January 12, 1995. No shares have been granted
to date under the 1998 plan.
38
<PAGE>
The following table shows the grants of stock options during 1996 to each
of the executives named in the Summary Compensation Table.
OPTION/WARRANT GRANTS IN 1996
<TABLE>
<CAPTION>
Individual Grants
--------------------------------------------------------------
Number of % of Total Potential Realizable Value At
Securities Options Assumed Annual Rates Of
Underlying Granted to Stock Price Appreciation
Options Employees in Exercise or Base Expiration For Option Term
------------------------
Name Granted(1) Fiscal Year Price ($/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 6, 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) 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 the
maximum allowable by law. 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 1997, the Company's matching contribution was $24,000, all of which was
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 Summary
Compensation Table set forth above.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On October 14, 1997, Fortune commenced a private placement of up to $4.5
million of 12% Convertible Subordinated Notes due December 31, 2007 (the
"Notes"). The private placement closed on December 1, 1997. An aggregate of
$3,225,000 principal amount of Notes was sold, and the Company received
$2,815,000 of net proceeds after offering expenses and commissions. The Notes
were sold under a placement agreement with J. Robbins Securities, L.L.C. (the
"Placement Agent"). The Placement Agent received a ten percent sales commission,
a three percent non-accountable expense allowance, and warrants to purchase
89,583 shares of Common Stock. The warrants are exercisable over a five-year
period at $3.60 per share. Barry W. Blank, a beneficial owner of more than five
percent of the Company's Common Stock, is a branch manager for the Placement
Agent and marketed substantially the entire private placement. As such, Mr.
Blank earned approximately 50% of the fees and commissions paid to the Placement
Agent for the Notes sold by him and 20% of the warrants to be issued to the
Placement Agent. A trust established by and, under certain circumstances, for
the benefit of Mr. Blank acquired $500,000 of the Notes and Mr. Blank's mother
acquired $50,000 of Notes. Mr. Blank disclaims beneficial ownership of the Notes
purchased by his mother. Barry Feiner, a director of the Company, acted as
outside counsel for the Placement Agent in connection with the private placement
and earned $32,250 in legal fees from the
39
<PAGE>
Placement Agent. Mr. Feiner's wife acquired $50,000 in Notes for which Mr.
Feiner disclaims beneficial ownership. Mr. Feiner recused himself from voting on
all Company board of director matters associated with the private placement.
Barry W. Blank is also the owner of 541,000 Old Public Warrants, which, if
exercised, would entitle him to receive 777,687 shares of Common Stock. (See
note 4 to "Principal Stockholders.") Certain of these warrants were acquired by
Mr. Blank as the underwriters' representative in the 1993 public Unit offering.
The balance of these warrants were acquired by Mr. Blank in open-market
transactions since that time.
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 each of the second and third anniversaries of the loan. (See "Management
- -- Employment Agreements").
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 1996, the law firm in which Dean Drulias was formerly a shareholder
billed the Company a total of $152,000 for legal fees and costs. (See
"Management - Directors and Executive Officers.")
During 1996 and 1997, Fortune paid $45,000 and $182,000, respectively, for
consulting services to Interpretation3, of which Daniel R. Shaughnessy is the
owner and president. Mr. Shaughnessy was elected to the Company's board of
directors in January 1997. (See "Management - Directors and Executive
Officers.")
40
<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 Commission such indemnification is against public policy as expressed in the
Act and is therefore unenforceable.
41
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table contains information at December 31, 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(1) 1,067,687 8.1%
William D. Forster
237 Park Ave, New York, NY (2)(3) 715,000 5.7%
BSR Investments, Inc.
Paris, France(2)(4) 715,000 5.7%
Klein Ventures, Inc.
1307 E. Pine St., Lodi, CA(5) 640,017 5.2%
Tyrone J. Fairbanks (Director, President and CEO)
515 W. Greens Rd., Houston, TX(6) 431,521 3.4%
John L. Collins (Vice President)
515 W. Greens Rd., Houston TX(6) 288,467 2.3%
William T. Walker, Jr. (Director)
515 W. Greens Rd., Houston TX(6) 227,278 1.8%
Dean W. Drulias (Director, Executive Vice President,
General Counsel and Corporate Secretary)
515 W. Greens Rd., Houston, TX(6) 183,841 1.5%
J. Michael Urban (Vice President and CFO)
515 W. Greens Rd., Houston, TX(6) 173,701 1.4%
Graham S. Folsom (Director)
515 W. Greens Rd., Houston, TX(6)(7) 134,751 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) 90,493 *
Daniel R. Shaughnessy (Director)
515 W. Greens Rd., Houston, TX(6) 34,900 *
All Officers and Directors
as a group of nine (9) persons 1,659,035 12.3%
========= ====
</TABLE>
* indicates less than 1%.
42
<PAGE>
(1) Includes 90,000 shares of Common Stock and an additional 777,687 shares of
Common Stock which underlie 541,000 Old Public Warrants held by Mr. Blank
and exercisable at $3.75 per warrant and 200,000 shares of Common Stock
underlying 200,000 stock purchase warrants, exercisable at $2.40 per share,
issued to the underwriters of the Company's 1995 Equity Offering, which Mr.
Blank acquired from Coleman & Company Securities, Inc. Mr. Blank is a Vice
President of and registered representative with J. Robbins Securities,
L.L.C.
(2) Mr. Forster and BSR are the record holders of these shares issued in
connection with the Company's acquisition of Lagniappe Exploration, Inc. in
1995. Ensign Financial Group Limited claims a one-third interest in such
shares and the stock purchase warrants issued in the acquisition, a claim
which is being contested by Forster and BSR. In light of this dispute, the
Company is unable to state the beneficial ownership of such shares and
warrants. Ensign has filed suit in New York state court; if its position is
upheld and it is awarded one-third of the securities issued in that
acquisition, to the best of the Company's knowledge, the ownership,
including shares underlying the stock purchase warrants and other
securities noted in footnotes (3) and (4), would be as follows:
<TABLE>
<CAPTION>
Amount and Nature of Percent
Beneficial Ownership of Class
-------------------- --------
<S> <C> <C>
Ensign Financial Group Limited, NY, NY 800,000 6.3%
William D. Forster, New York, NY 315,000 2.5%
BSR Investments, Inc., Paris, France 315,000 2.5%
</TABLE>
(3) Includes 515,000 shares of Common Stock underlying stock purchase warrants
exercisable at $4.75 per share and expiring April 2000.
(4) 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.
(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 Old Public Warrants
acquired in the Company's 1993 public equity offering exercisable at $3.75
per warrant. 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 Commission.
(6) Includes 406,999 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, and 3,080 shares
held by the trustees of the Company's 401(k) plan for the benefit of Mr.
Fairbanks; 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 common 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 Old
Public 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 common stock purchase warrants (at $3.25 per share)
issued to John L. Collins on May 30, 1995, and 3,467 shares held by the
trustees of the Company's 401(k) plan for the benefit of Mr. Collins;
35,000 shares issuable upon the exercise of common stock purchase warrants
(at $2.5625 per share) issued to J. Michael Urban on March 11, 1996 and
3,701 shares held by the trustees of the Company's 401(k) plan for the
benefit of Mr. Urban; and 20,000 shares issuable upon the exercise of
common stock purchase warrants (at $2.75 per share) issued to Dean W.
Drulias on October 16, 1996 and 2,600 shares held by the trustees of the
Company's 401(k) plan for the benefit of Mr. Drulias.
(7) Includes 7,187 shares issuable upon exercise of 5,000 Old Public Warrants
(at $3.75 per warrant).
(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 14,375 shares issuable upon exercise of 10,000 Old Public Warrants
(at $3.75 per warrant).
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THE EXCHANGE OFFER
PURPOSE AND EFFECT
The Old Public Warrants were sold by the Company to the public in
connection with the Company's 1993 public Unit offering. The purpose of the
Exchange Offer is to permit the existing warrantholders to have the opportunity
to continue to exercise warrants to acquire stock in the Company while
mitigating the potential for arbitrage between the Old Public Warrants and the
Common Stock.
CONSEQUENCES OF FAILURE TO EXCHANGE OLD PUBLIC WARRANTS
Following the expiration of the Exchange Offer, Old Public Warrants not
tendered will expire on September 28, 1998, unless exercised sooner. All of the
New Warrants will expire September 28, 1999 unless exercised sooner.
TERMS OF THE EXCHANGE OFFER
The Company hereby offers, upon the terms and subject to the conditions set
forth herein and in the accompanying Letter of Transmittal, to exchange each Old
Public Warrant to purchase 1.4375 shares of Common Stock for one New Warrant to
purchase 1.4375 shares of Common Stock. The Company will accept for exchange any
and all Old Public Warrants that are validly tendered on or prior to 5:00 p.m.,
New York City time, on the Expiration Date. Tenders of the Old Public Warrants
may be withdrawn at any time prior to 5:00 p.m., New York City time, on the
Expiration Date. The Exchange Offer is not conditioned upon tender for exchange
of any minimum number of Old Public Warrants. Holders of Old Public Warrants may
tender less than all of the Old Public Warrants held by them, provided that they
appropriately indicate this fact on the Letter of Transmittal accompanying the
tendered Old Public Warrants (or so indicate pursuant to the procedures for
book-entry transfer).
As of the date of this Prospectus, there are 1,917,000 Old Public Warrants
outstanding. Up to an additional 63,000 Old Public Warrants may be issued upon
exercise of the Unit Purchase Warrants granted to the representative of the
underwriters in connection with the 1993 public Unit offering. Solely for
reasons of administration (and for no other purpose), the Company has fixed the
close of business on January 29, 1998, as the record date (the "Record Date")
for purposes of determining the persons to whom this Prospectus and the Letter
of Transmittal will be mailed initially. Only a holder of the Old Public
Warrants (or such holder's legal representative or attorney-in-fact) may
participate in the Exchange Offer. There will be no fixed record date for
determining holders of the Old Public Warrants entitled to participate in the
Exchange Offer.
The Company shall be deemed to have accepted validly tendered Old Public
Warrants when, as and if the Company has given oral or written notice thereof to
the Exchange Agent. The Exchange Agent will act as agent for the tendering
holders of Old Public Warrants and for the purposes of receiving the New
Warrants from the Company.
If any tendered Old Public Warrants are not accepted for exchange because
of an invalid tender, the occurrence of certain other events set forth herein or
otherwise, certificates for any such unaccepted Old Public Warrants will be
returned, without expense, to the tendering holder thereof as promptly as
practicable after the Expiration Date.
EXPIRATION DATE; EXTENSIONS; AMENDMENTS
The Expiration Date shall be March 31, 1998 at 5:00 p.m., New York City
time, unless the Company, in its sole discretion, extends the Exchange Offer, in
which case the Expiration Date shall be the latest date and time to which the
Exchange Offer is extended.
In order to extend the Exchange Offer, the Company will notify the Exchange
Agent of any extension by oral or written notice and will make a public
announcement thereof, each prior to 10:00 a.m., New York City time, on the next
business day after the previously scheduled Expiration Date.
The Company reserves the right, in its sole discretion, (i) to delay
accepting any Old Public Warrants, (ii) to extend the Exchange Offer, (iii) to
terminate the Exchange Offer, by giving oral or written notice of such delay,
extension, or termination to the Exchange Agent, and (iv) to amend the terms of
the Exchange Offer in any manner. If the Exchange
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Offer is amended in a manner determined by the Company to constitute a material
change, the Company will promptly disclose such amendments by means of a
prospectus supplement that will be distributed to the registered holders of the
Old Public Warrants. Modifications of the Exchange Offer, including, but not
limited to extension of the period during which the Exchange Offer is open may
require that at least five business days remain in the Exchange Offer.
CONDITIONS OF THE EXCHANGE OFFER
The Exchange Offer is conditioned upon the declaration by the Commission of
the effectiveness of the Registration Statement of which this Prospectus
constitutes a part.
PROCEDURES FOR TENDERING OLD PUBLIC WARRANTS
The tender of a holder's Old Public Warrants as set forth below and the
acceptance thereof by the Company will constitute a binding agreement between
the tendering holder and the Company upon the terms and subject to the
conditions set forth in this Prospectus and in the accompanying Letter of
Transmittal. Except as set forth below, a holder who wishes to tender Old Public
Warrants for exchange pursuant to the Exchange Offer must transmit such Old
Public Warrants, together with a properly completed and duly executed Letter of
Transmittal, including all other documents required by such Letter of
Transmittal, to the Exchange Agent at the address set forth under "The Exchange
Offer - The Exchange Agent; Assistance," below, prior to 5:00 p.m., New York
City time, on the Expiration Date. THE METHOD OF DELIVERY OF OLD PUBLIC
WARRANTS, LETTERS OF TRANSMITTAL AND ALL OTHER REQUIRED DOCUMENTS IS AT THE
ELECTION, EXPENSE, AND RISK OF THE HOLDER. IF SUCH DELIVERY IS BY MAIL, THE
COMPANY RECOMMENDS THAT REGISTERED MAIL, PROPERLY INSURED, WITH RETURN RECEIPT
REQUESTED, BE USED. INSTEAD OF DELIVERY BY MAIL, THE HOLDER MAY USE AN OVERNIGHT
OR HAND DELIVERY SERVICE. IN ALL CASES, SUFFICIENT TIME SHOULD BE ALLOWED TO
ASSURE TIMELY DELIVERY.
Any financial institution that is a participant in DTC's Book-Entry
Transfer Facility system may make book-entry delivery of the Old Public Warrants
by causing DTC to transfer such Old Public Warrants into the Exchange Agent's
account in accordance with DTC's procedures for such transfer. In connection
with a book-entry transfer, a Letter of Transmittal need not be transmitted to
the Exchange Agent, provided that the book-entry transfer procedure must be
complied with prior to 5:00 p.m., New York City time, on the Expiration Date.
Each signature on a Letter of Transmittal or a notice of withdrawal, as the
case may be, must be guaranteed unless the Old Public Warrants surrendered for
exchange pursuant hereto are tendered (i) by a registered holder of the Old
Public Warrants who has not completed either the box entitled "Special Exchange
Instructions" or the box entitled "Special Delivery Instructions" in the Letter
of Transmittal, or (ii) by an Eligible Institution (as defined). In the event
that a signature on a Letter of Transmittal or a notice of withdrawal, as the
case may be, is required to be guaranteed, such guarantee must be by a firm
which is a member of a registered national securities exchange or the National
Association of Securities Dealers, Inc., a commercial bank or trust company
having an office or correspondent in the United States or otherwise be an
"eligible guarantor institution" within the meaning of Rule 17Ad-15 under the
Exchange Act (collectively, "Eligible Institutions"). If the Letter of
Transmittal is signed by a person other than the registered holder of the Old
Public Warrants, the Old Public Warrants surrendered for exchange must either
(i) be endorsed by the registered holder, with the signature thereon guaranteed
by an Eligible Institution, or (ii) be accompanied by a stock power, in
satisfactory form as determined by the Company in its sole discretion, duly
executed by the registered holder, with the signature thereon guaranteed by an
Eligible Institution. The term "registered holder" as used herein with respect
to the Old Public Warrants means any person in whose name the Old Public
Warrants are registered on the books of the Registrar.
All questions as to the validity, form, eligibility (including time of
receipt), acceptance and withdrawal of Old Public Warrants tendered for exchange
will be determined by the Company in its sole discretion, which determination
shall be final and binding. The Company reserves the absolute right to reject
any and all Old Public Warrants not properly tendered and to reject any Old
Public Warrants the Company's acceptance of which might, in the judgment of the
Company or its counsel, be unlawful. The Company also reserves the absolute
right to waive any defects or irregularities or conditions of the Exchange Offer
as to particular Old Public Warrants either before or after the Expiration Date
(including the right to waive the ineligibility of any holder who seeks to
tender Old Public Warrants in the Exchange Offer). The interpretation of the
terms and conditions of the Exchange Offer (including the Letter of Transmittal
and the instructions thereto) by the Company shall be final and binding on all
parties. Unless waived, any defects or irregularities in connection with tenders
of Old Public Warrants for exchange must be cured within such period of time as
the Company shall determine. The Company will use reasonable efforts to give
notification of defects or irregularities with respect to tenders
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of Old Public Warrants for exchange but shall not incur any liability for
failure to give such notification. Tenders of the Old Public Warrants will not
be deemed to have been made until such irregularities have been cured or waived.
If any Letter of Transmittal, endorsement, stock power, power of attorney
or any other document required by the Letter of Transmittal is signed by a
trustee, executor, corporation or other person acting in a fiduciary or
representative capacity, such person should so indicate when signing, and,
unless waived by the Company, proper evidence satisfactory to the Company, in
its sole discretion, of such person's authority to so act must be submitted.
Any beneficial owner of the Old Public Warrants (a "Beneficial Owner")
whose Old Public Warrants are registered in the name of a broker, dealer,
commercial bank, trust company or other nominee and who wishes to tender Old
Public Warrants in the Exchange Offer should contact such registered holder
promptly and instruct such registered holder to tender on such Beneficial
Owner's behalf. If such Beneficial Owner wishes to tender directly, such
Beneficial Owner must, prior to completing and executing the Letter of
Transmittal and tendering Old Public Warrants, make appropriate arrangements to
register ownership of the Old Public Warrants in such Beneficial Owner's name.
Beneficial Owners should be aware that the transfer of registered ownership may
take considerable time.
By tendering, each registered holder will represent to the Company that,
among other things (i) the New Warrants to be acquired in connection with the
Exchange Offer by the holder and each Beneficial Owner of the Old Public
Warrants are being acquired by the holder and each Beneficial Owner in the
ordinary course of business of the holder and each Beneficial Owner, (ii) the
holder and each Beneficial Owner are not participating, do not intend to
participate, and have no arrangement or understanding with any person to
participate, in the distribution of the New Warrants, (iii) the holder and each
Beneficial Owner acknowledge and agree that any person participating in the
Exchange Offer for the purpose of distributing the New Warrants must comply with
the registration and prospectus delivery requirements of the Securities Act in
connection with a secondary resale transaction of the New Warrants acquired by
such person and cannot rely on the position of the staff of the Commission set
forth in no-action letters that are discussed herein under "Resales of New
Warrants," (iv) that if the holder is a broker-dealer that acquired Old Public
Warrants as a result of market making or other trading activities, it will
deliver a prospectus in connection with any resale of New Warrants acquired in
the Exchange Offer, (v) the holder and each Beneficial Owner understand that a
secondary resale transaction described in clause (iii) above should be covered
by an effective registration statement containing the selling security holder
information required by Item 507 of Regulation S-K of the Commission, and (vi)
neither the holder nor any Beneficial Owner is an "affiliate," as defined under
Rule 405 of the Securities Act, of the Company except as otherwise disclosed to
the Company in writing. In connection with a book-entry transfer, each
participant will confirm that it makes the representations and warranties
contained in the Letter of Transmittal.
GUARANTEED DELIVERY PROCEDURES
Holders who wish to tender their Old Public Warrants and (i) whose Old
Public Warrants are not immediately available or (ii) who cannot deliver their
Old Public Warrants or any other documents required by the Letter of Transmittal
to the Exchange Agent prior to the Expiration Date (or complete the procedure
for book-entry transfer on a timely basis), may tender their Old Public Warrants
according to the guaranteed delivery procedures set forth in the Letter of
Transmittal. Pursuant to such procedures: (i) such tender must be made by or
through an Eligible Institution and a Notice of Guaranteed Delivery (as defined
in the Letter of Transmittal) must be signed by such Holder, (ii) on or prior to
the Expiration Date, the Exchange Agent must have received from the Holder and
the Eligible Institution a properly completed and duly executed Notice of
Guaranteed Delivery (by facsimile transmission, mail or hand delivery) setting
forth the name and address of the Holder, the certificate number or numbers of
the tendered Old Public Warrants, and the principal amount of tendered Old
Public Warrants, stating that the tender is being made thereby and guaranteeing
that, within four (4) business days after the date of delivery of the Notice of
Guaranteed Delivery, the tendered Old Public Warrants, a duly executed Letter of
Transmittal and any other required documents will be deposited by the Eligible
Institution with the Exchange Agent, and (iii) such properly completed and
executed documents required by the Letter of Transmittal and the tendered Old
Public Warrants in proper form for transfer (or confirmation of a book-entry
transfer of such Old Public Warrants into the Exchange Agent's account at DTC)
must be received by the Exchange Agent within four (4) business days after the
Expiration Date. Any Holder who wishes to tender Old Public Warrants pursuant to
the guaranteed delivery procedures described above must ensure that the Exchange
Agent receives the Notice of Guaranteed Delivery and Letter of Transmittal
relating to such Old Public Warrants prior to 5:00 p.m., New York City time, on
the Expiration Date.
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ACCEPTANCE OF OLD PUBLIC WARRANTS FOR EXCHANGE; DELIVERY OF NEW WARRANTS
Upon satisfaction or waiver of all the conditions to the Exchange Offer,
the Company will accept any and all Old Public Warrants that are properly
tendered in the Exchange Offer prior to 5:00 p.m., New York City time, on the
Expiration Date. The New Warrants issued pursuant to the Exchange Offer will be
delivered promptly after acceptance of the Old Public Warrants. For purposes of
the Exchange Offer, the Company shall be deemed to have accepted validly
tendered Old Public Warrants, when, as, and if the Company has given oral or
written notice thereof to the Exchange Agent.
In all cases, issuances of New Warrants for Old Public Warrants that are
accepted for exchange pursuant to the Exchange Offer will be made only after
timely receipt by the Exchange Agent of such Old Public Warrants, a properly
completed and duly executed Letter of Transmittal and all other required
documents (or of confirmation of a book-entry transfer of such Old Public
Warrants into the Exchange Agent's account at DTC); provided, however, that the
Company reserves the absolute right to waive any defects or irregularities in
the tender or conditions of the Exchange Offer. If any tendered Old Public
Warrants are not accepted for any reason, such unaccepted Old Public Warrants
will be returned without expense to the tendering Holder thereof as promptly as
practicable after the expiration or termination of the Exchange Offer.
WITHDRAWAL RIGHTS
Tenders of the Old Public Warrants may be withdrawn by delivery of a
written notice to the Exchange Agent, at its address set forth on the back cover
page of this Prospectus, at any time prior to 5:00 p.m., New York City time, on
the Expiration Date. Any such notice of withdrawal must (i) specify the name of
the person having deposited the Old Public Warrants to be withdrawn (the
"Depositor"), (ii) identify the Old Public Warrants to be withdrawn (including
the certificate number or numbers and principal amount of such Old Public
Warrants, as applicable), (iii) be signed by the Holder in the same manner as
the original signature on the Letter of Transmittal by which such Old Public
Warrants were tendered (including any required signature guarantees) or be
accompanied by a stock power in the name of the person withdrawing the tender,
in satisfactory form as determined by the Company in its sole discretion, duly
executed by the registered holder, with the signature thereon guaranteed by an
Eligible Institution together with the other documents required upon transfer by
the Indenture, and (iv) specify the name in which such Old Public Warrants are
to be re-registered, if different from the Depositor, pursuant to such documents
of transfer. Any questions as to the validity, form and eligibility (including
time of receipt) of such notices will be determined by the Company, in its sole
discretion. The Old Public Warrants so withdrawn will be deemed not to have been
validly tendered for exchange for purposes of the Exchange Offer. Any Old Public
Warrants which have been tendered for exchange but which are withdrawn will be
returned to the Holder thereof without cost to such Holder as soon as
practicable after withdrawal. Properly withdrawn Old Public Warrants may be
retendered by following one of the procedures described under "The Exchange
Offer Procedures for Tendering Old Public Warrants" at any time on or prior to
the Expiration Date.
THE EXCHANGE AGENT; ASSISTANCE
U. S. Stock Transfer Corporation is the Exchange Agent. All tendered Old
Public Warrants, executed Letters of Transmittal and other related documents
should be directed to the Exchange Agent. Questions and requests for assistance
and requests for additional copies of the Prospectus, the Letter of Transmittal
and other related documents should be addressed to the Exchange Agent as
follows:
BY HAND, REGISTERED OR CERTIFIED MAIL OR OVERNIGHT COURIER:
U.S. STOCK TRANSFER CORPORATION
1745 GARDENA AVENUE
SECOND FLOOR
GLENDALE, CA 91204-2991
ATTENTION: JIM HUNTER, VICE PRESIDENT
By Facsimile: (818) 502-1737
Confirm by Telephone: (818) 502-1404
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FEES AND EXPENSES
All expenses incident to the Company's consummation of the Exchange Offer
will be borne by the Company, including, without limitation: (i) all
registration and filing fees (including, without limitation, fees and expenses
of compliance with state securities or Blue Sky laws), (ii) printing expenses
(including, without limitation, expenses of printing certificates for the New
Warrants and of printing Prospectuses), (iii) messenger, telephone and delivery
expenses, (iv) fees and disbursements of counsel for the Company, (v) fees and
disbursements of independent certified public accountants, and (vi) internal
expenses of the Company (including, without limitation, all salaries and
expenses of officers and employees of the Company performing legal or accounting
duties).
The Company has not retained any dealer-manager in connection with the
Exchange Offer and will not make any payments to brokers, dealers or others
soliciting acceptance of the Exchange Offer. The Company, however, will pay the
Exchange Agent reasonable and customary fees for its services and will reimburse
it for its reasonable out-of-pocket expenses in connection therewith.
The Company will pay all transfer taxes, if any, applicable to the exchange
of Old Public Warrants pursuant to the Exchange Offer. If, however, a transfer
tax is imposed for any reason other than the exchange of Old Public Warrants
pursuant to the Exchange Offer, then the amount of any such transfer taxes
(whether imposed on the registered holder or any other persons) will be payable
by the tendering holder. If satisfactory evidence of payment of such taxes or
exemption is not submitted with the Letter of Transmittal, the amount of such
transfer taxes will be billed directly to such tendering holder.
ACCOUNTING TREATMENT
The New Warrants will be recorded at the same carrying value as the Old
Public Warrants, as reflected in the Company's accounting records on the date of
the exchange. Accordingly, no gain or loss will be recognized by the Company for
accounting purposes. The costs of the Exchange Offer, estimated to be $28,000,
will be charged to the Company's capital in excess of par value, thereby
reducing the Company's capitalization by the amount of the costs.
RESALES OF THE NEW WARRANTS
The Company believes that the (i) New Warrants issued pursuant to the
Exchange Offer to a holder in exchange for Old Public Warrants, subject to the
Company's prior written approval, and (ii) Common Stock issued upon exercise of
any of the New Warrants, may be offered for resale, resold and otherwise
transferred by such holder (other than a person that is an affiliate of the
Company within the meaning of Rule 405 under the Securities Act) without
compliance with the registration and prospectus delivery provisions of the
Securities Act, provided that such holder is acquiring the New Warrants in the
ordinary course of business and is not participating, and has no arrangement or
understanding with any person to participate, in the distribution of the New
Warrants.
It is expected that the New Warrants will be transferable by the holders
thereof, only upon compliance with the limitations described in the immediately
preceding paragraph. Sales of New Warrants acquired in the Exchange Offer by
holders who are "affiliates" of the Company within the meaning of the Securities
Act will be subject to certain limitations on resale under Rule 144 of the
Securities Act. Such persons will only be entitled to sell New Warrants in
compliance with the volume limitations set forth in Rule 144, and sales of New
Warrants by affiliates will be subject to certain Rule 144 requirements as to
the manner of sale, notice and the availability of current public information
regarding the Company. The foregoing is a summary only of Rule 144 as it may
apply to affiliates of the Company. Any such persons must consult their own
legal counsel for advice as to any restrictions that might apply to the resale
of their Warrants.
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CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
Set forth below is a discussion of certain federal income tax consequences
to persons exchanging Warrants pursuant to this offering. This discussion
summarizes the opinion of Looper, Reed, Mark & McGraw Incorporated, Houston,
Texas, delivered to the Company in connection with this Exchange Offer. This
discussion is based upon the Internal Revenue Code of 1986, as amended (the
"Code"), Treasury Regulations thereunder (final and proposed) and published
revenue rulings, revenue procedures, and other pronouncements of the Internal
Revenue Service ("IRS") in effect at the date hereof. This discussion does not
take into account possible changes in judicial or administrative rulings, some
of which may have retroactive effect. The discussion sets forth the material tax
consequences to investors in this offering but does not purport to deal with
persons who purchase the New Warrants subsequent to this offering or with all
aspects of federal taxation (or with any aspect of state, local, or foreign
taxation) that may be relevant to investors in light of their personal
investment circumstances. Certain investors (including insurance companies,
tax-exempt organizations, financial institutions, broker-dealers, foreign
corporations, and persons who are not citizens or residents of the United
States) may be subject to special rules not discussed below. PROSPECTIVE
INVESTORS ARE ADVISED TO CONSULT THEIR OWN TAX ADVISORS REGARDING THE FEDERAL,
STATE, LOCAL, AND FOREIGN TAX CONSEQUENCES OF EXCHANGING, HOLDING, AND DISPOSING
OF THE WARRANTS.
Under Section 1001 of the Code, the transfer of a capital asset is treated
as a taxable sale or exchange, unless an otherwise applicable exception in the
Code accords the transfer tax-free status. There is no specific exception in the
Code applicable to an exchange of warrants which would preclude such an exchange
from being taxable under Section 1001 of the Code. Therefore, it is likely the
IRS will treat the Exchange of Old Public Warrants for New Warrants (the
"Exchange") as a taxable exchange under Section 1001 of the Code. If the
Internal Revenue Service treated the Exchange as taxable, such treatment was
sustained by the courts, and the Old Public Warrants constitute a capital asset
of an exchanging Old Public Warrants holder, the exchanging Old Public Warrants
holder would recognize capital gain or loss on the Exchange equal to the
difference between the fair market value of the New Warrants received and the
exchanging holder's tax basis in the Old Public Warrants exchanged. Such capital
gain or loss would be subject to capital gains taxation at various rates
depending upon, among other things, the applicable marginal rate of federal
income tax of such holder and the length of time the exchanged Old Public
Warrants were held by the exchanging holder prior to the Exchange. If the
exchange of the Old Public Warrants is a taxable transaction, the Company cannot
make any representation with respect to the value of the New Warrants or the
gain or loss that may be realized or recognized by an exchanging Warrant holder
in the Exchange. Nevertheless, the value of such New Warrants received in the
Exchange may be speculative due to a variety of factors, including the lack of
an existing market for the New Warrants, restrictions on the New Warrants
transferability, and lack of protection against dilution from certain issuances
of Common Stock or other securities below current market value, all as described
elsewhere in this Registration Statement.
Several remote possibilities exist under which the Exchange of the Old
Public Warrants could be viewed as non-taxable. First, final regulations
recently issued under Code Sections 354, 355 and 356 (the "Reorganization
Warrants Regulations") will, after March 9, 1998, allow warrants, options and
similar instruments to be exchanged tax-free in connection with corporate
"reorganizations" under Code Section 368. Under the Reorganization Warrant
Regulations such instruments are to be treated as "securities" under Sections
354, 355, and 356 of the Code, resulting in tax-free exchange treatment if such
exchange is completed in a "reorganization." Although not entirely clear under
the Reorganization Warrant Regulations, it appears likely the IRS would take the
position that the Exchange of Old Public Warrants for New Warrants would not
qualify as a "reorganization" within the meaning of Section 368 of the Code
because the Exchange lacks the requisite concurrent transfer, exchange, or
issuance of common or other equity in the Company. As such, it is highly
unlikely that the Reorganization Warrant Regulations would make the subject
Exchange tax-free to the Old Public Warrant holders.
Second, the Exchange could be viewed by analogy as similar to the
modification of a "debt instrument" under Treasury Regulations Section 1.1001-3
(the "Debt Modification Regulations"). Under these regulations, if a
modification of a debt instrument is regarded as de minimis, the modification is
not realized or recognized as a taxable exchange of the debt under Section 1001
of the Code. If the Exchange of the Old Public Warrants could be characterized
as a "modification" of the terms of the Old Public Warrants under the principles
of the Debt Modification Regulations, the modification would likely be regarded
as de minimis and would not be considered a taxable exchange. Notwithstanding
this analogy, because the Debt Modification Regulations expressly apply only to
obligations characterized as "debt" under the Code, holders of the Old Public
Warrants, which would not qualify as "debt" under the Code, should not rely on
the analogous application of the Debt Modification Regulations to characterize
the Exchange as tax-free on their individual tax returns.
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DUE TO THE UNCERTAINTY OF THE FEDERAL INCOME TAX TREATMENT OF THE EXCHANGE,
EACH INVESTOR IS STRONGLY URGED TO CONSULT HIS OR HER PERSONAL TAX ADVISOR
CONCERNING TAXATION OF THE EXCHANGE OF THE OLD PUBLIC WARRANTS.
(this space left blank intentionally)
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DESCRIPTION OF SECURITIES
COMMON AND PREFERRED STOCK
The following description is qualified in all respects by reference to the
Company's Certificate of Incorporation and all amendments thereto and the
Company's Bylaws, copies of which are filed as exhibits to the Registration
Statement of which this Prospectus is a part.
The Company's Certificate of Incorporation, as amended, currently
authorizes 40,000,000 shares of Common Stock, $.01 par value and 2,000,000
shares of preferred stock, $1.00 par value. Of this total, 12,129,167 shares of
Common Stock were issued and outstanding as of January 30, 1998. An additional
4,513,665 shares of Common Stock were issuable upon exercise of options and
private warrants outstanding at January 30, 1998. No preferred stock is
currently outstanding.
COMMON STOCK
Holders of shares of Common Stock are entitled to dividends when and as
declared by the Board of Directors from funds legally available therefor and
upon liquidation are entitled to share ratably in any distribution to
stockholders. All holders of Common Stock are entitled to one vote per share on
any matter coming before the stockholders for a vote, including the election of
directors. In keeping with stockholder democracy rights, Fortune's Certificate
of Incorporation permits the stockholders to remove any director or the entire
board of directors, with or without cause, upon a vote of a majority of the
outstanding shares.
All issued and outstanding shares of Common Stock are validly issued, fully
paid and non-assessable. Holders of the Common Stock do not have pre-emptive
rights or other rights to subscribe for unissued or treasury shares or
securities convertible into shares.
Additionally, under Section 145 of the Delaware General Corporation Law,
the Company has availed itself of the provisions permitting the limitation of
liability through the indemnification of officers, directors, employees and
agents of Delaware corporations. (See "Certain Relationships and Related
Transactions - Limited Liability of Directors" and "- Indemnification of
Officers and Directors.")
PREFERRED STOCK
The Certificate of Incorporation authorizes the Board of Directors to
establish and designate the classes, series, voting powers, designations,
preferences and relative, participating, optional or other rights, and such
qualifications, limitations and restrictions of the Preferred Stock as the
Board, in its sole discretion, may determine without further vote or action by
the stockholders.
The rights, preferences, privileges and restrictions or qualifications of
different series of preferred stock may differ with respect to dividend rates,
amounts payable on liquidation, voting rights, conversion rights, redemption
provisions, sinking fund provisions and other matters. The issuance of Preferred
Stock could decrease the amount of earnings and assets available for
distribution to holders of Common Stock, or could adversely affect the rights
and powers, including voting rights, of holders of Common Stock.
The existence of the Preferred Stock, and the power of the Board of
Directors of the Company to set its terms and issue a series of Preferred Stock
at any time without stockholder approval, could have certain anti-takeover
effects. These effects include that of making the Company a less attractive
target for a "hostile" takeover bid or rendering more difficult or discouraging
the making of a merger proposal, assumption of control through the acquisition
of a large block of Common Stock or removal of incumbent management, even if
such actions could be beneficial to the stockholders of the Company.
WARRANTS
The Company has issued various Common Stock private purchase warrants from
time to time.
51
<PAGE>
Old Public Warrants
The Company currently has outstanding the Old Public Warrants which were
issued in connection with a 1993 public offering. The Old Public Warrants issued
to the public are listed on the AMEX and expire September 28, 1998.
Each Old Public Warrant originally entitled the holder to purchase one
share of Common Stock at a price of $3.75 per share. The Old Public Warrants
contain provisions that protect the holders against dilution by adjustment of
the exercise price in certain events, such as stock dividends and distributions,
stock splits, recapitalizations, mergers or consolidations and certain issuances
below the current market value of the Common Stock. As a result of the operation
of these provisions, the Old Public Warrants have been adjusted so that the
holder is entitled to purchase 1.4375 shares for an effective purchase price of
approximately $2.61 per share. The exercise price of each Old Public Warrant
remains $3.75 per warrant. The Old Public Warrants are redeemable by the
Company, at $.05 per Public Warrant, upon 30 days' notice, if the closing price
per share of the Common Stock for 20 consecutive trading days within the 30-day
period preceding the date notice of redemption is given equals or exceeds $5.50
per share. In the event the Company gives notice of its intention to redeem, a
holder would be forced to exercise his or her Old Public Warrants within 30 days
of the notice of redemption or accept the redemption price. (See "Risk Factors
Risks Associated with Investment in the Common Stock - Shares Eligible for
Future Sale.")
The Old Public Warrants were issued in registered form under a warrant
agreement between the Company and U.S. Stock Transfer, as warrant agent. The
shares of Common Stock underlying the Old Public Warrants, when issued upon
exercise of a Old Public Warrant, will be fully paid and nonassessable, and the
Company will pay any transfer tax incurred as a result of the issuance of Common
Stock to the holder upon its exercise. The Company is not required to issue
fractional shares upon the exercise of a Old Public Warrant. The holder of a
Public Warrant does not possess any rights as a stockholder of the Company until
such holder exercises the Old Public Warrant.
Representatives' Warrants
The Company currently has outstanding the Representatives' Warrants which
were issued to the representative of the underwriters in connection with the
1993 public Unit offering. The Representatives' Warrants are not listed on the
AMEX and expire September 28, 1998.
Each Representatives' Warrant originally entitled the holder to purchase a
unit (the "Unit") consisting of two shares of Common Stock and two Old Public
Warrants at a price of $11.14 per Unit. The Representatives' Warrants contain
provisions that protect the holders against dilution by adjustment of the
exercise price in certain events, such as stock dividends and distributions,
stock splits, recapitalizations, mergers or consolidations and certain issuances
below the current market value of the Common Stock. As a result of the operation
of these provisions, the Representatives' Warrants have been adjusted so that
the holder is entitled to purchase 3.3097 shares of Common Stock and two Old
Public Warrants for an aggregate purchase price of $11.14 per Unit. The
Representatives' Warrants are redeemable by the Company, at $.05 per
Representatives' Warrant, upon 30 days' notice, if the closing price per share
of the Common Stock for 20 consecutive trading days within the 30-day period
preceding the date notice of redemption is given equals or exceeds $5.50 per
share. In the event the Company gives notice of its intention to redeem, a
holder would be forced to exercise his or her Representatives' Warrants within
30 days of the notice of redemption or accept the redemption price. (See "Risk
Factors - Risks Associated with Investment in the Common Stock - Shares Eligible
for Future Sale.")
The Representatives' Warrants were issued in registered form under a
warrant agreement between the Company and U.S. Stock Transfer, as warrant agent.
The shares of Common Stock underlying the Representatives' Warrants, when issued
upon exercise of a Representatives' Warrant, will be fully paid and
nonassessable, and the Company will pay any transfer tax incurred as a result of
the issuance of Common Stock to the holder upon its exercise. The Company is not
required to issue fractional shares upon the exercise of a Representatives'
Warrant. The holder of a Representatives' Warrant does not possess any rights as
a stockholder of the Company until such holder exercises the Representatives'
Warrant.
52
<PAGE>
New Warrants
The Company's Board of Directors has authorized the issuance in the
Exchange Offer of the New Warrants to be exchanged for the Old Public Warrants.
The New Warrants will not be listed on the AMEX or any other exchange or
otherwise admitted for trading privileges and expire September 28, 1999. The New
Warrants may only be transferred upon the prior written consent of the Company.
Upon successful completion of the Exchange Offer, one New Warrant
exercisable for 1.4375 shares of Common Stock will be issued for each of the Old
Public Warrants tendered, exercisable for the same number of shares of Common
Stock at an initial exercise price of approximately $2.61 per share. The New
Warrants contain provisions that protect the holders against dilution by
adjustment of the exercise price in certain events, such as stock dividends and
distributions, stock splits, recapitalizations, mergers or consolidations. The
New Warrants do not contain the provisions contained in the Old Public Warrants
providing the holders of such warrants protection against dilution from certain
issuances of Common Stock or other securities below the current market value.
The New Warrants are redeemable by the Company, at $.05 per New Warrant, upon 30
days' notice, if the closing price per share of the Common Stock for 20
consecutive trading days within the 30-day period preceding the date notice of
redemption is given equals or exceeds $5.50 per share. In the event the Company
gives notice of its intention to redeem, a holder would be forced to exercise
his or her New Warrant within 30 days of the notice of redemption or accept the
redemption price. (See "Risk Factors Risks Associated with Investment in the
Common Stock - Shares Eligible for Future Sale.")
The New Warrants will be issued in registered form under a warrant
agreement between the Company and U.S. Stock Transfer, as warrant agent. The
shares of Common Stock underlying the New Warrants, when issued upon exercise of
a New Warrant, will be fully paid and nonassessable, and the Company will pay
any transfer tax incurred as a result of the issuance of Common Stock to the
holder upon its exercise. The Company is not required to issue fractional shares
upon the exercise of a Public Warrant. The holder of a New Warrant does not
possess any rights as a stockholder of the Company until such holder exercises
the New Warrant.
53
<PAGE>
Debenture Exchange Warrants
On February 26, 1997, the Company closed an offer to exchange shares of
Common Stock and Common Stock purchase warrants (the "Debenture Exchange
Warrants") for the Debentures. Exchange Warrants to purchase 174,250 shares of
Common Stock were issued. Such Exchange Warrants are not listed on the AMEX. All
Debentures not exchanged were repaid on December 5, 1997.
Each Debenture Exchange Warrant, which expires December 2, 1999, entitles
the holder to purchase one share of Common Stock. One-half of the Debenture
Exchange Warrants received by exchanging Debenture holders have an exercise
price equal to the $4.00 per share and one-half have an exercise price of $5.00
per share. The Debenture Exchange Warrants are callable by the Company, at $.05
per Debenture Exchange Warrant, upon 30 days notice, at any time after the
closing price per share of the Common Stock for ten consecutive trading days
equals or exceeds $6.00 per share. In the event the Company gives notice of its
intention to redeem, a holder would be forced either to exercise his or her
Debenture Exchange Warrant within 30 days of the notice of redemption or accept
the redemption price.
The Debenture Exchange Warrants were issued in registered form under a
warrant agreement between the Company and the warrant holders. The shares of
Common Stock underlying the Debenture Exchange Warrants, when issued upon
exercise of a Debenture Exchange Warrant, will be fully paid and nonassessable,
and the Company will pay any transfer tax incurred as a result of the issuance
of Common Stock to the holder upon its exercise. The Company is not required to
issue fractional shares upon the exercise of a Debenture Exchange Warrant. The
holder of a Debenture Exchange Warrant does not possess any rights as a
stockholder of the Company until such holder exercises the Exchange Warrant.
Other Warrants
The Company has also issued various other warrants to purchase shares of
Common Stock from time to time. The holders of such warrants have the right to
purchase up to 3,000,205 shares of Common Stock at prices ranging from $2.40 to
$5.00 and with expiration dates ranging from February 1998 to October 2001.
Notes
In December 1997, the Company closed its private placement of 12%
Convertible Subordinated Notes due December 31, 2007 (the "Notes"). An aggregate
of $3,225,000 principal amount of Notes was sold. The Notes are convertible into
the Company's Common Stock at a conversion price of $3.00 per share, subject to
adjustment. The Notes are convertible by the holders after May 1, 1999, subject
to a one-time option by the holders to convert at a lower conversion price prior
to that date in the event that the Company issues shares of Common Stock at a
price below the conversion price. The Notes are redeemable by the Company after
May 1, 1999, at a premium that reduces monthly from 10% to zero over an 18-month
period. Any such premium redemption is waived in the event that the Company's
Common Stock price averages at least $4.50 per share for 30 consecutive trading
days. The holders of the Notes will be entitled to receive additional shares
upon conversion in the event that the Company's Common Stock price averages less
than the conversion price for a certain period prior to May 1, 1999. The Notes
are subordinate to all of the Company's secured debt, including the credit
facility with Credit Lyonnais. The Notes bear interest at a rate of 12% per
year, payable quarterly.
TRANSFER AGENT AND REGISTRAR
The principal transfer agent and registrar for the Common Stock is U.S.
Stock Transfer Corporation, Glendale, California. The co-transfer agent and
co-registrar for such securities is Registrar and Transfer Company, Cranford,
New Jersey.
CERTAIN ANTI-TAKEOVER DEVICES
Section 203 of the Delaware General Corporation Law applies to Delaware
corporations with a class of voting stock listed on a national securities
exchange, authorized for quotation on an inter-dealer quotation system or held
of record by 2,000 or more persons. In general, Section 203 prevents an
"interested stockholder" (defined generally as any person owning, or who is an
affiliate or associate of the corporation and has owned in the preceding three
years, 15% or more of a corporation's outstanding voting stock and affiliates
and associates of such person) from engaging in a "business combination" (as
defined) with a Delaware corporation for three years following the date such
person became an interested stockholder unless (1) before such person became an
interested stockholder, the board of directors of the corporation approved
either the business
54
<PAGE>
combination or the transaction that resulted in the stockholder becoming an
interested stockholder; (2) the interested stockholder owned at least 85% of the
voting stock of the corporation outstanding at the time the transaction
commenced (excluding stock held by directors who are also officers of the
corporation and by employee stock plans that do not provide employees with the
rights to determine confidentially whether shares held subject to the plan will
be tendered in a tender or exchange offer); or (3) on or subsequent to the date
such person became an interested stockholder, the business combination is
approved by the board of directors of the corporation and authorized at a
meeting of stockholders by the affirmative vote of the holders of two-thirds of
the outstanding voting stock of the corporation not owned by the interested
stockholder. Under Section 203, the restrictions described above also do not
apply to certain business combinations proposed by an interested stockholder
following the announcement or notification of one of certain extraordinary
transactions involving the corporation and a person who had not been an
interested stockholder during the previous three years or who became an
interested stockholder with the approval of a majority of the corporation's
directors.
These provisions could have the effect of delaying, deferring or preventing
a change of control of the Company.
The Commission has indicated that the use of authorized unissued shares of
voting stock could have an anti-takeover effect. In such case, various specific
disclosures to the stockholders are required. Any business combination, as that
term is used in Section 203, would be reviewed by the Company's Board of
Directors solely for its impact on the Company.
The Company has in place a shareholder rights plan which is designed to
distribute preferred stock purchase rights to holders of Common Stock in the
event a person acquires beneficial ownership of fifteen percent or more of the
Company's stock or commences a tender offer which would result in ownership of
fifteen percent or more of such Common Stock. The plan, which expires February
28, 2007, provides for the issuance of a fraction of a share of a new series of
junior preferred stock of the Company for each outstanding share of the
Company's stock. Depending on the circumstances, such new preferred stock will
enable the holders to either buy additional shares of the Company at a discount
or buy an interest in any acquiring entity.
LEGAL MATTERS
The legality of the New Warrants and Common Stock or warrants issuable
thereunder will be passed upon for the Company by Boyer, Ewing & Harris
Incorporated, Houston, Texas.
EXPERTS
The financial statements of the Company as of December 31, 1995 and 1996
and for each of the years in the three year period ended December 31, 1996, have
been included herein and in the Registration Statement in reliance upon the
report of KPMG Peat Marwick LLP, independent certified public accountants,
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing. The report of KPMG Peat Marwick LLP covering the
December 31, 1996, financial statements refers to a change from the successful
efforts method to the full cost method of accounting for oil and gas properties.
The information appearing herein with respect to net proved oil and gas
reserves of the Company at December 31, 1994, 1995 and 1996, was estimated by
Huddleston & Co., Inc., independent petroleum engineers, and at December 31,
1994 was estimated in part by Sherwin D. Yoelin, independent petroleum engineer,
and is included herein on the authority of such engineers as experts in
petroleum engineering.
The discussion of "Certain Federal Income Tax Considerations" included
herein has been passed upon or the company by Looper, Reed, Mark & McGraw,
Incorporated, Houston, Texas.
55
<PAGE>
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Exchange
Act and, in accordance therewith, files reports and other information with the
Commission. Reports, proxy and information statements filed by the Company with
the Commission pursuant to the informational requirements of the Exchange Act
may be inspected and copied at the public reference facilities maintained by the
Commission, at Room 1024, Judiciary Plaza Building, 450 Fifth Street, N.W.
Washington, D.C. 20549, and the Regional offices of the Commission: Seven World
Trade Center, Suite 1300, New York, New York 10048, and Citicorp Center, 500 W.
Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material may
be obtained at prescribed rates from the Public Reference Section of the
Commission at Room 1025, Judiciary Plaza Building, 450 Fifth St., N.W.,
Washington, D.C. 20549. In addition, reports and other information concerning
the Company can be inspected at the offices of the American Stock Exchange,
Inc., 86 Trinity Place, New York, New York 10006-1881, on which the Common Stock
and the Old Public Warrants are listed.
The Company has filed with the Commission a Registration Statement on Form
S-2 (the "Registration Statement") under the Securities Act of 1933, as amended
(the "Act"), with respect to the Common Stock offered hereby. This Prospectus,
filed as part of the Registration Statement, does not contain all the
information set forth in the Registration Statement and the exhibits and
schedules thereto, certain portions of which have been omitted in accordance
with the rules and regulations of the Commission. For further information with
respect to the Company and the Common Stock offered hereby, reference is made to
the Registration Statement and to the exhibits and schedules thereto, which may
be inspected at the Commission's offices without charge or copies of which may
be obtained from the Commission upon payment of the prescribed fees. Statements
made in the Prospectus as to the contents of any contract, agreement or document
referred to are not necessarily complete, and in each instance, reference is
made to the copy of such contract or other document filed as an exhibit to the
Registration Statement.
56
<PAGE>
GLOSSARY OF OIL AND GAS TERMS
AMI. "AMI" means Area of Mutual Interest.
BBL. "Bbl" means barrel. "Mbbl" means thousand barrels. "MMBbl"
means million barrels.
BCF. "Bcf" means billion cubic feet.
BOPD. "BOPD" means barrels of oil (or condensate) per day of
production.
FARMOUT. "Farmout" means an agreement pursuant to which an owner of a
working interest sells a portion of its working interest in
an exploration well or prospect in exchange for either a
payment of previously incurred costs or an agreement to pay
a disproportionate share of future exploration costs. If the
exploration project is unsuccessful, the working interest
farmed out in this manner commonly reverts to the seller.
GROSS ACRES "Gross Acres or Wells" are the total acres or wells, as the
OR WELLS. case may be, in which an entity has an interest, either
directly or through an affiliate.
MCF. "Mcf" means thousand cubic feet. "Mmcf" means million cubic
feet. Natural gas volumes are stated at the legal pressure
base of the state or area in which the reserves are located
at 60 degrees Fahrenheit.
MCFD. "MCFD" means Mcf of gas per day of gas production.
MCFE. "MCFE" means thousand cubic feet of gas equivalent, which is
determined using the ratio of one Bbl of crude oil,
condensate or natural gas liquids to six Mcf of natural gas
so that one Bbl of oil is referred to as six Mcf equivalent
or "MCFE." "MMCFE" means Million cubic feet of gas
equivalent. "BCFE" means billion cubic feet of gas
equivalent.
NET ACRES OR WELLS. A party's "Net Acres" or "Net Wells" are
calculated by multiplying the number of gross acres or gross
wells in which that party has an interest by the fractional
interest of the party in each such acre or well.
NET REVENUE "Net Revenue Interest" reflects the percentage of net
INTEREST. revenues generated by operating activities on a property,
exclusive of any royalty or overriding royalty interests
which may burden that property.
OVERRIDING "Overriding Royalty Interest" is the right to share in the
ROYALTY INTEREST gross revenues generated by a producing property, free of
any costs of exploration, acquisition, development, or
operation, and free of all risks in connection therewith.
PAYOUT. "Payout" refers to the point in time when initial working
interest owners recover a defined portion of acquisition,
exploration, development, and lease operating expenses from
the revenues generated by a property or well.
PRODUCING "Producing Reserves" are Proved Developed Reserves expected
PROPERTIES to be produced from existing completion intervals now open
OR RESERVES. for production in existing wells. A "Producing Property" is
a property to which Producing Reserves have been assigned by
an independent petroleum engineer.
PROVED DEVELOPED "Proved Developed Non-Producing Reserves" (PDNP) are Proved
NON-PRODUCING Developed Reserves that are recoverable from zones behind
RESERVES. cemented casing in existing wells which will require
additional completion work or a future recompletion prior to
the start of production. The cost of making such reserves
available for production is insignificant relative to the
volume of reserves expected to be recovered from the planned
recompletion programs. The PDNP reserves are supported by
actual production performance from wells completed in the
same reservoir elsewhere in the local area.
57
<PAGE>
PROVED DEVELOPED "Proved Developed Producing Reserves" are Proved Developed
PRODUCING Reserves that are recoverable from completion intervals in
RESERVES. existing wells that are currently open and delivering
commercial volumes of hydrocarbons to market.
PROVED DEVELOPED "Proved Developed Reserves" are Proved Reserves which can be
RESERVES. expected to be recovered through existing wells with
existing equipment and operating methods.
PROVED RESERVES. "Proved Reserves" are the estimated quantities of crude oil,
natural gas and natural gas liquids which geological and
engineering data demonstrate with reasonable certainty to be
recoverable in future years from known oil and gas
reservoirs under existing economic and operating conditions,
that is, on the basis of prices and costs as of the date the
estimate is made and any price changes provided for by
existing conditions.
PROVED UNDEVELOPED "Proved Undeveloped Reserves" are Proved Reserves which can
RESERVES. be expected to be recovered from new wells on undrilled
acreage, or from existing wells where a relatively major
expenditure is required for recompletion. The offset units
containing the proved-undeveloped reserves are reasonably
certain of commercial production when drilled.
RESERVES. "Reserves" means crude oil and natural gas, condensate and
natural gas liquids, which are net of leasehold burdens, are
stated on a net revenue interest basis, and are found to be
commercially recoverable.
ROYALTY INTEREST. A "Royalty Interest" is an interest in an oil and gas
property entitling the owner to a share of oil and gas
production (or the proceeds of the sale thereof) free of the
costs of production.
SEC METHOD. The "SEC Method" is a method of determining the present
value of proved reserves. Under the SEC method, the future
net revenues from proved reserves are estimated assuming
that oil and gas prices and production costs remain
constant. The resulting stream of revenues is then
discounted at the rate of 10% per year to obtain a present
value.
SHUT IN. "Shut in" refers to a well or wells which are capable of
producing oil and/or gas, but which are not currently
operational due to required repairs or prevailing economic
conditions.
TRANSITION ZONE. "Transition Zone" is generally the area which may extend up
to five miles on either side of a shallow water coastline.
UNDEVELOPED "Undeveloped Acreage" is oil and gas acreage (including, in
ACREAGE. applicable instances, rights in one or more horizons which
may be penetrated by existing well bores, but which have not
been tested) to which Proved Reserves have not been assigned
by independent petroleum engineers.
WORKING INTEREST. A "Working Interest" is the operating interest under an Oil
and Gas Lease which gives the owner the right to drill,
produce and conduct operating activities on the property and
a share of production, subject to all royalties, overriding
royalties and other burdens and to all costs of exploration,
development and operations and all risks in connection
therewith. If a party owns a "back-in" working interest, it
has the right to acquire a portion of the working interest
owned by another party upon the occurrence of a specified
event, such as payout of the costs incurred by the other
party in drilling a well or undertaking another operation on
the property.
58
<PAGE>
INDEX TO FINANCIAL STATEMENTS
PAGE
Independent Auditors' Report - KPMG Peat Marwick LLP............ F-2
Balance Sheets - December 31, 1995 and December 31, 1996........ F-3
Statements of Operations for the years ended
December 31, 1994, 1995 and 1996............................. F-4
Statements of Stockholders' Equity for the years ended
December 31, 1994, 1995 and 1996.............................. F-5
Statements of Cash Flows for the years ended
December 31, 1994, 1995 and 1996.............................. F-6
Notes to Financial Statements................................... F-7
Balance Sheets - September 30, 1997 (unaudited) and
December 31, 1996 (audited)................................... F-21
Statement of Operations for the nine months
ended September 30, 1997 and 1996 (unaudited)................. F-22
Statements of Stockholders' Equity for the year
ended December 31, 1996 and nine months
ended September 30, 1997 (unaudited).......................... F-23
Statements of Cash Flows for the nine months ended
September 30, 1997 and 1996 (unaudited)....................... F-24
Notes to Financial Statements (unaudited)....................... F-25
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Fortune Natural Resources Corporation:
We have audited the financial statements of Fortune Natural Resources
Corporation (formerly 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 Natural Resources
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
F-2
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
December 31,
---------------------------
1995* 1996
------------ -----------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ............... .................... $ 1,888,000 $ 2,174,000
Accounts receivable ........................................... 1,035,000 695,000
Oil and gas properties held for sale .......................... 1,180,000 --
Prepaid expenses and oil inventory ............................ 127,000 25,000
------------ ------------
Total Current Assets .......................................... 4,230,000 2,894,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method .................................. 20,864,000 23,079,000
Automotive, office and other .................................. 227,000 375,000
------------ ------------
21,091,000 23,454,000
Less - accumulated depletion, depreciation
and amortization ............................................ (10,922,000) (12,545,000)
------------ ------------
10,169,000 10,909,000
OTHER ASSETS:
Materials, supplies and other ................................. 62,000 188,000
Bond issuance costs (net of accumulated amortization of
$180,000 and $238,000 at December 31, 1995
and 1996, respectively) ..................................... 109,000 51,000
Restricted cash ............................................... 3,230,000 2,293,000
------------ ------------
3,401,000 2,532,000
------------ ------------
TOTAL ASSETS .......................................................... $ 17,800,000 $ 16,335,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current portion of long term debt............................... $ 3,208,000 $ 2,253,000
Accounts payable................................................ 280,000 84,000
Accrued expenses................................................ 96,000 77,000
Royalties and working interests payable......................... 94,000 103,000
Accrued interest ............................................... 119,000 101,000
------------ -------------
Total Current Liabilities....................................... 3,797,000 2,618,000
------------ -------------
LONG-TERM DEBT, net of current portion ................................ 1,689,000 680,000
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value:
Authorized -- 2,000,000 shares
Issued and outstanding -- None................................. - -
Common stock, $.01 par value
Authorized -- 40,000,000 shares
Issued and outstanding -- 11,139,709 and 11,853,663 shares at
December 31, 1995 and 1996, respectively................... 111,000 119,000
Capital in excess of par value................................. 27,228,000 29,273,000
Accumulated deficit............................................ (15,025,000) (16,355,000)
----------- -------------
NET STOCKHOLDERS' EQUITY.............................................. 12,314,000 13,037,000
------------ -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............................ $ 17,800,000 $ 16,335,000
============ =============
</TABLE>
*Restated.
See accompanying notes to financial statements.
F-3
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
------------------------------------------
1994* 1995* 1996
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES:
Sales of oil and gas, net of royalties $ 3,339,000 $ 2,959,000 $ 3,825,000
Other income ......................... 58,000 184,000 215,000
------------ ------------ ------------
3,397,000 3,143,000 4,040,000
------------ ------------ ------------
OPERATING EXPENSES
Production and operating ............. 1,090,000 1,514,000 1,172,000
Provision for depletion, depreciation
and amortization ................... 1,708,000 1,816,000 1,623,000
General and administrative ........... 1,020,000 1,212,000 1,924,000
Executive severance .................. 225,000 -- --
Corporate relocation ................. -- -- 216,000
Interest ............................. 460,000 870,000 435,000
Loss on sale of oil and gas properties -- 3,607,000 --
Impairment to oil and gas properties . 3,347,000 -- --
------------ ------------ ------------
7,850,000 9,019,000 5,370,000
------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES ...... (4,453,000) (5,876,000) (1,330,000)
PROVISION FOR INCOME TAXES .................. -- -- --
------------ ------------ ------------
NET LOSS .................................... $ (4,453,000) $ (5,876,000) $ (1,330,000)
============ ============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING ................. 2,638,672 6,555,875 11,351,211
============ ============ ============
NET LOSS PER COMMON SHARE ................... $ (1.69) $ (0.90) $ (0.12)
============ ============ ============
</TABLE>
*Restated.
See accompanying notes to financial statements.
F-4
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<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.
F-5
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31,
------------------------------------------
1994* 1995* 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ........................................................ (4,453,000) $ (5,876,000) $ (1,330,000)
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
Common stock issued for directors' fees,
compensation and consulting fees .......................... 14,000 39,000 4,000
Depletion, depreciation and amortization ...................... 1,708,000 1,816,000 1,623,000
Amortization of deferred financing cost ....................... -- 172,000 74,000
Impairment to oil and gas properties .......................... 3,347,000 -- --
Loss on sale of oil and gas properties ........................ -- 3,607,000 --
Provision for executive severance ............................. 225,000 (17,000) --
Non-cash compensation expense ................................. -- -- 20,000
Changes in assets and liabilities:
Accounts receivable ........................................... 24,000 (485,000) 340,000
Prepaids and oil inventory .................................... (45,000) (13,000) 102,000
Accounts payable and accrued expenses ......................... (202,000) (95,000) (215,000)
Payment of executive severance ................................ (66,000) (111,000) --
Royalties and working interest payable ........................ (13,000) 41,000
9,000
Accrued interest .............................................. 31,000 (11,000) (18,000)
Materials, supplies and other ................................. (79,000) 189,000 (2,000)
------------ ------------ ------------
Net cash provided by (used in) operating activities ............. 491,000 (744,000) 607,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties ......................... (4,265,000) (5,654,000) (3,232,000)
(Increase) decrease in restricted cash .......................... -- (3,230,000) 937,000
Proceeds from sale of properties and equipment .................. 8,000 -- 2,197,000
Expenditures for other property and equipment ................... (30,000) 16,000 (297,000)
------------ ------------ ------------
Net cash used in investing activities ........................... (4,287,000) (8,868,000) (395,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ........................ 4,680,000 -- --
Proceeds from notes to stockholders ............................. 750,000 -- --
Repayment of long term debt ..................................... (1,326,000) (1,651,000) (1,979,000)
Proceeds from issuance of common stock .......................... 12,000 15,220,000 2,168,000
Expenditures for offering costs ................................. (29,000) (2,467,000) (115,000)
Common stock repurchase ......................................... (2,000) -- --
------------ ------------ ------------
Net cash provided by financing activities ....................... 4,085,000 11,102,000 74,000
------------ ------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS ............................ 289,000 1,490,000 286,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ......................... 109,000 398,000 1,888,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR ............................... $ 398,000 $ 1,888,000 $ 2,174,000
============ ============ ============
Supplemental information:
Interest paid in cash ............................................ $ 400,000 $ 692,000 $ 361,000
Common stock issued or issuable as directors' fees ............... 14,000 39,000 4,000
Common stock issued for payment of executive severance ........... -- 43,000 --
Common stock issued to acquire LEX ............................... -- 2,492,000 --
Common stock and warrants issued for payment of investment
banking fees ................................................... -- 265,000 --
Common stock issued for conversion of debt ....................... -- 575,000 --
Value of California assets transferred to oil and gas
properties held for sale ....................................... -- 1,180,000 --
</TABLE>
*Restated.
See accompanying notes to financial statements.
F-6
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
(1) GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fortune Natural Resources Corporation (formerly Fortune Petroleum
Corporation) ("Fortune" or the "Company"), 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.
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.
F-7
<PAGE>
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.
(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)
F-8
<PAGE>
(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 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
F-9
<PAGE>
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>
F-10
<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 Debenture holders 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
shares 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
Debenture holders 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.
F-11
<PAGE>
Under the Bank One, Texas, N.A. (the "Bank") credit facility, the Company
has the ability to borrow amounts up to an available borrowing base as defined
in the credit agreement. The amount the Company may borrow under the credit
facility is determined by the borrowing base as calculated by the Bank
semi-annually on the basis of the Company's oil and gas reserves. The credit
facility contains various financial covenants, is secured by all of the
Company's oil and gas producing properties and currently requires monthly
principal payments of $75,000. At December 31, 1995, the Company was not in
compliance with its cash flow coverage ratio covenant in the credit agreement.
Under the terms of the 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:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards........ $ 2,976,000 $ 4,354,000
Oil and Gas Properties difference
in accumulated depletion.............. 1,544,000 586,000
----------- -----------
4,520,000 4,940,000
Less valuation allowance (100%)......... 4,520,000 4,940,000
----------- -----------
Net deferred taxes...................... $ - $ -
=========== ===========
</TABLE>
At December 31, 1996, the Company estimates it had cumulative net operating
loss carryforwards for federal income tax purposes of $12.8 million which is
significantly restricted under IRC Section 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.
F-12
<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 the 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
alleging that suspicious trading activity in Fortune stock occurred immediately
prior to and during the time period in which the additional-share allocation was
computed. Fortune believes that it has discovered evidence of active market
manipulation in the Common Stock by these plaintiffs; accordingly, it has
commenced a countersuit for damages suffered by the Company and its shareholders
as a result of these acts. Fortune intends to continue to vigorously defend the
remaining litigation.
F-13
<PAGE>
(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.
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.
F-14
<PAGE>
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 company 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.
F-15
<PAGE>
Stock option transactions were:
<TABLE>
<CAPTION>
Weighted Average
Common Stock Of Exercise Price of
Options Exercisable(a) Shares Under Plans
--------------------- ---------------------
<S> <C> <C>
Balance, December 31, 1993.......... 54,438 $ 2.69
Granted............................. 356,000 2.71
Exercised........................... (4,688) 2.60
Forfeited........................... - -
---------- --------
Balance, December 31, 1994.......... 405,750 2.71
Granted............................. 289,000 2.46
Exercised........................... (202,481) 2.26
Forfeited........................... - -
---------- --------
Balance, December 31, 1995.......... 492,269 2.75
Granted............................. 505,000 3.07
Exercised........................... (46,150) 2.47
Forfeited........................... (16,410) 2.75
---------- --------
Balance, December 31, 1996.......... 934,709 $ 2.93
========== ========
</TABLE>
(a) Table includes 80,000 Common Stock warrants which were issued to employees
in 1995 and 1996 in lieu of Common Stock options.
All options are immediately exercisable upon grant. At December 31, 1996,
the Company had 16,400 Common Stock options available for grant under the 1993
Stock Option Plan. All options under all other plans have been granted. In
January 1995, the Company reduced the exercise price on 45,000 common stock
options held by Daniel E. Pasquini, the former president of the Company, from
$2.75 per share to $0.58 per share. (See note 10.) On January 12, 1995, the
prices of the options granted in 1991, 1993, 1994, and 1995 were reduced from
$6.00, $5.00, $5.48, and $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:
<TABLE>
<CAPTION>
Options Outstanding and Exercisable
------------------------------------------------------
Weighted
Average Weighted
Range of Remaining Average
Exercise Number Contractual Exercise
Price Outstanding Life Price
--------------- ------------ --------------- -------------
<S> <C> <C> <C>
$2.60 to $3.13 934,709 3.5 years $2.93
</TABLE>
F-16
<PAGE>
At December 31, 1996 the Company's outstanding warrants to purchase Common
Stock consisted of (d):
<TABLE>
<CAPTION>
Number of Warrants Exercise Price Expiration Date
------------------ -------------- ---------------
<S> <C> <C>
45,000 $ 1.88 - 2.40 1/15/97
150,000 $ 4.63 - 6.00 12/11/97
45,000 $ 3.00 2/15/98
75,000 $ 2.68 8/29/98
138,888 $ 3.89 9/28/98
64,015 $ 4.41 9/28/98 (a)
1,982,750 $ 3.75 9/28/98 (b)
31,500 $ 11.14 10/05/98 (c)
206,000 $ 3.50 12/3/98
35,000 $ 2.75 1/06/00
1,200,000 $ 4.75 5/12/00
400,000 $ 2.40 6/25/00
100,000 $ 4.75 8/01/00
60,000 $ 3.63 9/06/00
30,000 $ 2.44 8/29/01
-----------
4,563,153
</TABLE>
(a) Warrants permit the holder to purchase 88,289 total shares of Common Stock.
(b) Warrants permit the holders to purchase 2,841,610 total shares of Common
Stock.
(c) Each warrant permits the holder to purchase 3.3 shares of Common Stock plus
two stock purchase warrants, expiring September 28, 1998. Each stock
purchase warrant permits the holder to purchase 1.43 additional share of
Common Stock at an exercise price of $3.75.
(d) Table excludes warrants which have been issued to employees in lieu of
stock options.
(12) MAJOR CUSTOMER
The Company sold oil representing 54% of its oil production under contracts
to one customer for the year ended December 31, 1996. 86% of the Company's gas
production was sold to four customers (26%, 23%, 20% and 17%, respectively) for
the year ended December 31, 1996.
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.
F-17
<PAGE>
(14) RETIREMENT PLAN
During 1996, the Company adopted the Fortune Natural Resources Corporation
401(k) Profit Sharing Plan for its eligible employees. Under the plan, all
employees on the Company's payroll as of November 1, 1996, and all employees
hired after that date who have attained age 21 and three months of service, are
permitted to make salary deferrals up to the lesser of 15% of their annual
compensation or $9,500. Salary deferrals will be matched 50% by the Company and
are 100% vested after two years of service with the Company. Salary deferrals
are 100% vested at all times. The Company does not make profit sharing
contributions to the plan. For 1996, the Company's matching contribution was
$14,000, all of which will be paid in shares of Common Stock.
(15) SUBSEQUENT EVENTS
On February 26, 1997, the Company closed an Exchange Offer which resulted
in a portion of its 10-1/2% Convertible Subordinated Debentures being converted
into Common Stock and Common Stock Warrants. (See note 6.)
(16) UNAUDITED OIL AND GAS PRODUCING ACTIVITIES AND OIL AND GAS COST INFORMATION
All of the Company's reserves are located within the United States. Proved
reserves represent estimated quantities of crude oil and natural gas which
geological and engineering data demonstrate to be reasonably certain to be
recoverable in the future from known reservoirs under existing economic and
operating conditions. Proved developed oil and gas reserves are reserves that
can be expected to be recovered through existing wells using existing equipment
and operating methods.
For the year ended December 31, 1994, the oil and gas reserve estimates
were reviewed by Huddleston & Co., Inc., ("Huddleston") Houston, Texas,
independent petroleum engineers, and Sherwin D. Yoelin, independent petroleum
engineer, and for the years ended December 31, 1995 and 1996, by Huddleston, in
accordance with guidelines established by the Securities and Exchange
Commission. Such estimates are subject to numerous uncertainties inherent in the
estimation of quantities of proved reserves and in the projection of future
rates of production, prices and the timing of development expenditures. The
future cash inflow, as reflected in the "Standardized Measure of Discounted
Future Net Cash Flows Relating to Proved Oil and Gas Reserves," determined from
such reserve data are estimates only, and the present values thereof should not
be construed to be the current market values of the Company's oil and gas
reserves or the costs that would be incurred to obtain equivalent reserves.
Changes in Estimated Reserve Quantities
The Company's net interests in estimated quantities of proved developed and
undeveloped reserves of crude oil and natural gas at December 31, 1994, 1995,
and 1996, and changes in such quantities during the years, 1994, 1995 and 1996,
were as follows:
<TABLE>
CRUDE OIL (Barrels)
----------------------------
(in thousands)
Year Year Year
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
BEGINNING OF PERIOD........................... 813 1,647 347
Revisions of previous estimates........... 866 (160) 6
Extensions and discoveries................... - - 106
Production................................... (88) (92) (57)
Purchase of minerals in place............. 56 174 -
Sales of minerals in place*.................. - (1,222) (153)
-------- -------- --------
END OF PERIOD.................................. 1,647 347 249
======== ======== ========
Proved developed reserves
Beginning of period........................ 666 675 324
======== ======== ========
End of period.............................. 675 324 160
======== ======== ========
</TABLE>
F-18
<PAGE>
<TABLE>
<CAPTION>
NATURAL GAS (Mcf)
----------------------------
(in thousands)
Year Year Year
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
BEGINNING OF PERIOD........................... 5,562 5,911 5,938
Revisions of previous estimates........... 533 (388) (753)
Extensions and discoveries................... - - 85
Production................................... ( 1,017) (909) (1,038
Purchase of minerals in place............. 833 2,934 -
Sales of minerals in place*.................. - (1,610) (751)
-------- -------- --------
END OF PERIOD.................................. 5,911 5,938 3,481
Proved developed reserves ======== ======== ========
Beginning of period........................ 4,221 3,317 4,686
======== ======== ========
End of period.............................. 3,317 4,686 1,749
======== ======== ========
</TABLE>
* During 1995, the Company's interests in its California properties, which
were sold in February 1996, were transferred to oil and gas properties held
for sale.
NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVES
This statement attempts to present future net cash flows related to proved
oil and gas reserves without the subjectivity inherent in either direct
estimation of market value or entity specific discounted net cash 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.
F-19
<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.
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
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
======== ======== =======
</TABLE>
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET
CASH FLOWS FROM PROVEN RESERVE QUANTITIES
This statement discloses the sources of changes in the standardized measure
from period to period. The amount reported as "Net change in sales and transfer
prices net of production costs" represents the approximate effect of increasing
the evaluation of reserves proved in prior periods to reflect higher prices in
effect in the following years. The "Accretion of discount" was computed by
applying the 10 percent discount factor to the valuation of the proved reserves
as of the beginning of the period before income tax effects. "Changes in
estimated future development costs" arise from: (1) revisions of previous
estimates for both development costs actually incurred in the current period and
for development costs estimated to be incurred in succeeding periods and (2) new
discoveries from which future development must be performed. The "Sales and
transfers, net of production costs" are expressed in actual dollar amounts.
"Revisions of quantity estimates" are expressed at period-end prices. The "Net
change in income taxes" is computed as the change in present value of future
income taxes. The "Changes in production rates (timing) and other" reflects all
other changes, such as changes in timing, and includes the residual from
estimation errors in computing other elements of change. The average gas prices
received by the Company were $1.39, $2.32 and $4.04 per Mcf at year end 1994,
1995 and 1996, respectively. The average oil prices received by the Company were
$14.62, $16.10 and $22.79 per Bbl at year end 1994, 1995 and 1996, respectively.
At February 26, 1997, the Company was receiving an average of approximately
$2.96 per Mcf for its gas production and $20.62 per Bbl for its oil production.
These current prices represent declines from December 1996 and January 1997
prices and the Company expects further price declines through the spring and
summer of 1997.
<TABLE>
<CAPTION>
1994 1995 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
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
======== ======== ========
</TABLE>
*During 1995, the Company's interests in its California properties, which were
sold in February 1996, were transferred to oil and gas properties held for sale.
F-20
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ....................... $ 1,239,000 $ 2,174,000
Accounts receivable ............................. 995,000 695,000
Prepaid expenses ................................ 7,000 25,000
------------ ------------
Total Current Assets ........................ 2,241,000 2,894,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method .................... 26,290,000 23,079,000
Office and other ................................ 374,000 375,000
------------ ------------
26,664,000 23,454,000
Less -- accumulated depletion,
depreciation and amortization ................. (17,343,000) (12,545,000)
------------ ------------
9,321,000 10,909,000
------------ ------------
OTHER ASSETS:
Materials, supplies and other ................... 111,000 188,000
Debt issuance costs (net of accumulated
amortization of $303,000 and $238,000 at
September 30, 1997 and
December 31, 1996, respectively) .............. 158,000 51,000
Restricted cash ................................. -- 2,293,000
------------ ------------
269,000 2,532,000
------------ ------------
TOTAL ASSETS ......................................... $ 11,831,000 $ 16,335,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
------------ ------------
1997 1996
CURRENT LIABILITIES:
Current portion of long-term debt ............... $ 1,022,000 $ 2,253,000
Accounts payable ................................ 498,000 84,000
Accrued expenses ................................ 375,000 77,000
Royalties and working interests payable ......... 51,000 103,000
Accrued interest ................................ 55,000 101,000
------------ ------------
Total Current Liabilities ................... 2,001,000 2,618,000
------------ ------------
LONG-TERM DEBT, net of current portion .............. 865,000 680,000
------------ ------------
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 12,128,752 and
11,853,663 at September 30, 1997 and
December 31, 1996, respectively ............. 121,000 119,000
Capital in excess of par value .................. 30,283,000 29,273,000
Accumulated deficit ............................. (21,439,000) (16,355,000)
------------ ------------
NET STOCKHOLDERS' EQUITY ............................. 8,965,000 13,037,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ........... $ 11,831,000 $ 16,335,000
============ ============
</TABLE>
See accompanying notes to financial statements.
F-21
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30, September 30,
1997 1996*
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties ........... $ 2,870,000 $ 2,830,000
Other income ..................................... 137,000 160,000
------------ ------------
3,007,000 2,990,000
------------ ------------
COSTS AND EXPENSES
Production and operating ......................... 940,000 1,000,000
Provision for depletion, depreciation
and amortization ............................... 1,609,000 1,079,000
Impairment to oil and gas properties ............. 3,200,000 --
General and administrative ....................... 1,481,000 1,418,000
Office relocation and severance .................. -- 207,000
Debt conversion expense .......................... 316,000 --
Stock offering cost .............................. 323,000 --
Interest ......................................... 222,000 338,000
------------ ------------
8,091,000 4,042,000
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES ................ (5,084,000) (1,052,000)
PROVISION FOR INCOME TAXES ............................ -- --
------------ ------------
NET LOSS .............................................. $ (5,084,000) $ (1,052,000)
============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING ........................... 12,074,959 11,284,701
============ ============
NET LOSS PER COMMON SHARE ............................. $ (0.42) $ (0.09)
============ ============
</TABLE>
*Restated
See accompanying notes to financial statements.
F-22
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1996
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
Capital in
Common Stock Excess of Accumulated
-------------------------
Shares Amount Par Value Deficit Net
---------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C>
BALANCE, January 1, 1996* .................. 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
------------ ------------ ------------ ------------ ------------
Common stock issued for
exercise of stock options .............. 6,400 -- 18,000 -- 18,000
Common stock issued for
exercise of warrants ................... 45,000 -- 89,000 -- 89,000
Common stock issued in exchange
for debentures, net of offering costs .. 218,858 2,000 889,000 -- 891,000
Common stock contributed to
Company 401(k) Plan .................... 4,835 -- 14,000 -- 14,000
Common stock returned to treasury .......... (4) -- -- -- --
Net loss ................................... -- -- -- (5,084,000) (5,084,000)
------------ ------------ ------------ ------------ ------------
BALANCE, September 30, 1997 (unaudited)..... 12,128,752 $ 121,000 $ 30,283,000 $(21,439,000) $ 8,965,000
============ ============ ============ ============ ============
</TABLE>
*Restated
See accompanying notes to financial statements.
F-23
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Nine Months Ended
--------------------------
September 30, September 30,
1997 1996*
----------- -----------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ..................................................... $(5,084,000) $(1,052,000)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Common stock issued for directors' fees .................. -- 4,000
Depletion, depreciation and amortization ................. 1,609,000 1,079,000
Non-cash compensation expense ............................ 57,000 --
Amortization of deferred financing cost .................. 62,000 56,000
Impairment of oil and gas assets ......................... 3,200,000 --
Debt conversion expense .................................. 316,000 --
Stock offering cost ...................................... 323,000 --
Changes in assets and liabilities:
Accounts receivable ...................................... (300,000) 488,000
Prepaids ................................................. 18,000 65,000
Accounts payable and accrued expenses .................... 713,000 (86,000)
Royalties and working interest payable ................... (52,000) (74,000)
Accrued interest ......................................... (46,000) (62,000)
----------- -----------
Net cash provided by operating activities .................... 816,000 418,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties ...................... (3,414,000) (2,253,000)
Restricted cash used ......................................... 138,000 450,000
Return of exploration venture restricted cash ................ 2,154,000 --
Proceeds from sale of properties and equipment ............... 203,000 2,018,000
Expenditures for other property and equipment and other assets (26,000) (233,000)
----------- -----------
Net cash used in investing activities ........................ (945,000) (18,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ..................... 65,000 --
Repayment of long term debt .................................. (450,000) (1,754,000)
Proceeds from issuance of common stock ....................... 103,000 903,000
Expenditures for debenture exchange and stock offering ....... (353,000) (28,000)
Expenditures for debt refinancing ............................ (171,000) --
----------- -----------
Net cash used in financing activities ........................ (806,000) (879,000)
----------- -----------
NET DECREASE IN CASH AND CASH EQUIVALENTS ......................... (935,000) (479,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .................... 2,174,000 1,888,000
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD .......................... $ 1,239,000 $ 1,409,000
=========== ===========
Supplemental information:
Interest paid in cash ........................................ $ 160,000 $ 283,000
Non-cash transactions
Common stock issued or issuable as directors' fees ........... -- 4,000
Common stock issued for conversion of debt ................... 975,000 --
Common stock issued for 401(k) Plan contribution ............. 14,000 --
</TABLE>
*Restated
See accompanying notes to financial statements.
F-24
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS
September 30, 1997
(1) LINE OF BUSINESS AND BASIS OF PRESENTATION
The condensed financial statements at September 30, 1997, and for the three
months and nine months then ended included herein have been prepared by Fortune
Natural Resources Corporation ("Fortune" or the "Company"), without audit,
pursuant to the Rules and Regulations of the Securities and Exchange Commission.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such Rules and Regulations, although
the Company believes that the disclosures are adequate to make the information
presented not misleading. These condensed financial statements should be read in
conjunction with the financial statements and the notes thereto included in the
Company's latest annual report on Form 10-K/A. Certain reclassifications have
been made to prior period amounts to conform to presentation in the current
period. In the opinion of the Company, the financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary to
present fairly the financial position of the Company as of September 30, 1997
and December 31, 1996, the results of its operations for the three months and
nine months ended September 30, 1997 and September 30, 1996, and cash flows for
the nine months ended September 30, 1997 and 1996. The results of the operations
for such interim periods are not necessarily indicative of the results for the
full year.
In the fourth quarter of 1996, the Company changed its method of accounting
for oil and gas operations from the successful efforts to the full cost method.
All prior year financial statements presented herein have been restated to
reflect the change.
The Company has in place a shareholder rights plan which is designed to
distribute preferred stock purchase rights to holders of the Company' Common
Stock in the event a person acquires beneficial ownership of fifteen percent or
more of the Company's stock or commences a tender offer which would result in
ownership of fifteen percent or more of such Common Stock. The plan, which
expires February 28, 2007, provides for the issuance of a fraction of a share of
a new series of junior preferred stock of the Company for each outstanding share
of the Company's stock. Depending on the circumstances, such new preferred stock
will enable the holders to either buy additional shares of Common Stock of the
Company or any acquiring entity at a 50% discount.
(2) LONG-TERM DEBT
At September 30, 1997, a summary of long-term debt is as follows:
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------ ------------
<S> <C> <C>
Convertible Subordinated Debentures of $1,028,000 at September 30, 1997
and $1,725,000 at December 31, 1996 (net of discount of $6,000 and
$57,000) due December 31, 1997, including interest of 10-1/2%
per annum paid semi-annually............................................ $ 1,022,000 $ 1,683,000
Bank credit facility due July 11, 1999, including interest
at 1.25% over bank's base rate payable quarterly........................ 865,000 1,250,000
------------ -----------
Total long-term debt....................................................... 1,887,000 2,933,000
Less current installments.................................................. 1,022,000 2,253,000
------------ -----------
Long-term debt, excluding current installments............................. $ 865,000 $ 680,000
============ ===========
</TABLE>
F-25
<PAGE>
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, 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 recorded a non-cash debt conversion expense of $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.
On July 11, 1997, the Company refinanced its bank debt by entering into a
$20 million credit facility with Credit Lyonnais New York Branch ("Credit
Lyonnais"). The Credit Lyonnais facility is due July 11, 1999, extendable for
one year upon mutual consent. Under the new credit facility, the Company may
initially borrow up to a pre-determined borrowing base, for acquisitions and
development projects approved by Credit Lyonnais at either 1.25% above Credit
Lyonnais' base rate or 4% above LIBOR. The borrowing base, currently set at $2
million, was calculated based upon the Company's July 1, 1997 oil and gas
reserves and is subject to semi-annual review. The Credit Lyonnais facility is
secured by a mortgage on all of the Company's existing proved oil and gas
properties. The Company is also required to pay a commitment fee of 0.5% on the
unused portion of the borrowing base. The Company previously had a credit
facility in place with Bank One, Texas, N.A. which was due October 1, 1997, bore
interest at 1.5% over Bank One's prime rate and required monthly principal
payments of $75,000.
The Company's maturities of long-term debt over the next three years are as
follows:
Year Debt
-------- ------------
1997 $ 1,022,000
1998 -
1999 865,000
------------
$ 1,887,000
============
(3) INCOME TAX EXPENSE
No provision for income taxes was required for the three months and nine
months ended September 30, 1997.
At September 30, 1997, the Company estimates it had cumulative net
operating loss carryforwards for federal income tax purposes of $14 million
which are significantly restricted under IRC Section 382. These carryforwards
are available to offset future federal taxable income, if any, with various
expirations through 2010. The Company is uncertain as to the recoverability of
the above deferred tax assets and has therefore applied a 100% valuation
allowance.
F-26
<PAGE>
The Company has available IRC Section 29 Tax Credits that may be used to
reduce or eliminate any corporate taxable income in future years. 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.
(4) LEGAL PROCEEDINGS
There are no material pending legal proceedings involving any of the
Company's properties or which involve a claim for damages which exceed 10% of
the Company's current assets.
On April 16, 1996, Fortune was served with two lawsuits which had been
filed in the Federal District Court in New York by 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 plaintiffs acquired their shares,
each was entitled to receive additional shares of Fortune Common 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 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 received leave of court to add third-party defendants whose
actions furthered this market manipulation. Fortune intends to continue to
vigorously defend plaintiff's actions and prosecute its own counterclaims.
Discovery is continuing in these actions and a consolidated trial is expected in
the first quarter of 1998.
(5) COMPUTATION OF LOSS PER SHARE
Primary loss per common share is computed by dividing net loss by the
weighted average number of common and common equivalent shares outstanding.
Common equivalent shares are shares which may be issuable upon exercise of
outstanding stock options and warrants; however, they are not included in the
computation for the nine-month and three-month periods ended September 30, 1997
since they would not have a dilutive effect on earnings per share.
Fully diluted earnings per common share are not presented, since the
conversion of the Company's 10-1/2% Convertible Subordinated Debentures would
have an anti-dilutive effect.
(6) RETURN OF EXPLORATION VENTURE RESTRICTED CASH
On June 4, 1997, the Company exercised its right under the exploration
agreement between it and Zydeco Exploration, Inc. ("Zydeco") to have unexpended
capital contributions returned to Fortune. Under the terms of the February 13,
1995 agreement, Fortune contributed a total of $4,800,000 which was to be
expended for certain leasehold and seismic costs incurred by the venture within
the Transition Zone and Timbalier Trench areas of offshore Louisiana. Of that
total, $2,154,000 remained unspent as of June 4, 1997. This amount was returned
to Fortune in June 1997. Fortune will retain its current undivided 50% working
interest in each of the existing exploration projects that are currently subject
to the agreement. The Company's 50% working interest in each project is subject
to a proportionate reduction in the event that Zydeco expends additional funds
on such project.
F-27
<PAGE>
(7) IMPAIRMENT TO OIL AND GAS PROPERTIES
In connection with requesting the return of unexpended funds from its
exploration venture with Zydeco, the Company reviewed for impairment its $4.3
million remaining unevaluated investment in the Zydeco exploration venture
properties. The $4.3 million investment includes the value of the Fortune Common
Stock that was issued in 1995 to acquire its interest in the exploration venture
as well as the funds that Fortune has incurred for leases and seismic in the
exploration venture. As a result of this review, Fortune transferred $2.6
million of costs associated with the Zydeco exploration venture properties to
the evaluated property account during the second quarter of 1997. At the same
time, the Company also transferred its $300,000 remaining unevaluated investment
in its New Mexico properties to the evaluated property account. Furthermore, the
Company's unsuccessful well at South Lake Arthur was charged to the evaluated
property account in the second quarter of 1997. As a result, the Company has
recorded impairments to oil and gas properties through the second quarter of
1997 of $3.2 million.
(8) SUBSEQUENT EVENTS
Through November 13, 1997, the Company has sold $2,800,000 of 12%
Convertible Subordinated Notes due December 31, 2007 (the "Notes") in connection
with a private placement of up to $4.5 million of such Notes. The Notes are
convertible into the Company's Common Stock at a conversion price of $3.00 per
share, subject to adjustment. The Notes are convertible by the holders after May
1, 1999, subject to a one-time option by the holders to convert at a lower
conversion price prior to that date in the event that the Company sells shares
of its Common Stock at a price below the conversion price. The Notes are
redeemable by the Company after May 1, 1999, at a premium that reduces monthly
from 10% to zero over an 18-month period. Any such premium on redemption is
waived in the event that the Company's Common Stock price averages at least
$4.50 per share for 30 consecutive trading days. The holders of the Notes will
be entitled to receive additional shares upon conversion in the event that the
Company's Common Stock price averages less than the conversion price for a
certain period prior to May 1, 1999. The Notes are subordinate to all of the
Company's secured debt, including the credit facility with Credit Lyonnais. The
Notes bear interest at a rate of 12% per year, payable quarterly. The Company
has received proceeds, net of offering fees and commissions, of $2,446,000
through November 13, 1997. The private placement of Notes is set to expire on
November 19, 1997; however, there can be no assurance that the Company will sell
any additional Notes prior to the expiration date. The proceeds of the private
placement will be used to refinance existing debt, including the repayment of
the Company's Debentures that are due December 31, 1997. In connection
therewith, the Company has called for the redemption of those Debentures for
December 5, 1997. Additionally, up to $855,000 of the net proceeds received from
the private placement in excess of $2.5 million will be used to reduce the
Company's $865,000 of borrowings under its credit facility with Credit Lyonnais.
Net proceeds through November 13, 1997 are $2.4 million, thus no reduction to
the credit facility has occurred. All other proceeds from the offering will be
used for general corporate purposes.
The Notes were sold under a placement agreement with J. Robbins Securities,
L.L.C. (the "Placement Agent"). The Placement Agent is receiving a ten percent
sales commission, a three percent non-accountable expense allowance and warrants
to purchase a number of shares of Common Stock determinable by multiplying the
gross proceeds received in the offering by approximately .0278. The warrants are
exercisable over a five-year period at $3.60 per share. Barry W. Blank, a
beneficial owner of more than five percent of the Company's Common Stock, is a
branch manager for the Placement Agent and is marketing substantially the entire
private placement. As such, Mr. Blank will earn 50% of the fees and commissions
paid to the Placement Agent for the Notes sold by him. Mr. Blank will also
receive 20% of the warrants payable to the Placement Agent. Five hundred
thousand dollars of the Notes has been acquired by a trust established by and,
under certain circumstances, for the benefit of Mr. Blank. Barry Feiner, a
director of the Company, is acting as outside counsel for the Placement Agent in
connection with the private placement. If all of the Notes are sold, Mr. Feiner
will earn $45,000 in legal fees from the Placement Agent, $20,000 of which have
been paid to Mr. Feiner as of November 13, 1997.
F-28
<PAGE>
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER. THIS PROSPECTUS DOES
NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES
OR AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY
JURISDICTION WHERE SUCH AN OFFER OR SOLICITATION WOULD BE UNLAWFUL. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
---------------------
TABLE OF CONTENTS
Page
Prospectus Summary 3
Risk Factors 9
Dividend Policy 13
Price Range of Securities 14
Selected Financial and Operating Data 15
Management's Discussion and
Analysis of Financial Condition
And Results of Operations 16
Business and Properties 23
Management 35
Certain Relationships and Related
Transactions 39
Principal Stockholders 42
The Exchange Offer 44
Certain Federal Income Tax Considerations 49
Description of Securities 51
Legal Matters 55
Experts 55
Additional Information 56
Glossary of Oil and Gas Terms 57
Index to Financial Statements F-1
===============================================
EXCHANGE OFFER
COMMON STOCK
PURCHASE
WARRANTS
FORTUNE NATURAL
RESOURCES CORPORATION
P R O S P E C T U S
FEBRUARY 12, 1998
===============================================
<PAGE>
