AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON OCTOBER ___, 1998
REGISTRATION STATEMENT NO. 333-____________
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------
FORM S-2
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
------------------------------
FORTUNE NATURAL RESOURCES CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 1311 95-4114732
(State of other jurisdiction (Primary Standard (I.R.S. Employer
of incorporation or Industrial Classification Identification No.)
or organization) Code Number)
515 WEST GREENS ROAD, SUITE 720
HOUSTON, TEXAS 77067
(281) 872-1170
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
DEAN W. DRULIAS, ESQ.
FORTUNE NATURAL RESOURCES CORPORATION
515 WEST GREENS ROAD, SUITE 720
HOUSTON, TEXAS 77067
(281) 872-1170
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
COPIES TO:
RITA J. LEADER
BOYER, EWING & HARRIS INCORPORATED
THE COASTAL TOWER
NINE GREENWAY PLAZA, SUITE 3100
HOUSTON, TEXAS 77046
(713) 871-2025
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED
SALE TO THE PUBLIC: As soon as practicable after
this Registration Statement becomes effective.
------------------------------
If any of the securities being registered on this Form are to be
offered on a delayed or continuous basis pursuant to Rule 415 under the
Securities Act of 1933, check the following box. [ X ]
If the registrant elects to deliver its latest annual report to
security holders, or a complete and legible facsimile thereof, pursuant to Item
11(a)(1) of this Form, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule
462(c) under the Securities Act, check the following box and list the Securities
Act registration statement number of the earlier effective registration
statement for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to Rule
434, please check the following box. [ ]
------------------------------
<PAGE>
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
=======================================================================================================================
Proposed Maximum
Title of Each Class of Amount to Proposed Maximum Aggregate Amount of
Securities to be Registered be Registered Offering Price (1) Offering Price (1) Registration Fee
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
12% Convertible Subordinated Notes
due 2007............................ $3,225,000 100% $3,225,000 $951
Common Stock, $.01 par value.......... (2) (2) (2) None (2)
Common Stock, $.01 par value.......... 89,583(3) $3.125(4) $ 117,577 $ 35
======================================================================================================================
</TABLE>
(1) Estimated solely for purposes of calculating the registration fee.
(2) Such indeterminate number of shares of Common Stock as shall be issuable
on conversion of the Notes being registered hereunder. No additional
consideration will be received for the Common Stock and therefore no
registration fee is required pursuant to Rule 457(i).
(3) Shares of Common Stock issuable under the warrants issued to the
underwriter of the offering of the Notes. Also covers any additional
shares of Common Stock issuable by reason of the anti-dilution provisions
of the warrants.
(4) Pursuant to Rule 457(c), the proposed maximum offering price is based on
the average of the high and low prices quoted on the American Stock
Exchange on October 14, 1998.
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE
OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO
SECTION 8(A), MAY DETERMINE.
INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT
SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES
AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL
THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN
ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
<PAGE>
SUBJECT TO COMPLETION, DATED OCTOBER ___, 1998
LOGO
$3,225,000
12% CONVERTIBLE SUBORDINATED PROMISSORY NOTES DUE DECEMBER 31, 2007
The 12% Convertible Subordinated Promissory Notes due December 31, 2007
(the "Notes") of Fortune Natural Resources Corporation, a Delaware corporation
("Fortune" or the "Company"), and the Common Stock, par value $.01 per share, of
Fortune ("Common Stock") into which the Notes and the warrants issued to the
placement agent in the offering of the Notes are convertible (the "Underlying
Shares" and, together with the Notes, the "Securities") may be offered hereby by
certain holders of the Securities (the "Selling Holders").
Interest on the Notes is payable quarterly in arrears on the first day of
each January, April, July and October (the "Interest Payment Dates") commencing
on January 1, 1998. The Notes mature on December 31, 2007 and do not provide for
a sinking fund. Fortune, may, at its option, prepay the Notes on and after May
1, 1999 in whole or in part at the repayment prices set forth in this
prospectus, plus accrued interest. If an Event of Default (as defined herein)
occurs, the holders of at least 51% in principal amount of the Notes may cause
all the unpaid Notes to be immediately due and payable. See "Description of the
Notes".
The Notes are unsecured obligations of Fortune and subordinate to all
present and future Senior Debt (as defined herein) so long as the Senior Debt
remains outstanding. Fortune is not restricted in its ability to incur
indebtedness or other liabilities.
The Notes are convertible into Common Stock at any time after May 1, 1999
and before maturity, unless sooner prepaid, at a conversion price equal to the
lower of $3.00 per share or 5% above the average closing prices of the Common
Stock for the 60 calendar day period immediately preceding May 1, 1999. If,
however, prior to May 1, 1999, Fortune issues Common Stock (other than for
certain purposes) at less than the conversion price in effect on that date, the
holders of the Notes will have a one time right (the "Alternate Conversion
Right") to convert all of the Notes at a price equal to the conversion price
adjusted to reflect the dilution caused by that issuance. The conversion price
is subject to adjustment in certain events.
The Notes were issued in a private placement and have not been eligible for
public resale. The Notes will not be listed for trading. No assurance can be
given that a market for the Notes will develop or as to the liquidity or
sustainability of any market that may develop. See "Risk Factors - Limited
Market for the Notes." The Underlying Shares will be listed for trading on the
American Stock Exchange (the "AMEX"). The Common Stock of the Company trades on
the AMEX under the symbol FPX. On October 14, 1998, the closing price of the
Common Stock, as reported on the AMEX, was $1.31 per share.
THESE SECURITIES INVOLVE A HIGH DEGREE OF RISK. (SEE "RISK
FACTORS" BEGINNING ON PAGE 5.)
------------------------------
Fortune issued and sold the Notes on November 3, 1997 in a private
placement exempt from the registration requirements of the Securities Act of
1933, as amended (the "Securities Act"). J. Robbins Securities, LLC acted as the
placement agent for the Company in the offering and received, as a portion of
its fee, warrants (the "Warrants") to purchase 89,583 shares of Common Stock at
an exercise price of $3.60 per share, subject to adjustment. The term of the
Warrants is five years. Fortune will not receive any of the proceeds from the
sale of the Notes or the Underlying Shares but will receive the exercise price
for the Warrants if exercised.
The Selling Holders may sell the Securities from time to time to or through
underwriters, directly to purchasers or through agents in ordinary brokerage
transactions, in negotiated transactions or otherwise, at prices that represent
or relate to then prevailing market prices or are negotiated. The Selling
Holders may be deemed to be "underwriters" as defined in the Securities Act, and
agency commissions paid by Selling Holders to broker/dealers as well as profits
realized by Selling Holders and broker/dealers purchasing Securities for their
own account may be deemed underwriting discounts or commissions under the
Securities Act in connection with the sale of the Securities.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
THE DATE OF THIS PROSPECTUS IS OCTOBER ___, 1998
<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.")
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.
2
<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 OFFERING
SECURITIES OFFERED $3,225,000 principal amount of 12% Convertible
Subordinated Notes due December 31, 2007
PAYMENT OF INTEREST The first day of January, April, July and
October commencing January 1, 1998
CONVERSION Convertible into Common Stock of Fortune at the option of
the holder at any time after May 1, 1999 and before
maturity, unless previously prepaid, at the lower of $3.00
per share or 5% above the average closing prices for the 60
days preceding that date, subject to adjustment in certain
events.
ALTERNATE Convertible in whole on one occasion prior to May 1, 1999 if
CONVERSION Fortune issues Common Stock (other than for certain
purposes) at less than the conversion price in effect on
that date.
SUBORDINATION Subordinated to all present and future Senior Debt (as
defined herein) of Fortune. As of September 30, 1998, the
aggregate amount of Senior Debt to which the Notes were
subordinated was $10,000. The Notes do not restrict
Fortune's incurrence of additional indebtedness.
PREPAYMENT After May 1, 1999, Fortune may elect to prepay the Notes at
BY FORTUNE the premiums set forth herein, plus accrued interest, or, if
Company Common Stock trades at $4.50 or more per share for
30 consecutive trading days, without premium.
ACCELERATION If an Event of Default (as defined herein) occurs, the
OF PAYMENT holders of at least 51% in principal amount of the Notes may
BY HOLDERS accelerate maturity and demand payment in full of all unpaid
amounts, plus expenses. No assurance can be given that
Fortune will be able to pay the amounts due under the Notes
if an Event of Default occurs.
USE The Company will not receive any of the proceeds of the sale
OF PROCEEDS by the Selling Holders of the Notes or of the Underlying
Shares.
LISTING The Notes will not be listed for trading. The Common Stock
FOR TRADING of the Company trades on the AMEX under the symbol FPX. The
shares of Common Stock issuable on conversion of the Notes
or Warrants have been approved for listing on the AMEX.
FEDERAL For information regarding the federal income tax
INCOME TAX consequences of purchasing and selling the Notes and the
CONSEQUENCES Underlying Shares, see "Certain Federal Income Tax
Considerations."
3
<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, 1997 and the unaudited financial
information for the six months ended June 30, 1998 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 results for the six
months ended June 30, 1998 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>
SIX MONTHS
ENDED JUNE 30, YEARS ENDED DECEMBER 31,
---------------------- ----------------------------------
1998 1997 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................................... $ 1,199 $ 1,910 $ 4,005 $ 4,040 $ 3,143
Loss on sale of oil and gas properties........... $ - $ - $ - $ - $ 3,607
Impairment to oil and gas properties............. $ 260 $ 3,200 $ 3,650 $ - $ -
Net loss......................................... $ (1,464) $ (4,722) $ (5,958) $ (1,330) $ (5,876)
Net loss per share............................... $ (0.12) $ (0.39) $ (0.49) $ (0.12) $ (0.90)
Net weighted average shares outstanding.......... 12,128 12,050 12,086 11,351 6,556
Ratio of earnings to fixed charges(2)............ (3) (3) (3) (3) (3)
Pro forma ratio of earnings to fixed charges(2).. (4) (4)
OPERATING DATA:
Net Production:
Crude oil, condensate and gas liquids (Bbl).... 28,100 36,100 87,000 57,000 92,000
Natural gas (Mcf).............................. 319,800 407,800 821,000 1,038,000 909,000
Gas equivalent (MCFE).......................... 488,400 624,400 1,343,000 1,383,000 1,461,000
Average Sales Price:
Crude oil, condensate and gas liquids ($ per Bbl) $ 13.82 $ 19.76 $ 19.04 $ 20.24 $ 14.66
Natural gas ($ per Mcf)........................ $ 2.30 $ 2.67 $ 2.66 $ 2.56 $ 1.77
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
----------- ----------------------------------
1998 1997 1996 1995
----------- ----------- --------- ----------
(unaudited)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets..................................... $ 10,214 $ 12,626 $ 16,335 $ 17,800
Total debt....................................... $ 3,235 $ 3,775 $ 2,933 $ 4,897
Net stockholders' equity......................... $ 6,513 $ 8,053 $ 13,037 $ 12,314
RESERVES:
Estimated Net Proved Reserves (1):
Crude oil and condensate (MBbls)............... 257 249 347
Natural gas (Bcf).............................. 3.2 3.5 5.9
Estimated future net revenues before income taxes $ 8,410 $ 14,112 $ 12,600
Present value of estimated future net revenues
before income taxes (discounted at
10% per annum)................................. $ 6,503 $ 10,820 $ 8,942
</TABLE>
- ----------
(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 - Significant Properties
and Activities - Oil and Gas Reserves")
(2) The ratio of earnings to fixed charges is expressed as the ratio of: (I)
fixed charges plus income from operations, to (ii) fixed charges. Fixed
charges consist of interest expense and amortization of deferred financing
fees. The pro forma ratio is computed in a similar manner.
(3) Earnings were insufficient to cover fixed charges for the years ended
December 31, 1997, 1996, and 1995 by the amount of $5,562, $895, and
$5,006, respectively. The deficiency for the periods ended June 30, 1998,
and 1997 are $1,063 and $4,592, respectively.
(4) The pro forma earnings to fixed charges deficiencies for the periods
indicated would not differ from the actual deficiencies.
4
<PAGE>
RISK FACTORS
This Prospectus contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 (the "Securities Act") and Section 21E
of the Securities Exchange Act of 1934. 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," "Business and
Properties" and elsewhere herein. 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
Notes or Common Stock involves a high degree of risk. The Notes 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. The Company bases its
property acquisition decisions on various assumptions and subjective judgments
that may be 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 the Company expects that a substantial number of the projects in
which it 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 six months ended June 30,
1998. The losses equaled $5,958,000, $1,330,000 and $5,876,000 for 1997, 1996
and 1995, respectively, and $1,464,000 for the six months ended June 30, 1998.
These losses may continue. (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. Approximately 40% of the Company's
oil and gas revenues, cash flow and proved oil and gas reserves is currently
accounted for by the single well at South Timbalier Block 76. This 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 Significant
Properties and Activities - South Timbalier Block 76 - federal waters, offshore
Louisiana.") A significant curtailment or loss of production 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.
5
<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, 1997,
the Company incurred over $16 million of capital costs in its oil and gas
exploration, development and acquisition activities, of which $4.9 million was
spent 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, 1997
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, a $3.6 million impairment in 1997, and a
$260,000 impairment for the six-month period ended June 30, 1998. As a result of
lower oil and gas prices in September 1998, the Company expects to incur further
impairments in the third quarter of 1998.
PROPERTIES PLEDGED TO SECURE DEBT. All of the Company's producing
properties are pledged to secure its bank credit facility. If the Company fails
to pay the principal or interest or breaches financial covenants under the
credit facility, it could lose all or part of its interest in its principal
producing properties. The entire principal balance of the credit facility,
currently $10,000 as the result of the allocation of proceeds from the sale of
the Company's interests at East Bayou Sorrel, 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, Fortune's productive properties could be seized 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.
6
<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 depend on 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 $2.66, $2.56 and $1.77 per Mcf
in 1997, 1996 and 1995, respectively. The average oil prices received by the
Company were $19.04, $20.24 and $14.66 per Bbl in 1997, 1996 and 1995,
respectively. The average oil and gas prices received by the Company through
June 30, 1998 were $13.82 per Bbl and $2.30 per Mcf, respectively.
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 vary
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.
7
<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 - Significant Properties
and Activities - South Timbalier Block 76 federal waters, offshore Louisiana.")
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. The Company's oil and gas operations are impacted by
weather conditions, including severe rains, winter conditions, and hurricanes in
the Gulf of Mexico, which from time to time interrupt or curtail production and
drilling operations and damage equipment and 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 industry and other industries in
supplying the energy and fuel requirements of industrial, commercial,
residential and other consumers. Many of the Company's competitors have greater
financial and other resources than does the Company, and there is no assurance
that the Company will be able to compete successfully in acquiring desirable
opportunities.
GOVERNMENT REGULATION. The Company's business is regulated by certain
federal, state and local laws and regulations relating to the development,
production, marketing and transmission of oil and gas, as well as environmental
and safety matters. State conservation laws regulate the rates of production
from oil and gas wells for the purpose of ensuring maximum production of the
resource. Such regulations may require the Company to produce certain wells at
less than their maximum flow rate. 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 occupies a portion of the Company's Espiritu Santo Bay prospect. There is
no assurance that laws and regulations enacted in the future will not adversely
affect the Company's exploration for or production and marketing of oil and gas.
From time to time, proposals are introduced in Congress or by the Administration
that could affect the Company's oil and gas operations. (See "Business and
Properties - Governmental Regulation.")
8
<PAGE>
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
has recently experienced a shortage of certain types of drilling rigs and work
boats in the Gulf of Mexico. This shortage has and may continue to 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 THIS OFFERING
SUBORDINATION OF NOTES. The Notes are subordinate in right of payment to
all current and future Senior Debt of Fortune. Senior Debt includes all
indebtedness, and any deferrals, renewals, increases or extensions thereof,
borrowed under the Company's Credit Agreement with Credit Lyonnais New York
Branch, as agent (the "Credit Agreement") and all indebtedness secured by assets
of Fortune having a value (as determined by the Board of Directors) of more than
50% of the outstanding principal amount of such indebtedness or $100,000,
whichever is less, (i) for borrowed money, (ii) for money borrowed by others and
guaranteed by Fortune, or (iii) constituting purchase money indebtedness for the
payment of which Fortune is liable, whether existing on or created after the
date the Notes are issued, that is not made subordinate to or pari passu with
the Notes by the instrument creating the indebtedness. As of September 30, 1998,
Fortune had $10,000 outstanding under the Credit Agreement. The Company has no
other Senior Debt to which the Notes are subordinated. Fortune is not restricted
in the incurrence of additional indebtedness. In the event of any insolvency,
bankruptcy, liquidation, reorganization, dissolution or winding up of the
business of Fortune, the assets of Fortune will be available to pay the amounts
due on the Notes only after all Senior Debt has been paid in full.
LIMITATIONS ON PAYMENT IF AN EVENT OF DEFAULT OCCURS. If an Event of
Default, which consists of a failure by Fortune to make a timely payment of
principal or interest on the Notes, failure to issue the Common Stock upon
conversion of the Notes, a material failure to comply with certain covenants
regarding the conduct of its business, or the failure to comply with any of the
representations, warranties, or covenants contained in the Notes, occurs, the
holders of at least 51% in principal amount of the Notes may declare all unpaid
obligations immediately due and payable. Upon the filing of an action for the
bankruptcy, liquidation, reorganization, dissolution or winding up of the
business of Fortune, the Notes become immediately due and payable with no
further action by the holders. Fortune's ability to pay the obligations due
under the Notes upon the acceleration of their maturity may be limited by the
terms of the Senior Debt and will depend on the availability of sufficient
funds. Accordingly, no assurance can be given that Fortune will be able to meet
its obligations under the Notes upon the occurrence of an Event of Default.
LIMITED MARKET FOR THE NOTES. The Notes will not be listed for trading. No
assurance can be given that a market for the Notes will develop, or as to the
liquidity or sustainability of any market that may develop, or as to the ability
of Note holders to sell their Notes at any price. Future trading prices of the
Notes will depend on many factors, including, among others, prevailing interest
rates, Fortune's operating results, the price of the Common Stock and the market
for similar securities. It is anticipated that the Notes will not be rated by
any rating agency.
SHARES ELIGIBLE FOR FUTURE SALE/POTENTIAL DILUTION. At September 30, 1998,
12,134,678 shares of Common Stock were outstanding, of which 11,566,057 shares
were freely tradeable and 568,621 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 4,380,059 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 Company's public warrants may require
adjustment if the Company is required to issue the "reset" shares in the
above-described lawsuit or for other reasons.
9
<PAGE>
INCREASE IN INTEREST COSTS. The Company used $1,343,000 of the net proceeds
from the Notes to repay indebtedness with interest rates which were below the
rate being paid by the Company on the Notes. Prior to issuing the Notes, the
Company's interest bearing debt was comprised of bank debt and convertible
subordinated debentures due December 31, 1997 (the "1992 Debentures") (See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Capital Resources"). The 1992 Debentures were repaid with a portion
of the proceeds from this offering. The 1992 Debentures bore interest at 10.5%.
The Company's bank debt bears interest at 1.25% over the bank's base rate; the
interest rate is currently 9.50%. The Company repaid $315,000 of this debt with
a portion of the proceeds of the Notes. Thus, the Company replaced debt which
bore a fluctuating rate of interest with fixed rate debt. (See "Use of
Proceeds.")
INABILITY TO COVER FIXED CHARGES. Since 1993, the Company's earnings have
been insufficient to cover its fixed charges. (See "Selected Financial Data.")
As a result of closing the Note offering, the Company's total debt and fixed
charges has increased significantly. There can be no assurance that the
Company's earnings will ever increase sufficiently to cover its fixed charges.
RISK OF OWNERSHIP OF NOTES. The Notes are general unsecured obligations of
the Company and are subordinate to all "Senior Indebtedness" (as defined in the
Indenture) of the Company ($10,000 at September 30, 1998) except indebtedness
which by its term is subordinate or equal in right of payment to the Notes. The
Company's ability to make payments of interest on the Notes and to repay the
principal thereof at maturity may be affected by future prices of oil and gas,
the success of the Company's operations and the amount of other indebtedness of
the Company. The Company is permitted to incur additional indebtedness in the
future without limitation or restriction by reason of the Notes. This additional
indebtedness, subject to limited exceptions, could be superior to or equal in
right of payment with the indebtedness of the Notes. (See "Description of Notes
- -- Subordination.") No sinking fund is provided for the Notes.
An investment in the Notes is speculative, involves a high degree of risk,
and Notes should be purchased only by persons who can afford an entire loss of
their investment.
DEFAULT ON SENIOR INDEBTEDNESS. If the Company defaults on any Senior
Indebtedness, such Senior Indebtedness must be discharged in full before any
payments can be made for principal, interest, or otherwise on account of the
Notes. Senior Indebtedness includes the Company's bank debt. (See "Management
Discussion and Analysis of Financial Condition and Results of Operations -
Capital Resources.")
DEFAULT ON NOTES. Default on any Senior Indebtedness does not itself
constitute a default under the Notes. A default with respect to the Notes occurs
only upon the failure to timely make a payment required with respect to the
Notes or the occurrence of other specific events enumerated as defaults under
the Indenture. Inasmuch as payments under the Notes are due only quarterly, the
Company could experience financial difficulties between interest payment dates
interest payments are due on the Notes, and a default with respect to the Notes
would not occur until the next payment due date passed without payment being
made under the Notes. The terms of the Notes may be modified or affected by the
vote or action of certain percentages of the aggregate amount of the outstanding
Notes. (See "Description of the Notes.")
POSSIBLE LOSS OF INTEREST ON CONVERSION. If a Note is surrendered for
conversion after an Interest Payment Date, the holder of such Note will not
receive the accrued but unpaid interest on the Note. This forfeiture of interest
does not apply in the case of a Note called for redemption by the Company.
POSSIBLE TAXABLE DIVIDEND. If the Company were to make a distribution of
property to its stockholders which would be taxable to the stockholders as a
dividend for federal income tax purposes (e.g., distributions of evidences of
indebtedness or assets of the Company, but generally not stock dividends on
Common Stock or rights to holders of Common Stock to subscribe for Common Stock)
and the conversion price of the Notes were to be decreased pursuant to the
anti-dilution provisions of the Notes, such decrease could be deemed for federal
income tax purposes to be payment of a taxable dividend to Noteholders.
10
<PAGE>
CAPITALIZATION
The capitalization of the Company will not change as a result of a sale of
Securities by the Selling Holders.
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.
USE OF PROCEEDS
The Company will not receive any proceeds from the sale of Securities by
the Selling Holders, but will receive the exercise price if the Warrants are
exercised.
11
<PAGE>
PRICE RANGE OF SECURITIES
The following table sets forth the high and the low closing prices of the
Common Stock of the Company on the AMEX for the periods indicated.
Common Stock
-------------------
High Low
-------- -------
1996
First Quarter............................ 5 2
Second Quarter........................... 4 2 5/8
Third Quarter............................ 3 11/16 2 1/4
Fourth Quarter........................... 3 1/2 2 1/4
1997
First Quarter............................ 3 1/4 2 1/4
Second Quarter........................... 2 7/16 1 5/8
Third Quarter............................ 2 1/2 1 9/16
Fourth Quarter........................... 3 3/16 2 3/8
1998
First Quarter............................ 2 5/8 1 1/2
Second Quarter........................... 1 11/16 1 3/16
Third Quarter............................ 1 7/16 11/16
Fourth Quarter (through October 14)...... 1 5/16 1 1/8
At October 14, 1998, the closing price of the Common Stock was $1.31 per
share. At September 30, 1998, there were 12,134,678 shares of Common Stock
outstanding held of record by approximately 3,000 stockholders.
12
<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, 1997 are derived from, and qualified by
reference to, the Company's audited financial statements, appearing elsewhere
herein. The Summary Selected Financial Data should be read in conjunction with
the audited financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appearing elsewhere herein.
(dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEARS ENDED DECEMBER 31,
--------------------- ---------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- -------- --------- --------- -------- --------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Total Revenues.................... $ 1,199 $ 1,910 $ 4,005 $ 4,040 $ 3,143 $ 3,397 $ 2,834
Loss on sale of oil and
gas properties................... $ - $ - $ - $ - $ 3,607 $ - $ -
Impairment to oil and gas
properties ...................... $ 260 $ 3,200 $ 3,650 $ - $ - $ 3,347 $ 2,993
Net loss.......................... $ (1,464) $ (4,722) $ (5,958) $ (1,330) $ (5,876) $ (4,453) $ (3,703)
Net loss per share................ $ (0.12) $ (0.39) $ (0.49) $ (0.12) $ (0.90) $ (1.69) $ (2.09)
Net weighted average shares
outstanding..................... 12,128 12,050 12,086 11,351 6,556 2,639 1,773
Ratio of earnings to
fixed charges(2)................ (3) (3) (3) (3) (3)
Pro forma ratio of earnings to
fixed charges................... (4) (4)
OPERATING DATA:
Net Production:
Crude oil, condensate and
gas liquids (Bbl)............. 28,100 36,100 87,000 57,000 92,000 88,000 79,000
Natural gas (Mcf)............... 319,800 407,800 821,000 1,038,000 909,000 1,017,000 724,000
Gas equivalent (MCFE)........... 488,400 624,400 1,343,000 1,383,000 1,461,000 1,542,000 1,196,000
Average Sales Price:
Crude oil, condensate and gas
liquids ($ per Bbl)........... $ 13.82 $ 19.76 $ 19.04 $ 20.24 $ 14.66 $ 14.14 $ 14.33
Natural gas ($ per Mcf)......... $ 2.30 $ 2.67 $ 2.66 $ 2.56 $ 1.77 $ 2.09 $ 2.28
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
--------- ----------------------------------------------------------
1998 1997 1996 1995 1994 1993
--------- -------- --------- --------- -------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets...................... $ 10,214 $ 12,626 $ 16,335 $ 17,800 $ 10,066 $ 10,429
Total debt........................ $ 3,235 $ 3,775 $ 2,933 $ 4,897 $ 7,123 $ 3,003
Net Stockholders' Equity.......... $ 6,513 $ 8,053 $ 13,037 $ 12,314 $ 2,130 $ 6,588
RESERVES:
Estimated net proved reserves(1):
Crude oil and condensate (MBbl). 257 249 347 1,647 813
Natural gas (Bcf)............... 3.2 3.5 5.9 5.9 5.6
Estimated future net revenues
Before income taxes........... $ 8,410 $ 14,112 $ 12,600 $ 15,932 $ 12,835
Present value of estimated future
net revenues before income taxes
(discounted at 10% per annum)... $ 6,503 $ 10,820 $ 8,942 $ 8,148 $ 8,554
</TABLE>
- ----------
(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")
(2) The ratio of earnings to fixed charges is expressed as the ratio of: (I)
fixed charges plus income from operations, to (ii) fixed charges. Fixed
charges consist of interest expense and amortization of deferred financing
fees. The pro forma ratio is computed in a similar manner.
(3) Earnings were insufficient to cover fixed charges for the years ended
December 31, 1997, 1996, 1995, 1994 and 1993 by the amount of $5,562, $895,
$5,006, $3,993 and $3,392, respectively. The deficiency for the periods
ended June 30, 1998 and 1997 are $1,063 and $4,592, respectively.
(4) The pro forma earnings to fixed charges deficiencies for the periods
indicated are not different from the actual deficiencies.
13
<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 and
sale 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 in
exploration projects onshore and offshore Louisiana and Texas and in the related
transition zone.
Operating revenues increased slightly from 1996 to 1997, primarily because
production from the East Bayou Sorrel exploration success more than offset
depletion declines and the reduced revenues from the effect of selling a portion
of South Timbalier Block 76 in early 1996. Operating revenues have decreased in
the first half of 1998 because the Company sold its interest in East Bayou
Sorrel on March 31, 1998. In 1996 the Company sold its California properties,
but 1996 revenues increased from 1995 as production from the South Timbalier
Block 76 acquired in late 1995 contributed to revenues for a full year.
Results in 1997 were adversely affected by substantial impairments to oil
and gas properties, debt conversion expense and stock offering costs. Results in
1995 were adversely affected by a substantial 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 addition of executive personnel and litigation costs.
The Company experienced substantial net losses in 1997, 1995 and the first
half of 1998 primarily attributed to the items described above, and a smaller
net loss in 1996. Operations contributed cash in 1996 and 1997, primarily due to
relatively high gas prices and/or 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. Operations consumed cash during the
first six months of 1998 because of the lower revenues discussed above and lower
prices received by the Company for its production. Substantial sales of equity
securities in 1995 resulted in significant increases in the weighted average
shares outstanding in 1996. Net loss per share decreased in 1996 as a result of
a decrease in the net loss from operations and an increase in the weighted
average shares outstanding.
The Company made substantial net investments in oil and gas properties in
1997 and 1995, and a somewhat smaller net investment in 1996. From 1995 through
the first six months of 1998, the Company's primary sources of capital have been
the sale of equity and proceeds from the sale of oil and gas properties. During
this same period, the Company reduced its total debt by $3.8 million and, as a
result of restructuring its borrowing relationships, significantly increased the
maturity of its remaining debt obligations. The Company believes that it has
adequate capital resources to satisfy its obligations over the short term. The
Company also believes that its operating cash flow will increase as a result of
successful exploitation of its inventory of projects and prospects and that this
increased cash flow will be the basis for future Company growth. However, there
can be no assurance that Fortune will be successful in exploiting any of its
projects and operating cash flow has decreased significantly in the short term
as the result of the sale of the Company's interest in East Bayou Sorrel in
March 1998. In the event that Fortune's operating cash flow does not increase
significantly, or Management determines to accelerate the growth plans for the
Company, the Company will continue to require equity and debt financing for
additional capital.
SIX MONTHS ENDED JUNE 30, 1998 AND 1997
During the six months ended June 30, 1998, Fortune had a net loss of
$1,464,000 compared to a net loss of $4,722,000 for the same 1997 period. The
higher 1997 loss was 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 $269,000 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.
Net oil and gas revenues in the first six months of 1998 decreased by
$681,000 (38%) compared to the same 1997 period. The decrease primarily resulted
from significantly lower oil and gas prices and oil and gas production in 1998.
1997 revenues included revenues from the Company's East Bayou Sorrel field that
was sold effective April 1, 1998. South Timbalier Block 76 was shut-in for 26
days in 1997 for a workover, adversely affecting 1997 revenues and partially
offsetting the decrease from 1997 to 1998.
14
<PAGE>
Oil production decreased 22% to 28,100 barrels during the first six months
of 1998 versus 1997 as a result of the sale of East Bayou Sorrel. Gas production
decreased 22% to 320,000 MCF during the first six months of 1998 versus 1997,
also primarily because of the sale of East Bayou Sorrel, as discussed above.
For the first six months of 1998, the Company's natural gas prices averaged
$2.30 per MCF as compared to $2.67 per MCF for the same 1997 period (a 14%
decrease). Oil prices averaged $13.82 per barrel for the first six months of
1998 compared to $19.76 per barrel for the same 1997 period (a 30% decrease).
Production and operating expense decreased by $377,000 (51%) for the first
six months of 1998 over 1997. Production and operating expense in 1997 included
approximately $400,000 of costs attributable to a workover at South Timbalier
Block 76.
General and administrative expense decreased $199,000 (20%) for the first
six months of 1998 versus 1997 primarily because of lower litigation costs in
1998 in connection with the 1995 Regulation S offering (discussed in note 4 to
the December 31, 1997 Financial Statements) and lower personnel costs.
Interest expense increased by $106,000 (103%) for the first six months of
1998 versus 1997 due to the higher debt balance. Non-cash amortization of debt
financing costs increased by $165,000 during 1998 because of the Company's Notes
offering in December 1997 and credit facility refinancing in July 1997. The
Company's provision for depletion, depreciation and amortization (DD&A)
decreased by $139,000 (14%) in the first six months of 1998 as compared to 1997
because of the impact of impairments to oil and gas properties and the sale of
East Bayou Sorrel.
RESULTS OF OPERATIONS
Years ended December 31, 1997 and 1996
Fortune had a net loss of $6.0 million in 1997 compared to a net loss of
$1.3 million in 1996. The increased net loss in 1997 is primarily attributable
to the following 1997 items: $3.7 million non-cash impairments to oil and gas
properties, a $316,000 non-cash debt conversion expense incurred in connection
with closing the Company's 1992 Debenture exchange offer in February 1997 and
$323,000 of stock offering costs expensed as a result of the Company withdrawing
a proposed public offering in April 1997. (See notes 2 and 5 to the December 31,
1997 Financial Statements.)
Net oil and gas revenues increased slightly in 1997 compared to 1996. 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 option agreement. 1997 revenues were adversely affected by shutting
in the South Timbalier Block 76 well from March 24, 1997 to April 19, 1997 for a
workover. The same well was also shut in from April 29, 1996 to June 15, 1996
for a prior workover. Offsetting these decreases was the commencement of
production at East Bayou Sorrel from permanent production facilities in January
1997. The second well at East Bayou Sorrel was completed and placed on
production on June 23, 1997. As discussed above, the Company's entire interest
in the East Bayou Sorrel Field was sold effective March 31, 1998.
Oil production increased 52% in 1997 compared to 1996 as a result of the
Bayou Sorrel discovery. Gas production decreased 21% in 1997 versus 1996,
primarily because of the reduced ownership interest in 1997 in South Timbalier
Block 76, as discussed above, and natural depletion on the Company's properties.
Gas prices for the Company's production averaged $2.66 per Mcf in 1997 as
compared to $2.56 per Mcf in 1996. Oil prices averaged $19.04 per Bbl in 1997
compared to $20.24 per Bbl in 1996.
Production and operating expenses decreased by $78,000 (7%) in 1997
compared to 1996. The decrease results primarily from the Company's sale of its
relatively expensive-to-operate California properties in early 1996. Both 1997
and 1996 were adversely affected by the workovers at South Timbalier Block 76
that cost approximately $360,000 in 1997 and $300,000 in 1996.
Interest expense decreased by $39,000 (9%) for 1997 compared to 1996 due to
the lower average debt balance for most of 1997. The Company's debt balance
increased during the fourth quarter of 1997 and the Company expects to incur
higher interest expense in 1998 compared to 1997. (See "- Liquidity.")
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The Company's provision for depletion, depreciation and amortization (DD&A)
increased to $1.62 per MCFE in 1997 compared to $1.14 per MCFE in 1996 because
of higher average property costs and lower average proved reserves 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 was 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. Although 1996
revenues were up, they 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. This well 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.
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.
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 higher 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 1995 sale of the California properties recorded in December
1995, 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.
LIQUIDITY
Cash Balance, Working Capital and Cash Flows from Operating Activities
Although cash flow from operating activities declined in the first six
months of 1998, working capital increased significantly at June 30, 1998.
Fortune's operating activities during the first six months of 1998 consumed cash
flow in the amount of $498,000 as compared to cash flow provided from operating
activities of $1,484,000 for the first six months of 1997. This decrease results
primarily from the significant increase in payables in 1997 versus a decrease in
1998. Before considering the effect of changes in assets and liabilities,
operating cash flow was $(163,000) for 1998 as compared to $102,000 for 1997.
Lower oil and gas revenues and higher cash interest expense were the primary
contributors to the 1998 decrease in cash flow. The Company's significantly
higher working capital balance of $3,598,000 at June 30, compares to a December
31, 1997 balance of $1,376,000. The proceeds received from the sale of East
Bayou Sorrel were the primary contributor to this significant increase in
working capital. Management believes that, even in the face of fluctuating
commodity prices, this increase in cash and working capital as a result of the
sale of East Bayou Sorrel provides the Company with adequate capital to fully
fund its capital program during 1998.
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 and its
unused borrowing capacity, if any, under its bank credit facility.
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Although the Company's cash balance decreased from 1996 to 1997, working
capital increased significantly to $1,376,000 at December 31, 1997 compared to
$276,000 at December 31, 1996. Refinancing the Company's bank debt in July 1997
and completing a convertible subordinated debt offering in December 1997 were
major contributing factors to this increase in working capital. During 1997,
operating activities and financing activities were providers of cash while
investing activities were net users of cash.
Fortune's net cash flow provided by operating activities increased in 1997
to $1,379,000 as compared to $607,000 in 1996. Changes in accounts receivable
and accounts payable were significant components of these net cash flow amounts
in both years. Accounts payable increased in 1997 as a result of increased
exploration activity and accounts receivable decreased in 1997 primarily as a
result of lower year-end prices. Before considering changes in asset and
liability accounts, net operating cash flow still increased in 1997 to $755,000
compared to $391,000 in 1996. The absence of corporate relocation costs in 1997
and lower interest and production and operating expense in 1997 contributed to
this increase. The Company's 1996 exploratory discovery at East Bayou Sorrel,
Iberville Parish, Louisiana had no impact on the Company's revenues in 1996. Its
impact on 1997 production was partially offset by the items discussed in the
1997 operating results section above.
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. Fluctuations in current asset and liability accounts also
contributed to the variance. 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.
CAPITAL RESOURCES
Cash Used in Investing Activities - Capital Expenditures
Cash expenditures for oil and gas properties for the first six months of
1998 were $1,711,000 as compared to $2,124,000 for the same period in 1997. The
1998 expenditures have been incurred primarily in connection with the Company's
projects at LaRosa, Espiritu Santo Bay, East Bayou Sorrel, Whiskey Pass and
Southwest Segno.
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 seismic survey over one of the Company's existing producing
fields in Refugio County, Texas has been shot and drilling operations have
commenced. The Company sold one-half of its interest in the non-producing
portion of this field in exchange for the acquiring parties paying 100% of the
Company's 3D seismic costs. Seven wells had been drilled based upon the 3D
seismic through October 15, 1998. Three wells were completed as producers, three
wells have been plugged and abandoned and a seventh is being tested. During
1998, the Company has incurred $502,000 of seismic interpretation, leasing and
drilling costs through the second quarter. 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 seismic 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 was completed
in 1997 and is being interpreted. Three wells have been spud in 1998, two of
which appear to be productive and one was plugged and abandoned. Additional
drilling is planned for 1998 and beyond. During 1998, the Company has incurred
$137,000 of seismic interpretation and leasing costs through the second quarter.
During the second quarter of 1998, the Company entered into agreements to
participate in the drilling of three wells on prospects in the transition zone
offshore Louisiana. Two of the wells are on the Whiskey Pass prospect and the
third is on the Sea Serpent prospect. The prospects were identified by another
company on a 25 sq. mile transition zone 3D seismic survey which Fortune also
owns. Through June 30, 1998, the Company has incurred approximately $305,000 of
seismic, leasehold and drilling costs. The first well drilled on the Whiskey
Pass prospect was plugged and abandoned in May 1998. The Sea Serpent well was
drilled in July 1998 and plugged and abandoned on July 22, 1998. The second well
on the Whiskey Pass prospect is planned for late 1998. Fortune pays 12.5% of
drilling and completion costs of these wells. The Company also incurred $166,000
in 1998 in connection with its dry hole at the Southwest Segno prospect in
Liberty County, Texas.
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The Company continually reviews exploration, development and acquisition
opportunities and expects to participate in additional projects in 1998.
Capital expenditures funded with cash for the years ended December 31,
1997, 1996 and 1995 were $4.9 million, $3.2 million and $5.7 million,
respectively. 1997 capital expenditures consisted primarily of $2.5 million for
3D seismic and leases at Espiritu Santo Bay; $1.5 million for development at
East Bayou Sorrel and $0.4 million for the acquisition of an additional interest
at East Bayou Sorrel. 1996 capital expenditures were primarily for four
exploratory wells (East Bayou Sorrel, Lirette, DABM and South Lake Arthur) and
continued lease and seismic acquisition offshore Louisiana. Capital expenditures
for 1995 were 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.
In June 1997, Zydeco returned to the Company $2.2 million of exploration
venture cash under the terms of the venture agreement, as discussed in note 2 to
the Financial Statements. The cash was previously reported on the Company's
balance sheet as restricted cash in "Other Assets." The Company also received
$1.2 million for the sale of the California properties that was used to retire
debt in February 1996 and $940,000 for the sale of 25% of its interest in South
Timbalier Block 76. (See "Business and Properties - Exploration Activities" and
" -- Property Acquisition Activities.")
Fortune's net capital expenditures for its acquisition, exploration and
development activities in 1998 are currently estimated to range from
approximately $1.5 to $4.0 million, depending on the Company's capital
resources. The Company intends to provide for these expenditures with its
available cash, its cash flow from operations and, to the extent approved in
advance by the bank, its bank credit facility. 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.
Cash Flows from Financing Activities -
- Outstanding Debt and Debt Reduction
On March 31, 1998, the Company paid off all but $10,000 of its bank credit
facility using $540,000 of the proceeds from the sale of East Bayou Sorrel. The
Company's other debt, all of which is subordinated convertible debt, is not due
until 2007. Primarily as a result of the lower revenues in the current quarter,
the Company was unable to meet the 3 to 1 coverage ratio of cash flow to
fixed-charges which is required by the credit facility for the nine-months
period ended June 30, 1998. The Company received a waiver of this covenant from
the bank for the period ended June 30, 1998.
- Convertible Subordinated Notes due December 31, 2007
On December 1, 1997, Fortune completed a 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 and the Company received
$2,815,000 of net proceeds after offering expenses and commissions. The Notes
were sold to a group of accredited investors under a placement agreement with J.
Robbins Securities L.L.C.
The net proceeds of the private placement were used to refinance existing
debt and for general corporate purposes. On December 5, 1997, using the proceeds
of the Notes offering, the Company redeemed the remaining outstanding balance of
$1,028,000 of the Company's Debentures due December 31, 1997. In addition,
$315,000 of net proceeds of the Notes offering were used to reduce the
borrowings under the Company's credit facility with Credit Lyonnais. See
"Description of the Notes" for the terms of the Notes.
- Credit Facility
The Company has in place 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. On March 31, 1998, the
Company repaid all but $10,000 of the outstanding balance of the credit facility
with a portion of the proceeds from the sale of East Bayou Sorrel. Prior to the
Company's sale of its interest in the East Bayou Sorrel field, the Company's
borrowing base was $2 million. The bank has not completed its redetermination of
the borrowing base subsequent to this sale; consequently, the Company does not
know how much, if any, is currently available for borrowing under this credit
facility. Under the credit facility, once the borrowing base is redetermined,
the Company may 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%
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above LIBOR. 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.
Primarily as a result of the lower revenues in 1998 as a result of lower oil and
gas prices and the sale of East Bayou Sorrel, the Company was unable to meet the
3 to 1 coverage ratio of cash flow to fixed-charges which is required by the
credit facility for the twelve-month period ended June 30, 1998. The Company
received a waiver of this covenant from the bank for the period ended June 30,
1998.
- Debentures
On February 26, 1997, the Company closed an exchange offer for the
Convertible Subordinated Debentures due December 31, 1997 (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 at December 31, 1997 was $1,028,000. This
remaining balance was repaid on December 5, 1997 with 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.
- Cash Provided from Equity Transactions
Fortune's primary source of capital during 1996 and 1995 was stock
offerings and the exercise of warrants and options. In December 1996, the
Company received net proceeds of approximately $1.1 million from the sale of
412,000 shares of Common Stock at a price of $3.00 per share in a private
placement. On December 11, 1995, the Company received approximately $3.3 million
of net proceeds in a private placement of 1,321,117 shares of Common Stock. The
proceeds were used to acquire a producing property and for general corporate
purposes. (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 - Significant Properties and Activities - Joint Venture with
Zydeco.")
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. (See "Risk Factors - Risks Associated
with the Oil and Gas Industry - Volatility of Oil and Gas Prices".) The
Company's revenues, profitability and future rate of growth are substantially
dependent upon prevailing market prices for natural gas and oil, which can be
extremely volatile and in recent years have been depressed by excess domestic
and imported supplies. These fluctuating oil and gas prices have contributed to
impairments to oil and gas properties such as the $3.7 million impairment
recorded in 1997 and the $260,000 impairment recorded in the second quarter of
1998. As a result of lower oil and gas prices in September 1998, the Company
expects to incur further impairments in the third quarter of 1998. As of October
15, 1998, the Company was receiving an average of approximately $12.50 per
barrel for its oil production and $2.15 per MCF for its gas production.
The Company's December 31, 1997 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 $6.5 million at December 31, 1997, compared to a $10.8 million
discounted value at December 31, 1996. Of that total value, the proved developed
producing wells had a discounted present value of $3.4 million at December 31,
1997 compared to $6.3 million at December 31, 1996. The decrease in the present
value of the reserves is primarily attributable to significantly lower oil and
gas prices at year-end 1997 versus 1996. Total net proved reserves at December
31, 1997 were 257,000 Bbls of oil and 3.2 Bcf of gas compared to 249,000 Bbls of
oil and 3.5 Bcf of gas at December 31, 1996. (See "Business and Properties -
Exploration Activities.") At December 31, 1997, these net proved reserve figures
included 152,000
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barrels of oil and 204,000 mcf of gas attributable to the Company's interest at
East Bayou Sorrel. The Company sold its entire interest in East Bayou Sorrel
effective March 31, 1998. (See Note 6 to the June 30, 1998 Financial
Statements).
"Year 2000" Compliance
The Company is aware of the issues associated with the inability of many
computer systems worldwide to recognize dates beyond December 31, 1999 and that
a failure to correct this problem could result in significant disruption to
those systems. The Company has reviewed its internal and accounting systems and
believes that they are "year 2000 compliant." The Company currently does not
operate any of its producing properties; accordingly it does not use any
operating systems internally that must be evaluated for compliance. The
Company's concerns regarding year 2000 compliance rests almost solely with its
third party business associates. The Company has been assessing the readiness of
the third parties that it believes are important to its business, such as:
operators of its properties, its oil and gas product purchasers, its accounting
system providers, consultants, communication systems providers, etc. The third
parties contacted thus for have represented either to be in compliance or have
communicated their plans and timetables for compliance. This process, however,
is ongoing. The Company has begun making contingency plans in the event that its
third parties are unable to achieve compliance. With respect to product
purchasers, systems providers, consultants, its bank, and its stock transfer
agent, for example, the Company does not have any contracts that extend beyond
January 1999 and it will change to goods and service providers who are year 2000
compliant, if necessary. With respect to operators of its properties, the
Company believes that a failure to comply by the operator or its critical
suppliers would generally not be material except at South Timbalier Block 76.
CNG Producing Company ("CNG") operates South Timbalier Block 76 and the Company
is reviewing CNG's compliance efforts. The Company does not believe that the
direct, out-of-pocket cost of its year 2000 compliance requirements will be
significant. There are, however, numerous parties who the Company has no direct
contact with but who nonetheless could have a significant impact on the
Company's business activities if such parties do not achieve compliance. These
indirect third parties include oil and gas refiners, gas and oil transmission
companies, third party banking institutions, suppliers of supplier, etc.
Although the Company has no practical way of assessing the viability of these
companies, Fortune believes that its risk are no greater in this regard than
businesses and the public in general. The Company will continue to monitor the
status of year 2000 compliance issues to determine the impact, if any, on its
operations.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
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 new disclosures in its financial statements.
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits" ("SFAS 132"). SFAS 132 revises employers' disclosures
about pension and other postretirement benefit plans. It does not change the
measurement or recognition of those plans. SFAS 132 is effective for fiscal
years beginning after December 15, 1997. The Company does not expect SFAS 132 to
have a significant effect on its financial reporting.
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). SFAS 133 establishes accounting and reporting standards for derivative
instruments, including derivative instruments embedded in other contracts and
for hedging activities. SFAS 133 is effective for all fiscal quarters of fiscal
years beginning after June 15, 1999. As it has not historically utilized
derivative instruments, the impact upon the Company of SFAS 133 is not expected
to have an effect on the reporting of future operating results.
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BUSINESS AND PROPERTIES
GENERAL
Fortune Natural Resources Corporation ("Fortune" or the "Company") 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
computer-aided exploration ("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 implementing this program in early 1995, the Company
has been acquiring, with other industry partners, interests in oil and gas
prospects in the Louisiana Gulf Coast and is continually evaluating 3D and 2D
exploration projects.
The Company also seeks to take advantage of attractive acquisition targets
which will enable it to acquire producing properties at an attractive price. In
furtherance of that objective, the Company purchased for cash an additional
interest in the East Bayou Sorrel Field in early 1997 as well as an interest in
the South Timbalier Block 76 in December 1995. The Company subsequently sold its
entire interest at East Bayou Sorrel.
STRATEGY
Fortune's strategy is to invest in a diversified portfolio of oil and gas
exploration and development properties within its area of interest. Fortune
seeks to mitigate the risks of exploration drilling by generally taking minority
interests in projects with large potential reserves as well as 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 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 became a
director of Fortune in early 1997. (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 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. Recent significant exploration projects undertaken by the Company
include the 3D seismic surveys at Espiritu Santo Bay and LaRosa Field, both of
which are discussed below.
PROPERTY ACQUISITION ACTIVITIES
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 mid-1994, the Company made a
strategic decision to shift its emphasis from the acquisition of producing
properties to exploration for oil and 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 continues to examine attractive acquisition opportunities and
will seek to acquire producing properties on a selected basis. In furtherance of
that objective, the Company acquired an interest in South Timbalier Block 76 in
December 1995.
SIGNIFICANT PROPERTIES AND ACTIVITIES
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 20,015 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 has been processed
and is continually being interpreted. Over a dozen prospects have been
delineated to date, however, no assurance can be given that any commercial
quantities of hydrocarbons will be discovered. Drilling began on the first three
such prospects in September 1998. The first such well was plugged and abandoned;
the other two are currently being evaluated.
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 in Espiritu Santo Bay. 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
In 1994, the Company acquired an undivided 50% interest in the LaRosa
Field, a producing oil and gas field in Refugio County, Texas. In January 1997,
Fortune's working interest was reduced to a 37.5% working interest as the result
of an after-payout back-in negotiated at the time of purchase. On February 13,
1997, Fortune and its working interest partners commenced a proprietary 3D
seismic survey covering 24 square miles over the La Rosa Field and surrounding
acreage in Refugio County, Texas. The survey was conducted using
state-of-the-art technology. Processing was completed in September 1997. The
Company farmed out 50% of its rights in this proprietary seismic program and in
any new
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<PAGE>
exploration opportunities generated by that program in exchange for the payment
of all of Fortune's costs of such 3D survey. Accordingly, Fortune currently owns
an undivided 18.75% working interest in all newly-generated prospects. Fortune
maintains its 37.5% working interest in all production from wellbores existing
prior to the commencement of the 3D seismic survey. Fortune and its working
interest partners currently own 5,616 acres in the field and hold seismic
options to acquire up to an additional 6,462 acres. The first well drilled based
upon the 3D data was spudded December 2, 1997; since then six additional wells
have been drilled. Three of these wells have been completed, three have been
plugged and abandoned and a fourth is being tested. Further drilling has been
suspended pending a review of the results obtained from the first phase of this
drilling program.
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. A well was drilled in early 1998 at a cost of approximately
$165,000 to Fortune. Testing disclosed that the well was not economic to
complete and it was plugged and abandoned.
South Timbalier Block 76 - federal waters, offshore Louisiana
South Timbalier Block 76 is the Company's most prolific producer, currently
accounting for over 40% of the Company's revenues and proved reserves. On
December 11, 1995, Fortune acquired a 16.67% working interest (12.5% net revenue
interest) in this 5,000 acre producing oil and gas property. 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, so Fortune received the net cash flow from the
well from that date. 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, 1996. The well was also shut-in from March 24 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 of 1933 under Regulation S. From this sale in December 1995, the
Company netted approximately $3.3 million after payment of expenses of the
offering. The 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.")
Ship Shoal Blocks 43 and 67 - state waters, offshore Louisiana
On April 24, 1998 and July 1, 1998, the Company entered into agreements
with Rozel Energy, LLC ("Rozel") to participate in Rozel's Whiskey Pass (Block
43) and Sea Serpent (Block 67), respectively. The agreement on Block 43 required
Fortune to pay $138,000 for an assignment of a 12.5% working interest in
approximately 2,284 acres offshore Terrebonne Parish. The agreement further
provided for the drilling of two wells to test this acreage. The first such well
was drilled in June at an approximate cost to Fortune of $230,000. The well was
plugged and abandoned as a dry hole. The second Whiskey Pass well is currently
scheduled to spud in late October.
23
<PAGE>
The agreement on Block 67 provided for the payment by the Company of
$64,000 to acquire a 12.5% working interest in approximately 390 leasehold
acres. A single well was drilled on this prospect in August at a cost to the
Company of approximately $260,000. Although hydrocarbons were encountered, they
were not judged to be present in economic quantities and the well was plugged
and abandoned.
Joint Venture with Zydeco
Fortune owns varying working or royalty interests in eighteen projects
located in the transition zone and Timbalier Trench regions offshore Louisiana.
Each of these projects (referred to herein as the "Joint Venture Projects") was
acquired by a joint venture formed with Zydeco to identify, evaluate and explore
oil and gas prospects in this area. 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 $4.8
million 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 1997, $2.2 million
of the funds remained unspent and were returned to Fortune 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 in the remaining projects. One of the
prospects which was farmed out, located on South Timbalier Block 86, is
currently being drilled by Sonat Exploration Company. The Company has a 3.166%
override, convertible to a 12.5% working interest, in this project.
The Company does not currently expect that wells will be drilled on all of
the Joint Venture Projects or that it will, except in certain circumstances,
retain a working interest of more than 25% in any wells that are drilled. In
keeping with its strategy of balancing risk, 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 of 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, 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.
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 these wells 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.
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 Joint Venture Projects. The $4.3 million investment includes
the value of the Fortune Common Stock that was issued in 1995 to acquire LEX as
well as the funds that Fortune has expended for joint venture leases and
seismic. As a result of this review, Fortune transferred all of its investment
in the Joint Venture Projects to the evaluated property account in 1997. This
was the major contributing factor to the Company's $3.7 million impairments to
oil and gas properties recorded in 1997.
24
<PAGE>
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 (the "LLC"), 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 that county. 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 on these properties during 1994 and 1995, two
were completed as producing wells. The Company did not participate in the
drilling of any additional wells in 1996 or 1997. 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. On August
26, 1998 the Company sold its entire interest in these properties and the LLC to
the operator in exchange for an assumption of all existing liabilities.
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.
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 undeveloped 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.
25
<PAGE>
Divestiture of East Bayou Sorrel
On March 31, 1998, the Company sold its interest in the East Bayou Sorrel
field, Iberville Parish, Louisiana to National Energy Group, Inc. for cash in
the amount of $4,695,000. The properties sold consisted of the Company's
interest in the Schwing #1 and #2 wells and all of the Company's leases,
facilities and interests in the East Bayou Sorrel area of mutual interest, as
such area is defined in the East Bayou Sorrel operating agreement. The sale was
effective April 1, 1998. The sale closed on March 31, 1998, whereupon the
Company received $4,535,000, which is net of ordinary closing adjustments.
The Company's interest in the two productive wells at East Bayou Sorrel
were pledged to secure the Company's Credit Facility with Credit Lyonnais. The
total balance outstanding under the Credit Facility prior to this sale was
$550,000. Concurrently with closing the sale of the East Bayou Sorrel field, the
Company paid down the outstanding balance of the Credit Facility by $540,000.
The Company plans to reinvest the remaining proceeds from the sale of East Bayou
Sorrel into its exploration, development and property acquisition activities,
including, for example, future anticipated exploration and development wells at
its Espiritu Santo Bay and LaRosa 3D seismic exploration projects.
The Schwing #1 and #2 wells began producing from permanent production
facilities in January 1997 and June 1997, respectively. Although both wells were
shut-in from March 13, 1998 through the date of the sale to repair production
facilities, they accounted for a significant portion of the Company's oil and
gas revenues during 1997 and proved reserves as of December 31, 1997. A third
well in the field, the Schwing #3, which was spudded October 9, 1997, was
temporarily plugged and abandoned on March 5, 1998 pending further evaluation of
the well's potential. During 1997 and 1998, the Company incurred approximately
$1 million in connection with drilling and attempting to complete this well as a
result of difficult drilling conditions and mechanical problems.
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.
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.
26
<PAGE>
Drilling Activities
The following table sets forth information regarding development and
exploratory wells drilled by Fortune in the years ended December 31, 1997, 1996
and 1995:
WELL DRILLING ACTIVITY
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------
1997 1996 1995
----------------- ------------------ ------------------
Gross Net Gross Net Gross Net
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Exploratory Wells
Productive - - 1.0 .11 - -
Dry 1.0 .13 3.0 1.21 - -
------- ------- ------- ------- ------- -------
1.0 .13 4.0 1.32 - -
======= ======= ======= ======= ======= =======
Development Wells
Productive 1.0 .13 2.0 .20 1.0 .20
Dry - - - - - -
------- ------- ------- ------- ------- -------
1.0 .13 2.0 .20 1.0 .20
======= ======= ======= ======= ======= =======
</TABLE>
Oil and Gas Reserves
The Company's 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, 1997, 1996 and 1995 were
determined by Huddleston & Co., Inc., Houston, Texas, independent petroleum
engineers. 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. 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 vary substantially.
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.
27
<PAGE>
The following sets forth information with respect to estimated proved oil
and gas reserves as determined by Fortune's independent petroleum engineers
attributable to the Company's interests in oil and gas properties as of December
31, 1997, 1996 and 1995. At December 31, 1997, these figures included 152,000
barrels of oil and 204,000 mcf of gas attributable to the Company's interest at
East Bayou Sorrel. The Company sold its entire interest in East Bayou Sorrel
effective March 31, 1998. (See Note 6 to the June 30, 1998 Financial
Statements).
ESTIMATED NET RESERVE QUANTITIES
<TABLE>
<CAPTION>
December 31,
----------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Total Proved Reserves (1)
Oil (Bbls)......................... 257,000 249,000 347,000
Gas (Mcf).......................... 3,217,000 3,481,000 5,938,000
Equivalent Mcf (MCFE) (2).............. 4,759,000 4,975,000 8,020,000
Total Proved Developed Reserves:
Oil (Bbls)......................... 198,000 160,000 324,000
Gas (Mcf).......................... 1,548,000 1,749,000 4,686,000
Equivalent Mcf (MCFE) (2).............. 2,736,000 2,709,000 6,630,000
</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 slight decrease in equivalent proved
reserves in 1997 versus 1996 was primarily attributable to production,
which was almost offset by reserve extensions and discoveries. The decrease
in proved reserves in 1996 versus 1995 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.
(2) After conversion (1:6); one Bbl of oil to six Mcf of gas.
Discounted Present Value of Future Net Revenues
The following table represents the estimated future net revenues (using
unescalated prices) and the present value of the estimated future net revenues
from the proved reserves at December 31, 1997, 1996 and 1995.
FUTURE NET REVENUES
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Estimated Future Net Revenue
Undiscounted (1)................. $ 8,410,000 $14,112,000 $12,600,000
----------- ----------- -----------
Standardized Measure of Discounted
Future Net Cash Flows (1) (2).. $ 6,503,000 $10,820,000 $ 8,942,000
----------- ----------- -----------
</TABLE>
- ----------
(1) The decrease in the estimated discounted and undiscounted future net
revenues in 1997 versus 1996 is primarily attributable to the
significant decrease in prices to $2.60 per Mcf and $16.90 per Bbl at
December 31, 1997. The increase in the discounted present value of the
reserves in 1996 versus 1995 is primarily 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.
(2) The Standardized Measure of Discounted Future Net Cash Flow represents
the present value of future net revenues after income taxes, discounted
at 10%.
28
<PAGE>
Production
The approximate net production data related to the Company's properties for
the years ended December 31, 1997, 1996 and 1995 are set forth below:
NET PRODUCTION DATA
<TABLE>
<CAPTION>
December 31,
---------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Oil (Bbls).................. 87,000 57,000 92,000
Gas (Mcf)................... 821,000 1,038,000 909,000
</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 properties for the years
ended December 31, 1997, 1996 and 1995:
AVERAGE SALES PRICES AND PRODUCTION COSTS
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Average Sales Price Received:
Oil (per Bbl).................................... $ 19.04 $ 20.24 $ 14.66
Gas (per Mcf).................................... 2.66 2.56 1.77
Average Production and Operating Cost per MCFE... 0.81 0.85 1.04
</TABLE>
29
<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, 1997.
PRODUCING WELLS
<TABLE>
<CAPTION>
Gross Net
------------------ -----------------
Oil Gas Oil Gas
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Texas................................. 39.0 43.0 3.90 11.15
Louisiana............................. 2.0 - .26 -
Federal waters - Gulf of Mexico....... - 1.0 - .13
-------- -------- -------- --------
Total............................... 41.0 44.0 4.16 11.28
======== ======== ======== ========
</TABLE>
Principal Customers
During 1997, 63% of the Company's oil production was sold to Plains
Marketing and Transportation, Inc. and 25% to Scurlock Permian Corporation; of
the Company's gas production, 41% was sold to CNG Energy Services Corporation,
16% to Pinnacle Natural Gas Company and 16% to Valero Industrial Gas, L.P.
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. During 1995, 56% of the
Company's oil production was sold to Texaco Trading and Transportation and 10%
to Laroco, LLP; of the Company's gas production, 29% was sold to Laroco LLP, 26%
to Michael Gas Marketing and 16% to AWP.
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, 1997 were approximately as follows:
LEASEHOLD ACREAGE
<TABLE>
<CAPTION>
Developed Undeveloped
------------------ ------------------
Gross Net Gross Net
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Louisiana............................ 160 21 5,347 1,297
Federal waters - Gulf of Mexico...... 500 63 21,095 5,607
Texas ............................ 11,270 1,677 18,306 3,113
New Mexico........................... 1,320 285 27,180 5,882
Oklahoma ............................ - - 80 5
-------- -------- -------- --------
Total.............................. 13,250 2,046 72,008 15,904
======== ======== ======== ========
</TABLE>
30
<PAGE>
Title to Properties
Detailed title examinations were performed for many of the Company's
properties in 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 the Company's bank Credit
Facility. Transfers of many of the Company's properties are subject to various
restrictions.
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 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 with its landlord, for the balance of the term of Fortune's
lease. 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 8 of
notes to the Financial Statements)
COMPETITION
The principal 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 and other
service contractors to evaluate and explore for such reserves; and knowledgeable
personnel to conduct all phases of oil and gas operations. The Company must
compete for such 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 whom 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 September 30, 1998, the Company employed seven 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.
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.
The Company is not currently a party to any judicial or administrative
proceedings which involve environmental regulations or requirements and believes
that it is in substantial compliance with all applicable environmental
regulations. The Company believes that it is reasonably likely that the trend in
environmental legislation and regulations will continue toward stricter
standards. The Company is unaware of future environmental standards that are
reasonably likely to be adopted that will have a material effect on the
Company's financial position or results of operations, but cannot rule out the
possibility.
The Company has never had a material environmental problem, but if a
property in which Fortune has an interest is found to be contaminated, the
Company could be required to participate in a "clean up" program. Such a clean
up, depending on its magnitude and the Company's ownership interest therein,
could require undetermined amounts of capital and exceed the Company's ability
to pay. The Company has obtained insurance against oil spills providing
$11,000,000 of coverage with a $5,000 deductible for such hazards.
31
<PAGE>
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. 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.
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 regulations prevent the Company from freely conducting operations at
all times during the year, such as those which protect the whooping crane
habitat which occupies a portion of the Company's Espiritu Santo Bay prospect.
There is no assurance that laws and regulations enacted in the future will not
adversely affect the Company's exploration for or production and marketing of
oil and gas. From time to time, proposals are introduced in Congress or by the
Administration that could affect the Company's oil and gas operations.
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 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 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 furthered this market manipulation. Fortune intends to continue to
vigorously defend plaintiffs' actions and prosecute its own counterclaims.
Discovery has been stayed pending a ruling by the court on a motion filed by one
of these third-party defendants.
ADDITIONAL 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. Information on the operation of the Public Reference
Room may be obtained by calling 800-SEC-0330. In addition, reports and other
information concerning the Company can be inspected at the offices of the
American Stock Exchange, Inc., 86 Trinity Place, New York, New York 10006-1881,
on which the Common Stock is listed. The SEC maintains an Internet site which
contains reports, proxy and information statements, and other information
regarding issuers which file electronically with the SEC, as does the Company.
The address of that site is http://www.sec.gov. The Company does not currently
have an Internet address.
32
<PAGE>
All documents filed by the Company with the Commission pursuant to Section
13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of this
Prospectus and prior to the termination of the offering of the securities made
hereby shall be deemed to be incorporated by reference in this Prospectus and to
be a part hereof from the date of the filing of such documents. Any statement
contained in a document incorporated or deemed to be incorporated herein by
reference shall be deemed to be modified or superseded for purposes of this
Prospectus to the extent that a statement contained herein or in any other
subsequently filed document which also is incorporated or deemed to be
incorporated by reference herein modifies or supersedes such statement. Any such
statement so modified or superseded shall not be deemed, except as so modified
or superseded, to constitute a part of this Prospectus.
The Company will provide without charge to each person to whom this
Prospectus is delivered, upon oral or written request, a copy of any or all of
the documents incorporated herein by reference (other than exhibits to such
documents, unless such exhibits are specifically incorporated by reference in
such documents). Written or telephone requests should be directed to Fortune
Natural Resources Corporation, 515 West Greens Road, Suite 720, Houston, Texas
77067. Attention: Dean W. Drulias, General Counsel (telephone (281) 872-1170).
33
<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......... 42 1991 President, Chief Executive
Officer, and Director
Dean W. Drulias(1).......... 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(2)......... 41 1992 Director
Barry Feiner(1)............. 64 1995 Director
Gary Gelman(2).............. 32 1995 Director
Daniel Shaughnessy(2)....... 48 1997 Director
Dewey A. Stringer, III(1)... 55 1998 Director
</TABLE>
- ----------
(1) Member of Compensation Committee
(2) Member of Audit 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 Gulf of Mexico. Norcen was
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.
34
<PAGE>
Barry Feiner graduated from Columbia Law School and 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. Mr. Feiner also serves on the board of
directors of Alfin, Inc. (AMEX). He is chairman of the Company's Compensation
Committee.
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".)
Dewey A. Stringer has been the president of Petro-Guard Company, Inc.
("Petro-Guard") since 1982. Petro-Guard specializes in acquiring operated and
non-operated oil and gas properties, exploration utilizing 3D seismic technology
and organizing large exploration projects. Petro-Guard currently operates the
Espiritu Santo Bay project in which the Company is a participant. Mr. Stringer
received his B.S. degree from the University of Houston in 1966.
EXECUTIVE COMPENSATION
The following table lists the total compensation paid by the Company to
persons who served in the capacity of chief executive officer during the periods
indicated and to the other executive officers whose combined 1997 salary and
bonus exceeded $100,000:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term Compensation
------------------------------------
Annual Compensation Awards Payouts
----------------------------- -------------------------- --------
Restricted Securities
Stock Underlying LTIP All Other
Name and Principal Salary Bonus Other(1) Awards Options/Warrants Payouts Compensation
Position Year ($) ($) ($) ($) (No.) ($) ($)
- ---------------------------- ---- -------- -------- -------- -------- ---------------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks......... 1997 155,833 17,500 35,309 - 120,000 - 4,748
President and CEO 1996 150,000 - 20,934 - 80,000 - 3,000
1995 125,000 25,000 - - 105,599 - -
Dean W. Drulias............. 1997 125,000 3,000 - - 75,000 - 4,750
Executive Vice President 1996 26,291 250 - - 56,0002 - 1,643
J. Michael Urban............ 1997 120,000 5,000 - - 100,000 - 4,750
Chief Financial Officer 1996 97,308 - - - 55,0003 - 4,750
</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 $2.5625 per share (the market price of the
Common Stock on March 11, 1996, the date of issue) and expiring on March
11, 2001.
35
<PAGE>
The following table lists the outstanding options under Company's Stock
Option Plans held on December 31, 1997 by the Company's executive officers
listed in the Summary Compensation Table:
AGGREGATE OPTION EXERCISES IN 1997 AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Number of Value of Unexercised
Unexercised Options/ in the Money Options
Warrants at FY-End at FY-End (1)
Shares Acquired Exercisable/ Exercisable/
Name on Exercise Value Realized ($) Unexercisable(1) Unexercisable
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Tyrone J. Fairbanks - - 406,999 / 0 -
Dean W. Drulias 6,400 - 151,000 / 0 -
J. Michael Urban - - 155,000 / 0 -
</TABLE>
- ----------
(1) Includes warrants reflected in the preceding table.
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
the employment 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 years of
consulting services upon the completion of the primary term of his contract at
40% of the last compensation thereunder. Mr. Fairbanks' employment agreement
provides for an annual salary of $160,000, annual salary increases, and
additional compensation, in an amount not to exceed his annual salary, based
upon certain increases in the value of the Company's Common Stock. Mr.
Fairbanks' employment contract expires the later of May 31, 2000, or six months
following notice of non-renewal. 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 two 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 both plans must be exercised within
five years of the date of grant or they are forfeited.
Options have been granted as follows: (1) 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 and (2)
727,500 shares at $1.5625 per share granted under the 1998 plan. The exercise
prices of all options granted in 1993, 1994 and 1995 were reduced to $2.75 on
January 12, 1995.
36
<PAGE>
The following table shows the grants of stock options during 1997 to each
of the executives named in the Summary Compensation Table.
OPTION GRANTS IN 1997
<TABLE>
<CAPTION>
Individual Grants
------------------------------------------------------------
Number of % of Total Potential Realizable Value At
Securities Options Assumed Annual Rates Of
Underlying Granted to Exercise or Stock Price Appreciation
Options Employees in Base Price Expiration For Option Term
Name Granted Fiscal Year ($/Share) Date 5% 10%
- ------------------- ---------- ----------- ----------- ----------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks 120,000 20.2 3.00 February 13, 2002 $ 99,461 $219,784
Dean W. Drulias 75,000 12.6 3.00 February 13, 2002 62,163 137,365
J. Michael Urban 100,000 16.8 3.00 February 13, 2002 82,884 183,153
</TABLE>
In addition to the grants shown, Mr. Fairbanks was granted options to
purchase 100,000 shares and Messrs. Drulias and Urban were each granted options
to purchase 150,000 shares on March 5, 1998.
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 Natural Resources Corporation
401(k) Profit Sharing Plan for its eligible employees. Under the plan, eligible
employees are permitted to make salary deferrals of up to 15% of their annual
compensation, subject to Internal Revenue Service (IRS) limitations. Salary
deferrals will be matched 50% by the Company, subject to IRS limitations, 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 the 1997 plan year, the Company's matching contribution obligation was
$24,000, all of which was paid in shares of Common Stock. The amounts
contributed to the plan as matching contributions for executives of the Company
are shown in the Summary Compensation Table set forth above.
DIRECTOR COMPENSATION
The Company pays outside directors fees of $2,500 per quarter. Inside
directors do not receive any compensation for serving as directors.
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 was completed 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 managing director 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 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.
37
<PAGE>
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 and a secured recourse
loan in the amount of $70,000. The $80,000 loan bears 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 not been terminated by the Company with cause. The $70,000 loan also bears
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. (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 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 Company borrowed an
aggregate of $175,000 from the directors, $375,000 from Klein Ventures, Inc.,
and $200,000 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 Common Stock purchase warrants with an exercise price of $2.40
per share, and Mr. Farber received 35,000 Common 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 and 1995, the law firm of which Dean W. Drulias was formerly a
shareholder billed the Company a total of $152,000 and $183,000, respectively,
for legal fees and costs. (See "Management - Directors and Executive Officers.")
During 1997 and 1996, Fortune paid $182,000 and $45,000, respectively, and
$195,000 for the six months ended June 30, 1998 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.")
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'
38
<PAGE>
duty of loyalty to the Company or its stockholders, (ii) for acts or omissions
not in good faith or which involve intentional misconduct or a knowing violation
of law, (iii) for unlawful payment of dividends or unlawful stock purchases or
redemptions, or (iv) for any transaction from which any director derived an
improper personal benefit.
This provision protects the Company's directors against personal liability
for monetary damages arising from breaches of their duty of care. Directors
remain liable for breaches of their duty of loyalty to the Company and its
stockholders and for the specific matters set forth above, as well as for
violations of the federal securities laws. The provision has no effect on the
availability of equitable remedies such as injunction or rescission.
Additionally, these provisions do not protect a director from activities
undertaken in any capacity other than that of director.
INDEMNIFICATION OF OFFICERS AND DIRECTORS
The Company's bylaws provide for indemnification of its officers and
directors to the fullest extent permitted by the Delaware General Corporation
Law in effect at the time of a claim for indemnification. Such indemnification
applies to any threatened, pending or contemplated suit or proceeding arising by
reason of such person acting as an officer or director of the Company or its
affiliates.
Insofar as indemnification for liabilities arising under the Act may be
permitted to directors, officers or persons controlling the Company pursuant to
the foregoing provisions, the Company has been informed that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Act and is therefore unenforceable.
PRINCIPAL STOCKHOLDERS
The following table contains information at September 30, 1998, 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) 1,132,604 8.6%
William D. Forster
237 Park Ave, New York, NY(2) 681,000 5.4%
Tyrone J. Fairbanks (Director, President and CEO)
515 W. Greens Rd., Houston, TX(3) 533,521 4.2%
John L. Collins (Vice President)
515 W. Greens Rd., Houston TX(3) 410,267 3.3%
Dean W. Drulias (Director, Executive Vice President,
General Counsel and Corporate Secretary)
515 W. Greens Rd., Houston, TX(3) 333,641 2.7%
J. Michael Urban (Vice President and CFO)
515 W. Greens Rd., Houston, TX(3) 323,701 2.6%
Graham S. Folsom (Director)
515 W. Greens Rd., Houston, TX(3)(4) 172,251 1.4%
Gary Gelman (Director)
515 W. Greens Rd., Houston, TX(3) 131,583 1.1%
Barry Feiner (Director)
515 W. Greens Rd., Houston, TX(3)(5) 127,993 1.0%
Daniel R. Shaughnessy (Director)
515 W. Greens Rd., Houston, TX(3) 77,500 *
Dewey A. Stringer, III (Director)
515 W. Greens Rd., Houston, TX(3) 15,000 *
All Officers and Directors
as a group of nine (9) persons 2,125,457 15.2%
========= =====
</TABLE>
- ----------
* indicates less than 1%.
39
<PAGE>
(1) Includes 137,000 shares of Common Stock and 17,917 shares of Common Stock
which underlie an equal number of private stock purchase warrants,
exercisable at $3.60 per warrant, issued in connection with the Company's
1997 Convertible Note offering; 777,687 shares of Common Stock which
underlie 541,000 publicly-traded stock purchase 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
managing director of J. Robbins Securities, LLC., the underwriter for the
Company's 1997 Convertible Note offering.
(2) Includes 515,000 shares of Common Stock underlying stock purchase warrants
exercisable at $4.75 per share and expiring April 2000.
(3) Includes the following shares of Common Stock issuable upon the exercise of
stock options granted under the Company's various stock option plans and
shares of Common Stock issuable upon the exercise of stock purchase
warrants issued to employees in lieu of stock options:
<TABLE>
<CAPTION>
Common Stock Average Weighted
Issuable Exercise Price
------------ ----------------
<S> <C> <C>
Tyrone J. Fairbanks 506,999 $2.63
J. Michael Urban 305,000 2.25
Dean W. Drulias 299,800 2.27
John L. Collins 297,000 2.57
Graham S. Folsom 148,475 2.61
Gary Gelman 111,750 2.56
Barry Feiner 111,750 2.56
Daniel R. Shaughnessy 47,500 1.87
Dewey A. Stringer, III 10,000 1.50
</TABLE>
(4) Includes 7,187 shares issuable upon exercise of 5,000 stock purchase
warrants (at $3.75 per warrant).
(5) All shares shown, except those which underlie stock purchase options
granted to Mr. Feiner by virtue of his service as a director, are owned by
Janet Portelly, wife of Barry Feiner; Mr. Feiner disclaims beneficial
ownership of all such shares owned by Mrs. Portelly. The number shown
includes 14,375 shares issuable upon exercise of 10,000 public warrants (at
$3.75 per warrant).
40
<PAGE>
THE SELLING HOLDERS
Fortune issued and sold the Securities to the Selling Holders in a private
sale exempt from the registration requirements of the Securities Act, and agreed
to register the sale of the Securities with the Securities and Exchange
Commission on one occasion after December 31, 1997 upon the request of holders
of a majority of the underlying shares. Fortune has agreed to indemnify the
Selling Holders against certain liabilities, including liabilities under the
Securities Act, and to bear the expenses of the registration of which this
prospectus is a part.
Except as otherwise indicated, the following table is as of September 30,
1998. The term "Selling Holders" includes the beneficial owners of the
Securities listed below and their respective transferees, pledgees, donees or
other successors. Except as noted below or in "Certain Relationships and Related
Transactions", no Selling Holder has had any material relationship with the
Company or any of its affiliates within the past three years.
<TABLE>
<CAPTION>
Number of Shares
Aggregate Principal Amount of Common Stock Owned
Name of Selling Holder of Notes Owned and Offered Hereby and Offered Hereby (1)
- -------------------------------------- --------------------------------- --------------------
<S> <C> <C>
Sherrill M. Baird $ 150,000 50,000
Violet M. Blank Trust 50,000 16,666
William N. Jones 50,000 16,666
Robert A. Mignatti 50,000 16,666
Janet M. Portelly 50,000 16,666
Richard J. Cranmer 50,000 16,666
Joseph Roselle 150,000 50,000
Harlan W. Smith 150,000 50,000
Dwight and Judith Haight 100,000 33,333
Ben Branch 30,000 10,000
Tenaire Profit Sharing Trust 20,000 6,666
Suzanne Bader 50,000 16,666
Richard Maser 50,000 16,666
JoAnn Timbanard Trust 50,000 16,666
Compass Bank, Custodian FBO Renaissance
Capital Growth and Income Fund III, Inc. 350,000 116,666
Compass Bank, Custodian FBO Renaissance
US Growth and Income Trust PLC 350,000 116,666
George P. Haight 100,000 33,333
J. E. McConnaughy, Jr. 500,000 166,666
Barry A. Friedman 50,000 16,666
Stuart D. Wechsler 50,000 16,666
Kenneth W. Moore IRA 50,000 16,666
Sam A. and Barbara C. Phillips 50,000 16,666
John L. and Sharon L. Kiser 50,000 16,666
Willard J. Kiser Living Trust 100,000 33,333
Alec G. Land 75,000 25,000
J. Robbins Securities, LLC (2) - 71,666
Barry W. Blank (2) (3) 500,000 184,582
----------
Total $3,225,000
==========
</TABLE>
(1) Unless otherwise noted, the nature of beneficial ownership is sole voting
and/or investment power. Shares shown are the number of whole shares into
which the Holder's Notes are convertible at the initial conversion price of
$3.00 and the shares underlying the underwriter's warrants issued in
connection with this transaction. Except as disclosed in footnote 3 below,
no Selling Holder reported owning any other shares of capital stock of
Fortune.
(2) The number of shares of Common Stock shown are the number of whole shares
into which the Selling Holders' Warrants are convertible at their initial
exercise price. The Warrants are not registered or listed for trading.
41
<PAGE>
(3) Mr. Blank is the beneficiary of a trust which owns $500,000 in principal
amount of the Notes, convertible into 166,666 shares, and separately holds
a Warrant to purchase 17,916 shares at $3.60 per share paid to him as a
representative for the placement agent in the offering of the Notes. Mr.
Blank is also the owner of 137,000 shares of Fortune Common Stock, which
represents approximately 1.1% of the outstanding shares, and holds warrants
to purchase an additional 995,604 shares at effective prices ranging from
$2.40 to $3.60 per share. If Mr. Blank exercised all warrants to purchase
Fortune Common Stock held by him, he would own 1,132,604 shares,
representing approximately 8.6% of the outstanding shares of Fortune Common
Stock.
The table above reflects information furnished to Fortune by or on behalf
of the Selling Holders. Changes in that information and information respecting
additional Selling Holders will be included in supplements hereto when
necessary.
42
<PAGE>
DESCRIPTION OF THE NOTES
The following summary of certain provisions of the Notes does not purport
to be complete and is subject to and is qualified in its entirety by reference
to the Notes, a copy of which is filed as an exhibit to the Registration
Statement of which this prospectus is a part and is incorporated herein by this
reference.
GENERAL
The Notes are unsecured obligations of Fortune, are limited to $3,225,000
in aggregate principal amount and mature on December 31, 2007. The Notes bear
simple interest at the annual rate of 12%, payable quarterly in arrears, on the
first day of each January, April, July and October commencing on January 1,
1998, until paid in full. Interest on the Notes will be paid on the basis of a
360-day year of twelve 30-day months.
Payment of principal and interest on the Notes may be made by the Company's
check. Interest payments are mailed to the holder's address as furnished to the
Company, and principal payments will be made upon surrender of the Note to
Fortune.
CONVERSION RIGHTS
Subject to the Alternate Conversion Right described below, the Notes are
convertible into Common Stock, at the option of the Holder, at any time
commencing on May 1, 1999 until the close of business on the business day
preceding the day the Notes are paid in full, if not earlier prepaid by the
Company. The Notes may be converted in part so long as such portion is $50,000
or a whole multiple thereof. The conversion price, subject to adjustment as
described below, shall be the lower of (i) $3.00 per share or (ii) 5% above the
average Closing Prices of the Common Stock for the 60 calendar day period
immediately preceding May 1, 1999.
If, however, prior to May 1, 1999 Fortune issues any shares of Common Stock
for purposes other than for an Adjustment Event (as defined below) or in
satisfaction of any exercise of stock options or stock purchase warrants, for a
per share consideration less than the conversion price in effect on the date of
such issue, Fortune shall, within ten business days after such issuance, give
notice of such issuance to each holder who shall have the one time right (the
"Alternate Conversion Right"), exercisable within 20 business days thereafter,
to convert all, but not less than all, of the Notes. In that event, the
conversion price shall be reduced by an amount equal to the number obtained by
dividing the number of shares of Common Stock so issued and outstanding by the
total number of share of Common Stock issued and outstanding after such issuance
and multiplying the quotient by the difference between the existing conversion
price and the price of the shares of Common Stock so issued. Shares issued for
cash shall be deemed to be sold for the gross cash proceeds received; issuances
for other than cash shall be deemed to be for the value of the consideration
placed by the parties to the transaction or, if no such value is stated, by the
Board of Directors of Fortune acting in good faith and with respect to all
aspects of the transaction. No fractional shares shall be issued on conversion.
The conversion price is subject to adjustment on the occurrence of any of
the following events by Fortune (each an "Adjustment Event"): (i) the
declaration of a dividend on its outstanding Common Stock in shares of its
capital stock, (ii) the subdivision of its outstanding Common Stock, (iii) the
combination of its outstanding Common Stock into a smaller number of shares,
(iv) the issuance of any shares of its capital stock by reclassification of its
Common Stock (including any such reclassification in a consolidation or merger
in which Fortune is the continuing corporation), unless in connection with a
merger, consolidation or similar transaction, the Notes are converted into the
equivalent kind and amount of securities, cash or other assets, and with
equivalent adjustments, as would have been owned if the Note had been converted
immediately prior to the transaction, (v) the issuance to all its existing
stockholders of rights, options, or warrants for Common Stock at a price per
share less than the average of the daily closing prices for the 30 consecutive
trading days commencing 45 trading days before the record date for the
determination of stockholders entitled to receive such rights, or (vi) the
distribution to its stockholders of evidences of its indebtedness or assets;
provided, however, that no adjustment need be made if (a) in each case the
holder is permitted to participate in the transaction on a basis no less
favorable than any other party and at a level which would preserve holder's
percentage equity participation in the Common Stock upon conversion of the Note,
(b) the sales of Common Stock are pursuant to a Company plan for reinvestment of
dividends or interest, the granting or exercise of options under existing stock
option plans, the exercise of any other outstanding options or authorized
warrants, or (c) the Note becomes convertible solely into cash. In the case of
each Adjustment Event, the conversion price shall be adjusted to reflect the
dilutive effect of the Adjustment Event on the conversion price. Adjustments are
made successively whenever an Adjustment Event occurs, and are effective
immediately after the record
43
<PAGE>
date in the case of a dividend or distribution and immediately after the
effective date in the case of a subdivision, combination or reclassification.
Any adjustment of less than 1% of the conversion price will not be made, but
will be carried forward and taken into account in any subsequent adjustment.
Fortune will promptly mail a notice of adjustment to all holders, stating the
facts requiring the adjustment, the adjusted conversion price, the manner of
computing it and the effective date of the adjustment. As of the date of this
prospectus, no Alternate Conversion Right has arisen and no Adjustment Event has
occurred.
Fortune may reduce the conversion price for any period of time of at least
20 days by any amount, and shall mail a notice of the reduction to all holders
at least 15 days before the effective date of the reduction. A reduction of the
conversion price will not, however, change or adjust the conversion price
otherwise in effect beyond the period specified in the notice.
Any conversion prior to an interest payment date will result in forfeiture
of accrued interest on the Notes so converted. Upon a partial conversion of the
principal amount of a Note, shares of Common Stock will be issued in accordance
with the conversion price for that portion of the principal amount of the Note
so converted, and a new Note will be issued for the balance of the principal
amount.
SUBORDINATION
The payment of the principal of and premium, if any, and interest on the
Notes and any other payment obligations of Fortune in respect of the Notes
(including any obligation to repurchase the Notes) are subordinated in right of
payment to the prior payment in full of all Senior Debt, whether outstanding on
the date of the issuance of the Notes or thereafter incurred. Senior Debt
includes all indebtedness, and any deferrals, renewals, increases or extensions
thereof, borrowed under the Company's Credit Agreement with Credit Lyonnais New
York Branch, as agent (the "Credit Agreement") and all indebtedness secured by
assets of Fortune having a value (as determined by the Board of Directors) of
more than 50% of the outstanding principal amount of such indebtedness or
$100,000, whichever is less, (i) for borrowed money, (ii) for money borrowed by
others and guaranteed by Fortune, or (iii) constituting purchase money
indebtedness for the payment of which Fortune is liable, whether existing on or
created after the date the Notes are issued, that is not made subordinate to or
pari passu with the Notes by the instrument creating the indebtedness. Purchase
money indebtedness means indebtedness evidenced by a note, debenture, bond or
other similar instrument issued to or assumed for a vendor as all or part of the
purchase price of such asset acquired by the Company. Each Note shall be paid on
a pari passu basis with all other Notes. All Senior Debt evidenced by the Credit
Agreement and the documents related thereto, and all modifications and
amendments thereto and substitutions thereof are herein referred to as the
"Senior Bank Debt".
If there is a payment or distribution of assets to creditors on any
liquidation, dissolution, winding up, receivership, reorganization, assignment
for the benefit of creditors, marshaling of assets and liabilities or any
bankruptcy, insolvency or similar case or proceeding of Fortune, the holders of
all Senior Bank Debt will be entitled to receive payment in full of all
obligations under the Senior Debt before the holders of the Notes will be
entitled to receive any payment in respect of the principal or interest on the
Notes. In addition, Fortune may not make any payment on any of its obligations
under the Notes if a default or potential default, as defined in the Credit
Agreement, occurs and until it is remedied by payment in full of all Senior Bank
Debt or waived in writing by all affected holders of the Senior Bank Debt. So
long as any Senior Bank Debt is outstanding, holders of the Notes may not take
any enforcement action to accelerate the debt evidenced by the Notes or exercise
any remedies against Fortune to collect any of its obligations thereunder, or
join in or initiate any action in bankruptcy, insolvency, liquidation,
reorganization, receivership, dissolution or similar law, if a default or
potential default under the Credit Agreement has occurred and has not been
remedied or waived so that the full amount of the Senior Bank Debt is declared
due and payable. In addition, holders of the Notes may not institute any
proceedings against Fortune or the holder of the Senior Bank Debt which would
interfere with or delay the exercise of the rights of such holders in respect of
any property of the Company constituting collateral security for the Senior Bank
Debt or under the Credit Agreement. Any distribution received by the holders of
the Notes (other than the Underlying Shares received in conversion of the Notes)
in contravention of any of the terms of the Note before all Senior Bank Debt has
been paid in full shall be deemed to be held in trust for the benefit of the
holders of the Senior Bank Debt.
The Company is not prohibited or limited in the incurrence of additional
Senior Debt. As of September 30, 1998, $10,000 was outstanding under the Credit
Agreement; the Company has no other Senior Debt. Fortune expects to incur Senior
Debt from time to time in the future. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
44
<PAGE>
PREPAYMENT
Fortune may not repay the Notes or any portion thereof prior to May 1,
1999. Thereafter, Fortune may prepay the Notes or any portion thereof, together
with accrued interest to the date fixed for repayment, at any time after notice
to the holders. Notice of such repayment shall be given to the holders not more
than 30 nor less than 60 days before the date fixed for repayment. Beginning May
1, 1999, Fortune may prepay the Notes without any premium or penalty on 30 days
notice to the holders if the closing price of the Common Stock on the principal
national securities exchange on which it is listed for 30 consecutive trading
days immediately preceding the day on which the repayment notice is sent equals
or exceeds $4.50 per share. Alternatively, if such trading price is not reached,
Fortune may prepay the Notes at the percent of principal amount of the Notes as
indicated below for the dates shown:
<TABLE>
<CAPTION>
Percent of Percent of
Date Principal Date Principal
----------------- ---------- ----------------- ----------
<S> <C> <C> <C>
May 1, 1999 110.00 February 1, 2000 104.96
June 1, 1999 109.44 March 1, 2000 104.40
July 1, 1999 108.88 April 1, 2000 103.84
August 1, 1999 108.32 May 1, 2000 103.28
September 1, 1999 107.76 June 1, 2000 102.72
October 1, 1999 107.20 July 1, 2000 102.16
November 1, 1999 106.64 August 1, 2000 101.60
December 1, 1999 106.08 September 1, 2000 101.04
January 1, 2000 105.52 October 1, 2000 100.48
</TABLE>
Repayment after October 1, 2000 shall be at 100% of principal. No sinking
fund is provided for the Notes. Notes called for repayment will be convertible
until the close of business on the day before the repayment date, but Note
holders will forfeit the accrued interest for the then-current period on any
Notes surrendered for conversion.
RIGHTS UPON AN EVENT OF DEFAULT
An "Event of Default" consists of (i) the failure by Fortune to make a
timely payment of principal or interest on the Note when due and payable under
the Notes, which failure remains uncured for a period of 15 days after notice
thereof has been given by a holder to Fortune, (ii) Fortune's failure to be in
material compliance with its covenant to issue the Common Stock upon a holder's
conversion of the Notes in accordance with their terms, (iii) Fortune's failure
to be in material compliance with its covenant to keep its corporate existence
and rights in full force and effect, continue conducting its business, keep
adequate books and records of account of its business activities, maintain
appropriate levels and types of insurance with reputable carriers, and comply in
all material respects with all governmental laws and regulations applicable to
it which, if breached, would have a material adverse effect on its business or
financial condition, (iv) Fortune's failure to be in material compliance with or
neglect to perform any of the provisions of the Note, which failure remains
uncured for 30 days after notice has been given by holder or the agent under the
Credit Agreement to Fortune, (v) any representation or warranty made by Fortune
in the Note which is untrue or incorrect in any material respect as of the date
made, (vi) the commencement of any bankruptcy, receivership, winding up or
liquidation of the affairs of Fortune or any of its subsidiaries, which remains
undismissed for a period of 90 consecutive days, or (vii) the institution of
bankruptcy, custodianship, receivership or similar action by or with the consent
of Fortune or one of its subsidiaries.
The occurrence of an Event of Default as described under subparagraphs (vi)
or (vii) above shall result in all obligations due under the Notes becoming
immediately due and payable without notice. If an Event of Default as described
under subparagraphs (i) through (v) above shall occur, the holders of at least
51% in principal amount of the Notes may at their option by notice to Fortune
declare all unpaid obligations immediately due and payable. In addition to the
obligations remaining unpaid under the Notes, all reasonable costs and expenses
of collection and enforcement of the Note shall be payable by Fortune.
Fortune's ability to pay the obligations due under the Notes upon the
acceleration of their maturity may be limited by the terms of the Senior Debt
and will depend on the availability of sufficient funds. Accordingly, no
assurance can be given that Fortune will be able to meet its obligations under
the Notes upon the occurrence of an Event of Default.
45
<PAGE>
FORM, DENOMINATION AND TRANSFER
The Notes were issued in registered form, without coupons, in denominations
of $10,000 or integral multiples thereof, and in such principal amounts as were
determined by the Company. No transfer shall be valid unless effected on
Fortune's books by the registered holder in person or by an attorney duly
authorized in writing, and similarly noted on the Note. Fortune may charge
holder a reasonable fee for any re-registration, transfer or exchange of the
Notes.
REGISTRATION RIGHTS
Pursuant to the registration rights extended to the Selling Holders under
the Notes, Fortune has registered the sale of the Notes and the Underlying
Shares under the Securities Act for resale by the holders thereof who satisfy
certain conditions relating to the provision of information in connection with
the registration statement of which this prospectus is a part. Fortune has also
agreed to use its best efforts to keep the registration statement effective
until the earliest of two years after the date of this prospectus, the date all
the Securities registered hereunder have been sold or until the Securities may
be sold publicly without registration (November 4, 1999 for holders that have
not then been affiliates of Fortune for at least three months). Fortune will
also use its best efforts to qualify the Securities under the securities laws of
the states in which holders reside, provided that Fortune is not required to
consent to service or to qualify to do business in any state as a result of such
qualification. Fortune cannot assure it will be able to maintain an effective,
current registration statement under the Securities Act as required, and any
failure to do so might adversely affect the marketability and sale price of the
Securities. Each of the Securities will remain restricted in its transfer until
sold in accordance with this registration under the Securities Act or
distributed to the public pursuant to Rule 144 or any similar provision then in
force.
Holders also have the right to include the Securities in any registration
statement filed by Fortune with respect to any of the Company's securities
(except one relating to stock option or employee benefit plans) in a piggy-back
registration, subject to exclusion of those Securities by any underwriter of
Fortune's offering, so long as the Securities cannot be sold pursuant to the
exemption from registration provided by Rule 144(k) promulgated under the
Securities Act (November 4, 1999 for holders that have not then been affiliates
of Fortune for at least three months).
The holders electing to include Securities in any registration filed by the
Company must provide the Company with such information and execute such
documents, including appropriate cross-indemnification, as are reasonably
required to prepare and process the Company's registration statement. Fortune
has agreed to bear all expenses (except underwriting discounts and commissions,
if any, and the legal fees and expenses, if any, of counsel to holders)
necessary and incidental to either registration.
LIMITED MARKET FOR THE NOTES
On their original issuance, the Notes were issued in a private placement to
accredited investors and were severely restricted in their transfer. The Notes
have not been and will not be listed for trading on any recognized market. No
assurance can be given that a market for the Notes will develop, as to the
liquidity or sustainability of any market that may develop, or the ability of
holders to sell their Notes at any price. Future trading prices of the Notes
will depend on many factors, including prevailing interest rates, Fortune's
operating results, the price of the Common Stock and the market for similar
securities.
GOVERNING LAW; MODIFICATION
The Notes are construed in accordance with, and the rights of the parties
thereto shall be governed by, the laws of the State of Texas applicable to
contracts made and to be performed entirely within such state. The Notes may be
modified only by a writing signed by the holder and Fortune, and then only to
the extent set forth in such writing and only in the specific instance for which
it is given. No forbearance, delay or failure to exercise any right or remedy by
a holder of a Note will operate as a waiver of or acquiescence in any default.
46
<PAGE>
DESCRIPTION OF SECURITIES
COMMON AND PREFERRED STOCK
The following description is qualified in all respects by reference to the
Company's Certificate of Incorporation and all amendments thereto and the
Company's Bylaws, copies of which are filed as exhibits to the Registration
Statement of which this Prospectus is a part.
The Company's Certificate of Incorporation, as amended, currently
authorizes 40,000,000 shares of Common Stock, $.01 par value and 2,000,000
shares of preferred stock, $1.00 par value. Of this total, 12,134,678 shares of
Common Stock were issued and outstanding as of September 30, 1998. An additional
4,380,059 shares of Common Stock were issuable upon exercise of options and
private warrants outstanding as of that date. 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.
47
<PAGE>
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 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.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion has been prepared by the Company to present the
material federal income tax considerations under generally applicable current
law of the acquisition, ownership, conversion and disposition of the Notes and
the acquisition, ownership and disposition of any Common Stock which is received
on the conversion of a Note or the Warrants, for persons who acquire the Notes
and hold those Notes and any such Common Stock as capital assets. It does not,
however, discuss the effect of (i) special rules, such as those which apply to
tax-exempt organizations, insurance companies, financial institutions, persons
who hold the Notes or Common Stock in connection with a straddle or dealers or
(ii) any foreign, state or local tax law. Accordingly, each prospective
purchaser of Notes is advised to consult its own tax advisor regarding the
matters discussed herein in light of its particular circumstances, the
application of state, local and foreign tax laws, and the fact that such laws
change from time to time.
The following statements are based upon the Internal Revenue Code of 1986,
as amended (the "Code"), existing regulations thereunder and the current
judicial and administrative interpretations thereof.
48
<PAGE>
OWNERSHIP BY U.S. PERSONS
The following applies to a person who is a citizen or resident of the
United States (a "U.S. Holder"), a corporation or partnership created or
organized in the United States or any state thereof or an estate or trust the
income of which is includible in income for United States federal income tax
purposes regardless of its source.
Interest on Notes
The stated interest on a Note will be taxable as ordinary income at the
time interest is paid or accrued in accordance with the U.S. Holder's method of
accounting for United States federal income tax purposes. The Notes were not
issued with original issue discount.
Market Discount
If a Note is acquired at a "market discount," gain realized on a taxable
disposition (and certain nontaxable dispositions) thereof will be treated as
interest income to the extent of the theretofore unrecognized accrued market
discount. Subject to a de minimis exception, "market discount" with respect to a
Note is equal to the excess of (i) the stated redemption price at maturity of
the Note over (ii) the holder's initial basis in the Note. Any market discount
accrues on a ratable basis or, at the election of the Holder, on the basis of a
constant interest rate, and a Holder of a market discount Note may elect to
include the market discount in its income as that market discount accrues. If a
holder converts a market discount Note into Common Stock, the theretofore
unrecognized accrued market discount on that Note will not, in general, be
recognized, but will be treated as ordinary income on the later disposition of
that Common Stock to the extent of any gain recognized at that time on the
disposition of that Common Stock.
Conversion of Notes
A U.S. Holder generally will not recognize gain or loss on the conversion
of a Note into Common Stock except that it will recognize a capital gain or loss
as a result of the receipt of cash in lieu of a fractional share equal to the
amount of cash reduced by the basis of the portion of the Note in respect of
which that cash was paid. The basis of the Common Stock that is received on the
conversion will be the adjusted basis of the Note which was converted at the
time of conversion increased by any gain that is recognized, decreased by any
loss that is recognized and decreased by any cash that is received. The holding
period of that Common Stock will include the holding period of the converted
Note.
Constructive Dividend
A distribution to holders of Common Stock may cause a deemed distribution
(which will be a dividend to the extent of Fortune's current or accumulated
earnings and profits) to the Noteholders if the conversion price or conversion
ratio of the Notes is adjusted to reflect that distribution.
Sale or Exchange of Notes or Common Stock
Gain or loss will be recognized on the sale or exchange of the Notes or of
Common Stock in an amount equal to the difference between (i) the amount of cash
and the fair market value of any other property received by the Holder
(excluding, in the case of the Notes, any amount representing accrued interest,
which will be taxable as such) and (ii) the Holder's adjusted basis in the
property sold or exchanged. Any such gain (other than gain characterized as
interest under the market discount rules) or loss with respect to a Note or
Common Stock will be a capital gain or loss. If the holding period of the asset
was more than one year it will be a long-term capital gain or loss subject to a
maximum tax rate of 28%, or a maximum tax rate of 20% if the holding period was
more than eighteen months.
Dividends on Common Stock
Distributions on the Common Stock will be dividends to the extent of the
current or accumulated earnings and profits of Fortune, then a nontaxable return
of capital reducing the holder's adjusted basis in the Common Stock until such
adjusted basis is reduced to zero and finally an amount received in exchange for
the Common Stock. Dividends paid to domestic corporations may qualify for the
dividends received deduction subject to the limiting provisions that apply
thereto.
49
<PAGE>
OWNERSHIP BY NON-U.S. HOLDERS
The following applies to a person who is not a U.S. Holder (a "Non-U.S.
Holder") and to the income received thereby, such as interest, dividends and
gain or loss on disposition, with respect to Notes and Common Stock which is not
effectively connected with the conduct by the Non-U.S. Holder of a trade or
business within the United States. Any such effectively connected items of
income will be subject to the United States federal income tax that applies to
U.S. Holders generally, and, in the case of such a Non-U.S. Holder that is a
foreign corporation, those items also will be subject to the branch profits tax.
Interest on Notes
Interest paid on Notes to a Non-U.S. Holder will not be subject to United
States federal income tax or to withholding in respect thereof if: (i) the
beneficial owner (or if certain requirements are satisfied, a member of a class
of financial institutions) certifies, under penalties of perjury, that the
beneficial owner is not a U.S. Holder and provides the beneficial owner's name
and address, (ii) the Non-U.S. Holder does not actually or constructively own
10% or more of the total voting power of all classes of stock of Fortune
entitled to vote (Common Stock into which a Note can be converted is
constructively owned for these purposes), (iii) the Non-U.S. Holder is not a
controlled foreign corporation with respect to which Fortune is a "related
person" within the meaning of Section 864(d)(4) of the Code, and (iv) the
Non-U.S. Holder is not a bank holding the Notes as a result of an extension of
credit made pursuant to a loan agreement entered into in the ordinary course of
its trade or business. Accrued market discount on a Note is not treated for
these purposes as interest income. If the foregoing conditions are not
satisfied, then the interest will generally be subject to United States federal
income tax withholding at a rate of 30% (or any lower rate that is provided by
any applicable treaty).
Sale or Exchange of Notes or Common Stock; Conversion of Notes
A Non-U.S. Holder generally will not be subject to United States federal
income tax on gain recognized on the sale or exchange of Notes or Common Stock
or on the conversion of a Note unless (i) the Holder is an individual who is
present in the United States for 183 or more days in the taxable year and
certain other conditions are satisfied or (ii) Fortune is (as is not expected) a
"United States real property holding corporation," as defined in Section 897 of
the code, and certain exceptions do not apply.
Dividends on Common Stock
Any distribution on Common Stock to a Non-U.S. Holder will be subject to
United States federal income tax withholding at a rate of 30% (or any lower rate
which is provided by any applicable treaty).
Estate Tax
An individual Non-U.S. Holder of a Note will not be required to include the
value of such Note in his gross estate for United States federal estate tax
purposes, provided that such Holder did not at the time of death actually or
constructively own 10% or more of the combined voting power of all classes of
stock of Fortune and, at the time of such Holder's death, payments of interest
on such Note would not have been effectively connected with the conduct by such
Holder of a trade or business in the United States. An individual Non-U.S.
Holder who is treated as the owner, or has made certain lifetime transfers, of
an interest in the Common Stock will be required to include the value thereof in
his gross estate for United States federal estate tax purposes (and may be
subject to United States federal estate tax with respect thereto), unless
otherwise provided by an applicable estate tax treaty.
Backup Withholding; Information Reporting
A noncorporate U.S. Holder holding Notes or Common Stock (and any Non-U.S.
Holder failing to provide a certificate that it is not a U.S. Holder) will be
subject to backup withholding at the rate of 31% with respect to interest paid
on the Notes, dividends paid on Common Stock and the proceeds of any sale,
exchange or redemption thereof if the payee fails to furnish a taxpayer
identification number and in certain other circumstances. Any amounts so
withheld will be allowed as a refund or a credit against the Holder's United
States federal income tax liability, provided that certain information is
furnished to the Internal Revenue Service. Information reporting will be
required with respect to a payment of proceeds from the sale or exchange of
Notes or Common Stock through a foreign office of a broker that is a United
States person or of certain foreign brokers unless the broker has documentary
evidence in its files that the owner is a Non-U.S. Holder and the broker has no
actual knowledge to the contrary.
50
<PAGE>
PLAN OF DISTRIBUTION
The Selling Holders may offer and sell the Securities from time to time and
will act independently of Fortune in deciding the timing, manner and size of any
sale. Fortune expects that sales generally will be made at then prevailing
market prices, but prices in negotiated transactions may differ considerably.
Fortune cannot predict the extent, if any, to which Selling Holders may sell the
Notes.
Selling Holders may sell Securities in the over-the-counter market or
otherwise and the Common Stock on the AMEX, at prices that (i) represent or
relate to then prevailing market prices or (ii) are negotiated, including by
means of purchase by a broker-dealer as principal and resale by such broker or
dealer for its account pursuant to this prospectus, ordinary brokerage
transactions and transactions in which a broker solicits purchasers, and block
trades in which a broker-dealer so engaged will attempt to sell the Securities
as agent but may take a position and resell a portion of the block as principal
to facilitate the transaction. In addition, any Securities covered by this
prospectus which qualify for sale pursuant to Rule 144 of the Securities Act may
be sold under Rule 144 rather than pursuant to this prospectus.
No Selling Holder has advised Fortune, as of the date hereof, that it has
arranged for the offering or sale of any Security with any broker. Underwriters,
brokers, dealers or agents (collectively, "underwriters") may participate in
these transactions as agents and, in that capacity, may (i) be deemed
underwriters for purposes of the Securities Act and (ii) receive brokerage
commissions from Selling Holders or their purchasers which (together with any
profits received by the Selling Holders) may be deemed underwriting discounts
and commissions under the Securities Act. The Selling Holders have disclaimed
the status of Securities Act "underwriters."
To comply with the securities laws of certain jurisdictions, if applicable,
the Securities will be offered or sold in those jurisdictions only through
registered or licensed brokers or dealers. In addition, in certain
jurisdictions, the Securities may not be offered or sold unless they have been
registered or qualified for sale in those jurisdictions or unless an exemption
from that registration or qualification is available and is complied with.
Under applicable rules and regulations under the Exchange Act, any person
engaged in a distribution of the Securities may be limited in its ability to
engage in market activities respecting the Securities. In addition and without
limiting the foregoing, each Selling Holder is subject to applicable provisions
of the Exchange Act and the rules and regulations thereunder, including, Rule
10b-2 and Regulation M, which provisions may limit the timing of purchases and
sales of any of the Securities by the Selling Holders. All the foregoing may
affect the marketability of the Securities.
Fortune may suspend the use of this prospectus and any supplements hereto
in certain circumstances because of pending corporate developments or a need to
file a post-effective amendment. In any such event, Fortune will use its
reasonable efforts to ensure that the use of the prospectus may be resumed as
soon as practicable.
Fortune has agreed to pay substantially all the expenses incident to the
registration, offering and sale of the Securities by the Selling Holders to the
public other than any brokers' commission, agency fee or underwriter's discount
or commission, which will be borne by the relevant Selling Holder.
LEGAL MATTERS
The legality of the Notes and the Underlying Shares will be passed upon
for the Company by Dean W. Drulias, Esq., General Counsel for the Company.
EXPERTS
The financial statements of the Company as of December 31, 1996 and 1997
and for each of the years in the three year period ended December 31, 1997, 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.
51
<PAGE>
The information appearing herein with respect to net proved oil and gas
reserves of the Company at December 31, 1995, 1996 and 1997, was estimated by
Huddleston & Co., Inc., independent petroleum engineers, and is included herein
on the authority of such engineers as experts in petroleum engineering.
AVAILABLE INFORMATION
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.
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 for the year ended December 31, 1997, filed on
March 3, 1998.
2. Current report on Form 8-K filed on March 31, 1998.
3. Current report on Form 10-Q for the quarterly period ended March 31, 1998,
filed on May 8, 1998.
4. Current report on Form 10-Q for the quarterly period ended June 30, 1998,
filed on August 3, 1998.
52
<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 OR WELLS. "Gross Acres or Wells" are the total
acres or wells, as the case may be,
in which an entity has an interest,
either directly or through an affiliate.
MCF. "Mcf" means thousand cubic feet. "Mmcf"
means million cubic feet. Natural
gas volumes are stated at the legal
pressure base of the state or area in
which the reserves are located at 60
degrees Fahrenheit.
MCFD. "MCFD" means Mcf of gas per day of gas
production.
MCFE. "MCFE" means thousand cubic feet of gas
equivalent, which is determined
using the ratio of one 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 INTEREST. "Net Revenue Interest" reflects the
percentage of net revenues generated
by operating activities on a property,
exclusive of any royalty or
overriding royalty interests which may
burden that property.
OVERRIDING ROYALTY INTEREST. "Overriding Royalty Interest" is the right
to share in the gross revenues generated
by a producing property, free of any
costs of exploration, acquisition,
development, or operation, and free
of all risks in connection therewith.
PAYOUT. "Payout" refers to the point in time when
initial working interest owners
recover a defined portion of acquisition,
exploration, development, and
lease operating expenses from the revenues
generated by a property or well.
PRODUCING PROPERTIES
OR RESERVES. "Producing Reserves" are Proved
Developed Reserves expected to be
produced from existing completion
intervals now open for production
in existing wells. A "Producing
Property" is a property to which
Producing Reserves have been
assigned by an independent
petroleum engineer.
PROVED DEVELOPED
NON-PRODUCING RESERVES. "Proved Developed Non-Producing Reserves"
(PDNP) are Proved Developed
Reserves that are recoverable from
zones behind cemented casing in
existing wells which will require additional
completion work or a future recompletion
prior to the start of production. The cost
of making such 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.
53
<PAGE>
PROVED DEVELOPED PRODUCING
RESERVES. "Proved Developed Producing Reserves" are
Proved Developed Reserves that are
recoverable from completion intervals
in existing wells that are
currently open and delivering commercial
volumes of hydrocarbons to market.
PROVED DEVELOPED RESERVES. "Proved Developed Reserves" are Proved
Reserves which can be 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 RESERVES. "Proved Undeveloped Reserves" are Proved
Reserves which can 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 ACREAGE. "Undeveloped Acreage" is oil and gas acreage
(including, in applicable instances, rights
in one or more horizons which may be
penetrated by existing well bores, but
which have not been tested) to which
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.
54
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
Independent Auditors' Report - KPMG Peat Marwick LLP............. F-2
Balance Sheets - December 31, 1997 and 1996...................... F-3
Statements of Operations for the years ended
December 31, 1997, 1996 and 1995.............................. F-4
Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995............................... F-5
Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995............................... F-6
Notes to Financial Statements.................................... F-7
Balance Sheets - June 30, 1998 (unaudited)
and December 31, 1997 (audited)................................. F-22
Statement of Operations for the six months ended
June 30, 1998 and 1997 (unaudited).............................. F-23
Statement of Stockholders' Equity for the year
ended December 31, 1997 and
six months ended June 30, 1998 (unaudited)...................... F-24
Statement of Cash flows for the six months
ended June 30, 1998 (unaudited)................................. F-25
Notes to Financial Statements (unaudited)......................... F-26
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 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, 1997 and 1996, and the results of its
operations and its cash flows for each of the years in the three-year period
ended December 31, 1997, in conformity with generally accepted accounting
principles.
/s/ KPMG PEAT MARWICK LLP
Houston, Texas
February 20, 1998
F-2
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
December 31,
---------------------------
1997 1996
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ............................. $ 1,667,000 $ 2,174,000
Accounts receivable ................................... 507,000 695,000
Prepaid expenses ...................................... -- 25,000
------------ ------------
Total Current Assets .................................. 2,174,000 2,894,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method .......................... 27,822,000 23,079,000
Office and other ...................................... 383,000 375,000
------------ ------------
28,205,000 23,454,000
Less--accumulated depletion, depreciation
and amortization .................................... (18,403,000) (12,545,000)
------------ ------------
9,802,000 10,909,000
------------ ------------
OTHER ASSETS:
Deposits and other .................................... 124,000 188,000
Debt issuance costs (net of accumulated amortization of
$93,000 and $238,000 at December 31, 1997
and 1996, respectively) ............................. 526,000 51,000
Restricted cash ....................................... -- 2,293,000
------------ ------------
650,000 2,532,000
------------ ------------
TOTAL ASSETS ................................................. $ 12,626,000 $ 16,335,000
============ ============
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt ..................... $ -- $ 2,253,000
Accounts payable ...................................... 279,000 84,000
Accrued expenses ...................................... 407,000 77,000
Royalties payable ..................................... 36,000 103,000
Accrued interest ...................................... 76,000 101,000
------------ ------------
Total Current Liabilities ............................. 798,000 2,618,000
------------ ------------
LONG-TERM DEBT, net of current portion ....................... 3,775,000 680,000
------------ ------------
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--12,118,982 and 11,853,663
shares at December 31, 1997 and 1996,
respectively ...................................... 121,000 119,000
Capital in excess of par value ........................ 30,283,000 29,273,000
Treasury stock, at cost (9,769 and -0- shares,
respectively)...................................... (38,000) --
Accumulated deficit ................................... (22,313,000) (16,355,000)
------------ ------------
NET STOCKHOLDERS' EQUITY ..................................... 8,053,000 13,037,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................... $ 12,626,000 $ 16,335,000
============ ============
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES
Sales of oil and gas, net of royalties $ 3,851,000 $ 3,825,000 $ 2,959,000
Other income ......................... 154,000 215,000 184,000
------------ ------------ ------------
4,005,000 4,040,000 3,143,000
------------ ------------ ------------
EXPENSES
Production and operating ............. 1,094,000 1,172,000 1,514,000
Provision for depletion, depreciation
and amortization ................... 2,219,000 1,623,000 1,816,000
General and administrative ........... 1,965,000 1,924,000 1,212,000
Corporate relocation ................. -- 216,000 --
Debt conversion expense .............. 316,000 -- --
Stock offering cost .................. 323,000 -- --
Interest ............................. 396,000 435,000 870,000
Loss on sale of oil and gas properties -- -- 3,607,000
Impairments to oil and gas properties 3,650,000 -- --
------------ ------------ ------------
9,963,000 5,370,000 9,019,000
------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES ...... (5,958,000) (1,330,000) (5,876,000)
PROVISION FOR INCOME TAXES .................. -- -- --
NET LOSS .................................... $ (5,958,000) $ (1,330,000) $ (5,876,000)
============ ============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING ................. 12,086,219 11,351,211 6,555,875
============ ============ ============
NET LOSS PER COMMON SHARE ................... $ (0.49) $ (0.12) $ (0.90)
============ ============ ============
</TABLE>
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 Treasury Accumulated holders'
Shares Amount Par Value Stock Deficit Equity
--------- --------- ------------ --------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
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
========== ========== ============ --------- ============ =============
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 repurchased in
odd-lot buyback...................... (9,769) - - (38,000) - (38,000)
Common stock returned to treasury...... (5) - - - - -
Net loss............................... - - - - (5,958,000) (5,958,000)
---------- ---------- ------------ --------- ------------ -------------
BALANCE, December 31, 1997............. 12,118,982 $ 121,000 $ 30,283,000 $ (38,000) $(22,313,000) $ 8,053,000
========== ========== ============ ========= ============ =============
</TABLE>
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,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................................... $ (5,958,000) $ (1,330,000) $ (5,876,000)
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
Common stock issued for directors' fees,
compensation and consulting fees .............................. -- 4,000 39,000
Depletion, depreciation and amortization ........................ 2,219,000 1,623,000 1,816,000
Amortization of deferred financing cost ......................... 147,000 74,000 172,000
Debt conversion expense ......................................... 316,000 -- --
Stock offering cost ............................................. 323,000 -- --
Impairments to oil and gas properties ........................... 3,650,000 -- --
Loss on sale of oil and gas properties .......................... -- -- 3,607,000
Provision for executive severance ............................... -- -- (17,000)
Non-cash compensation expense ................................... 58,000 20,000 --
Changes in assets and liabilities:
Accounts receivable ............................................. 188,000 340,000 (485,000)
Prepaids and oil inventory ...................................... 25,000 102,000 (13,000)
Accounts payable and accrued expenses ........................... 525,000 (215,000) (95,000)
Payment of executive severance .................................. -- -- (111,000)
Royalties and working interest payable .......................... (67,000) 9,000 41,000
Accrued interest ................................................ (25,000) (18,000) (11,000)
Deposits and other .............................................. (22,000) (2,000) 189,000
------------ ------------ ------------
Net cash provided by (used in) operating activities ............... 1,379,000 607,000 (744,000)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties ........................... (4,946,000) (3,232,000) (5,654,000)
(Increase) decrease in restricted cash ............................ 2,293,000 937,000 (3,230,000)
Proceeds from sale of properties and equipment .................... 203,000 2,197,000 --
Expenditures for other property and equipment ..................... (27,000) (297,000) 16,000
------------ ------------ ------------
Net cash used in investing activities ............................. (2,477,000) (395,000) (8,868,000)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Gross proceeds from issuance of long-term debt,
net of issuance costs ........................................... 3,290,000 -- --
Repayment of long term debt ....................................... (1,793,000) (1,979,000) (1,651,000)
Gross proceeds from issuance of common stock ...................... 103,000 2,168,000 15,220,000
Debt and equity offering costs .................................... (971,000) (115,000) (2,467,000)
Common stock repurchase ........................................... (38,000) -- --
------------ ----------- ------------
Net cash provided by financing activities ......................... 591,000 74,000 11,102,000
------------ ----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ................... (507,000) 286,000 1,490,000
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ........................... 2,174,000 1,888,000 398,000
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR ................................. $ 1,667,000 $ 2,174,000 $ 1,888,000
============ =========== ============
Supplemental information:
Interest paid in cash .............................................. $ 249,000 $ 361,000 $ 692,000
Common stock issued or issuable as directors' fees ................. -- 4,000 39,000
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 ......................... 975,000 -- 575,000
Value of California assets transferred to oil and gas
properties held for sale.......................................... -- -- 1,180,000
Common stock issued for 401(k) Plan contribution ................... 14,000 -- --
</TABLE>
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 (Fortune or the Company), formerly
Fortune Petroleum Corporation, is an independent energy company engaged in the
acquisition, production and exploration of oil and gas, primarily offshore
Louisiana and the Texas and Louisiana Gulf Coast.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates, judgments
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the financial statements and revenues and expenses during the
reported period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid instruments with original
maturities of three months or less to be cash equivalents.
Property and Equipment
The Company accounts for its oil and gas operations using the full cost
method. 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, 1997.
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 $1.62, $1.14, and $1.22 for the
years ended December 31, 1997, 1996, and 1995, 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.
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 3 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 1997, the Company recorded
$3.7 million of impairments to oil and gas properties. See note 2 regarding
these impairments.
Office and other property and equipment are stated at cost. Depreciation is
provided using the straight-line method over the estimated future service life
of the property and equipment.
F-7
<PAGE>
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.
Debt Issuance Costs
Debt issuance costs are being amortized using the straight line method over
the life of the related debt, or in the case of convertible debt outstanding at
December 31, 1997, over the period that such debt is not convertible.
Stock Option Plans
Prior to January 1, 1996, the Company accounted for its stock option plans
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 only if the market price of the
underlying stock exceeded the exercise price on the date of grant. 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.
Computation of Net Loss Per Share
Net loss per common share is computed by dividing net loss by the weighted
average number of common shares outstanding. Diluted earnings per common share
are not presented, since the issuance or conversion of additional securities
would have an anti-dilutive effect.
In 1997, the Company adopted SFAS No. 128 Earnings Per Share. SFAS No. 128,
under certain circumstances, changes the calculation and financial statement
presentation of earnings per share and requires the restatement of prior period
earnings per share amounts. The adoption of SFAS No. 128 by the Company did not
result in a change to the net loss per share information presented herein.
(2) RESTRICTED CASH AND IMPAIRMENTS TO OIL AND GAS PROPERTIES
Under the terms of the Company's exploration venture agreement with Zydeco
Exploration, Inc. ("Zydeco"), Fortune contributed $4.8 million in cash to the
Zydeco venture during 1995 for payment of certain prior and future lease and
seismic costs incurred by the venture. Fortune's contribution entitled it to a
50% working interest in all projects generated within the venture AMI. Prior to
June 1997, the remaining unspent contribution had been recorded as restricted
cash on Fortune's balance sheet. On June 4, 1997, the Company exercised its
right under the exploration agreement with Zydeco to have all unspent capital
contributions returned to Fortune. The balance of unspent funds of $2,154,000
was returned to Fortune in June 1997. Fortune is relieved of any obligation to
pay future costs associated with the projects; however, the Company's 50%
working interest in each project which has not already been farmed out is
subject to a proportionate reduction in the event that Zydeco expends additional
funds on such project.
In connection with requesting the return of unspent funds from its
exploration venture with Zydeco, the Company reviewed its $4.3 million remaining
unevaluated investment in the Zydeco exploration venture properties (see note
3). 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 spent for leases and seismic in the
exploration venture. As a result of this review in the second quarter of 1997
and subsequent reviews in the third and fourth quarters of 1997, Fortune has
transferred all of its investment in the Zydeco exploration venture projects to
the evaluated property account during 1997. As a result, the Company has
recorded impairments to oil and gas properties during 1997 of $3.7 million.
F-8
<PAGE>
(3) 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 Langniappe
Exploration, Inc. was issued (see below and note 9), 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
In December 1995, the Company entered into a purchase and sale agreement to
sell all but one of its California properties to a private 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. 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 net sales proceeds received from the sale of the properties. During 1996
and 1995, the operation of these properties did not have a significant impact on
net income.
Lagniappe Exploration, Inc./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 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 acquired a 50% interest in certain seismically defined oil
and gas projects. (See notes 2 and 9).
F-9
<PAGE>
(4) 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, 1997, 1996
and 1995 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Capitalized costs of oil
and gas properties............... $27,822,000 $23,079,000 $20,864,000
Less accumulated depletion,
depreciation and amortization....... (18,137,000) (12,308,000) (10,730,000)
----------- ----------- -----------
$ 9,685,000 $10,771,000 $10,134,000
=========== =========== ===========
</TABLE>
Of the above capitalized costs, the amount representing unproved properties
was $3.2 million, $4.9 million, and $5.9 million in 1997, 1996 and 1995,
respectively.
Costs incurred in oil and gas producing activities were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ----------- -----------
<S> <C> <C> <C>
Property acquisition
Unproved.......................... $ 333,000 $ 77,000 $ 4,596,000
Proved............................ 368,000 - 2,192,000
Exploration............................ 2,285,000 2,317,000 576,000
Development............................ 1,960,000 838,000 498,000
------------ ----------- -----------
$ 4,946,000 $ 3,232,000 $ 7,862,000
============ =========== ===========
</TABLE>
F-10
<PAGE>
The results of operations from oil and gas producing activities for the
years ended December 31, 1997, 1996 and 1995, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Revenues from oil and gas producing activities:
Sales to unaffiliated parties.............................. $ 3,851,000 $ 3,825,000 $ 2,959,000
Production and other taxes................................... 1,094,000 1,172,000 1,514,000
Depreciation, depletion and amortization...................... 2,179,000 1,576,000 1,781,000
Loss on sale of oil and gas properties........................ - - 3,607,000
Impairments to oil and gas properties......................... 3,650,000 - -
----------- ------------ ------------
Total expenses............................................... 6,923,000 2,748,000 6,902,000
----------- ------------ ------------
Pretax income (loss) from producing activities................ (3,072,000) 1,077,000 (3,943,000)
Income tax (expense) benefit.................................. - - -
Results of oil and gas producing activities
(excluding corporate overhead and interest costs)........... $ (3,072,000) $ 1,077,000 $ (3,943,000)
=========== ============ ============
</TABLE>
(5) LONG-TERM DEBT
A summary of long-term debt follows:
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Convertible Subordinated Notes due December 31, 2007........................... $ 3,225,000 $ -
Credit Lyonnais credit facility due July 11, 1999,
including interest at 1-1/4 over the bank's base rate....................... 550,000 -
Convertible Subordinated Debentures converted or repaid in 1997................ - 1,683,000
Bank One credit facility repaid July 11, 1997.................................. - 1,250,000
------------ ------------
Total long-term debt........................................................... 3,775,000 2,933,000
Less current installments...................................................... - 2,253,000
------------ ------------
Long-term debt, excluding current installments................................. $ 3,775,000 $ 680,000
============ ============
</TABLE>
During November and December of 1997, Fortune closed a 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, and the Company
received $2,815,000 of proceeds, net of offering expenses and commissions.
The Notes are currently 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 Company has
determined that the value of the potential adjustments to the conversion price
is not material. 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 costs incurred to issue the Notes
is being amortized as additional interest expense over the 18-month period
ending May 1, 1999, the first date that the Notes are convertible. As a result
of this amortization of issuance costs, the effective interest rate of the Notes
over this 18-month period is 21.2%. If the Notes were held to maturity, the
effective interest rate over the life of the Notes would be 13.4%.
A portion of the net proceeds of the private placement was used to
refinance existing debt. On December 5, 1997, the Company redeemed the remaining
outstanding balance of $1,028,000 of the Company's Debentures due December 31,
1997. In addition, $315,000 of net proceeds was used to reduce the borrowings
under the Company's credit facility with Credit Lyonnais.
F-11
<PAGE>
As discussed in the proceeding paragraph, the remaining balance on the 10
1/2% Convertible Subordinated Debentures (the "Debentures") was repaid on
December 5, 1997. The Debentures bore an effective interest rate of 12.13% and
were convertible into shares of the Company's Common Stock at a conversion price
of $6.32 per share (158 shares of Common Stock 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. Furthermore, the Company recorded a non-cash debt conversion expense
of $316,000 during the first quarter of 1997. The $316,000 non-cash expense
represents the difference between the fair market value of all of the Common
Stock and Common Stock Warrants issued in the Exchange Offer and the fair market
value of the lower number of Common Stock shares that could have been issued
upon the conversion of the Debentures 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
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 $2.0 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 five years are
as follows:
Year Debt
-------- ------------
1998 $ -
1999 550,000
2000 -
2001 -
2002 -
------------
$ 550,000
F-12
<PAGE>
(6) INCOME TAXES
No provision for income taxes was required for the years ended December 31,
1997, 1996 and 1995. Deferred taxes consist of the following:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................ $ 4,990,000 $ 4,354,000
Oil and gas properties difference
in accumulated depletion...................... 1,517,000 586,000
----------- -----------
6,507,000 4,940,000
Less valuation allowance (100%)............... 6,507,000 4,940,000
----------- -----------
Net deferred taxes.............................. $ - $ -
=========== ===========
</TABLE>
At December 31, 1997, the Company estimates it had cumulative net operating
loss carryforwards for federal income tax purposes of approximately $15 million
which, subject to significant restrictions under I.R.C. 382, is available to
offset future federal taxable income, if any, with various expirations through
2012. 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 federal 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.
(7) STOCK OFFERINGS
In December 1996, the Company received $1.1 million of net proceeds for the
sale of 412,000 shares of Common Stock at a price of $3.00 per share in a
private placement. 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.
On December 15, 1995, the Company received approximately $3.3 million of
net proceeds in a private placement of 1,321,117 shares of Common Stock at a
price of $3.22 per share. 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 alleges
certain irregularities occurred in the trading in its Common Stock and is
uncertain whether it will be required to issue additional shares. (See note 8.)
In June and July 1995, the Company received net proceeds of $8.1 million
for the sale of 4.6 million shares of the Company's Common Stock at $2.00 per
share in a public offering. 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.
(8) 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 $160,000
through the later of May 31, 2000, or six months following notice of
non-renewal. 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, the CEO is entitled to receive a lump-sum payment of two
year's compensation and all shares of Common Stock subject to stock options then
held by him without payment of the exercise price. The agreement also provides
for two years of consulting services upon the completion of the primary term of
his contract at 40% of the last compensation thereunder. The agreement further
provides for additional compensation, in an amount not to exceed his annual
salary, based upon certain increases in the value of the Company's Common Stock.
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. In the event of a termination of employment after a change of
control, the Executive Vice President and General Counsel is also entitled to a
lump sum payment of two year's compensation and all shares of Common Stock
subject to stock options then held by him without payment of the exercise price
thereof.
F-13
<PAGE>
The Company leases certain office space under non-cancelable operating
leases. Rental expense under the office lease for the years ended December 31,
1997, 1996 and 1995 was $86,000, $75,000 and $53,000, respectively.
Minimum future lease payments under the non-cancelable operating leases are
as follows:
Year ending December 31,
1998........................................ $ 87,000
1999........................................ 87,000
2000........................................ 87,000
2001........................................ 36,000
----------
$ 297,000
==========
On March 26, 1996, Fortune was served with a lawsuit that 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 of 1933. The terms of the subscription agreement pursuant to
which the plaintiff acquired his shares entitled him 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 contested this lawsuit, 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 that it had
voluntarily placed in escrow. 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 Common 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 plaintiffs' actions and prosecute its
own counterclaims. Discovery is continuing in these cases and a consolidated
trial is expected in 1998.
(9) RELATED PARTY TRANSACTIONS
The Convertible Subordinated Notes discussed in note 5 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 managing director 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 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 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.
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 and a secured recourse
loan in the amount of $70,000. The $80,000 loan bears 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 not been terminated by the Company with cause. The $70,000 loan also bears
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.
F-14
<PAGE>
On April 24, 1995, the Company obtained a $300,000 "bridge" loan to enable
it to pay certain expenses, including $100,000 on its credit facility. The loan
was obtained from LEX, which in turn had borrowed the funds from several
individuals. Upon the consummation of the Company's acquisition of LEX, it
became liable on such loans. (See note 3.) The loans were repaid out of the
proceeds of the Company's June 1995 Common Stock offering. The individuals who
loaned funds to LEX included 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 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 Common Stock purchase warrants with an exercise
price of $2.40 per share, and Mr. Farber received 35,000 Common 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 appointed to
the board of directors in January 1995 pursuant to this agreement. Both Mr.
Feiner and Mr. Gelman were subsequently re-elected to the board by the Company's
stockholders.
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 was repaid in full.
No future transaction will be entered into between the Company and members
of management or principal stockholders unless such transactions are approved by
a majority of the directors who are not members of management or principal
stockholders.
In January 1995, Daniel E. Pasquini, the former president of the Company,
agreed to a modification of a previous severance package. He accepted $85,000 in
cash, the exercise price of 45,000 Common 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 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 1996
and 1995, his firm billed the Company a total of $152,000 and $183,000,
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 1997, 1996 and 1995, Mr.
Shaughnessy's firm billed the Company a total of $182,000, $45,000 and $1,500,
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.
F-15
<PAGE>
(10) STOCKHOLDERS' EQUITY
On September 30, 1997 the Company completed an odd-lot shareholder stock
buy back wherein the Company offered to buy for $3.00 per share the Common Stock
owned by shareholders who held fewer than 100 shares of the Company's Common
Stock. The Company initiated the odd-lot buy back in an effort to reduce the
cost of administering odd-lot shareholders. In connection with the buy back,
9,769 shares of the Company's Common Stock were acquired as treasury stock.
Fortune has three Stock Option Plans. The plans cover all officers and
employees of the Company. Two plans also provide for options for directors of
the Company. The board of directors grants awards 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 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.
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 methodology prescribed under FAS 123, the impact on the Company's
reported net loss and loss per share would have been:
Year ended December 31,
-----------------------------------
1997 1996 1995
-------- -------- ---------
Impact on net loss:
Increase in net loss (millions) $ 0.6 $ 0.5 $ 0.1
Increase in net loss per share $ 0.05 $ 0.05 $ 0.02
The fair value on the date of grant of the options granted during 1997 is
estimated as $1.23 per Common Stock option using the Black-Scholes
option-pricing model. Following are the assumptions used by the Company to
calculate the fair value of options granted and the impact on its net loss and
net loss per share based upon the methodology prescribed under FAS 123:
Year ended December 31,
--------------------------------
1997 1996 1995
-------- -------- --------
Assumptions:
Dividend yield 0% 0% 0%
Volatility 65% 65% 65%
Risk-free interest rate 6.3% 6.14% 7.8%
Forfeiture rate 5% 5% 5%
Expected life (years) 2.5 2.5 2.5
F-16
<PAGE>
Common 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, 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
Granted............................. 595,000 3.00
Exercised........................... (6,400) 2.75
Forfeited........................... (20,411) 2.74
--------- --------
Balance, December 31, 1997.......... 1,502,898 $ 2.96
========= ========
</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, 1997,
the Company had 623,243 and 2,000,000 Common Stock options available for grant
during 1998 under the 1993 and 1998 Stock Option Plans, respectively. All
options under the 1988 Plan 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 $0.575
per share. (See note 9) 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 and warrants issued in lieu of options:
Options Outstanding and Exercisable
---------------------------------------------
Weighted
Average Weighted
Range of Remaining Average
Exercise Number Contractual Exercise
Price Outstanding Life Price
-------------- ----------- -------------- --------
$2.38 to $3.25 1,502,898 3.20 years $2.96
F-17
<PAGE>
At December 31, 1997 the Company's outstanding Common Stock purchase
warrants consisted of (d):
Number of Warrants Exercise Price Expiration Date
------------------ -------------- ---------------
45,000 $ 3.00 2/15/98
75,000 $ 2.68 8/29/98
138,888 $ 3.89 9/28/98
64,015 (a) $ 4.41 9/28/98
1,982,750 (b) (e) $ 3.75 9/28/98
31,500 (c) (e) $ 11.14 10/05/98
168,500 $ 3.50 12/3/98
37,500 $ 3.50 12/5/98
100,000 $ 3.50 3/31/99
50,000 $ 4.0 5/19/99
87,125 $ 4.00 12/2/99
87,125 $ 5.00 12/2/99
35,000 $ 2.75 1/06/00
27,600 $ 3.19 2/25/00
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
20,000 $ 2.44 8/29/01
10,000 $ 2.44 9/06/01
---------
4,720,003
=========
(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) Represents units that permit each unitholder to purchase 3.3097 shares of
Common Stock plus two stock purchase warrants. Each stock purchase warrant,
which expires September 28, 1998, permits the holder to purchase 1.4375
additional shares of Common Stock at an exercise price of $3.75.
(d) Table excludes warrants that have been issued to employees in lieu of stock
options.
(e) See note 14 regarding offer to exchange certain warrants for new warrants.
(11) MAJOR CUSTOMERS
The Company sold oil representing 88% of its oil production to two
customers (63% and 25%, respectively) for the year ended December 31, 1997. The
Company sold gas representing 73% of its gas production to three customers (41%,
16% and 16%, respectively) for the year ended December 31, 1997.
The Company sold oil representing 54% of its oil production under contracts
to one customer for the year ended December 31, 1996. The Company's sold gas
representing 86% of its gas production 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. The Company sold gas
representing 71% of its gas production to three customers (29%, 26% and 16%,
respectively) for the year ended December 31, 1995.
(12) 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-18
<PAGE>
(13) RETIREMENT PLAN
During 1996, the Company adopted the Fortune Natural Resources Corporation
401(k) Profit Sharing Plan for its eligible employees. Under the plan, eligible
employees are permitted to make salary deferrals of up to 15% of their annual
compensation, subject to Internal Revenue Service (IRS) limitations. Salary
deferrals will be matched 50% by the Company, subject to IRS limitations, 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 the 1997 and 1996 plan years, the Company's
matching contribution was $24,000 and $14,000, respectively, all of which was
paid in shares of Common Stock.
(14) SUBSEQUENT EVENTS
On February 12, 1997, the Company commenced a voluntary exchange offer of
its outstanding publicly traded Common Stock purchase warrants and certain
private warrants (collectively referred to herein as the old warrants) for new
private warrants. The old warrants include 1,917,000 publicly traded warrants
and 63,000 private warrants currently held by unitholders, all of which expire
September 28, 1998. (See note 10.) Under the terms of the exchange offer,
holders of the old warrants will have until March 31, 1998, subject to extension
at the Company's sole discretion, to exchange their old warrants for an equal
number of new private warrants that expire September 28, 1999. The new private
warrants will not be listed for trading, are restricted from transfer and do not
contain the same anti-dilution provisions as the public warrants. Otherwise, the
new private warrants generally contain the same terms and conditions as the old
warrants. The Company will not receive any proceeds as a result of this exchange
offer.
(15) 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 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 reserves that can be expected to be
recovered through existing wells using existing equipment and operating methods.
For the years ended December 31, 1997, 1996 and 1995, the oil and gas
reserve estimates were determined by Huddleston & Co., Inc., ("Huddleston")
Houston, Texas independent petroleum engineers, 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 oil and gas at December 31, 1997, 1996, and 1995, and
changes in such quantities during the years then ended were as follows:
<TABLE>
<CAPTION>
Oil (MBbls)
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
BEGINNING OF PERIOD......................... 249 347 1,647
Revisions of previous estimates.......... (1) 6 (160)
Extensions and discoveries............... 88 106 -
Production............................... (87) (57) (92)
Purchase of minerals in place............ 13 - 174
Sales of minerals in place*.............. (5) (153) (1,222)
---------- ---------- ----------
END OF PERIOD............................... 257 249 347
========== ========== ==========
Proved developed reserves
Beginning of period.................... 160 324 675
========== ========== ==========
End of period.......................... 198 160 324
========== ========== ==========
</TABLE>
F-19
<PAGE>
<TABLE>
<CAPTION>
Gas (Mmcf)
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
BEGINNING OF PERIOD......................... 3,481 5,938 5,911
Revisions of previous estimates........ 431 (753) (388)
Extensions and discoveries............. 187 85 -
Production ......................... (821) (1,038) (909)
Purchase of minerals in place.......... 11 - 2,934
Sales of minerals in place*............ (72) (751) (1,601)
---------- ---------- ----------
END OF PERIOD............................... 3,217 3,481 5,938
========== ========== ==========
Proved developed reserves
Beginning of period.................. 1,749 4,686 3,317
========== ========== ==========
End of period ....................... 1,548 1,749 4,686
========== ========== ==========
</TABLE>
- -----------
* During 1995, the Company's interests in its California properties that were
sold in February 1996 were transferred to oil and gas properties held for sale.
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil
and Gas Reserves
The following information has been developed utilizing procedures
prescribed by Statement of Financial Accounting Standards No. 69 "Disclosures
about Oil and Gas Producing Activities" ("FAS 69") and based on oil and gas
reserve and production volumes determined by the Company's reserve engineers. It
may be useful for certain comparative purposes, but should not be solely relied
upon in evaluating the Company or its performance. Further, information
contained in the following table should not be considered as representative of
realistic assessments of future cash flows, nor should the Standardized Measure
of Discounted Future Net Cash Flows be viewed as representative of the current
value of the Company.
The Company believes that the following factors should be taken into
account in reviewing the following information: (1) future costs and selling
prices will probably differ from those required to be used in these
calculations; (2) due to future market conditions and governmental regulations,
actual rates of production achieved in future years may vary significantly from
the rate of production assumed in the calculations; (3) selection of a 10%
discount rate is arbitrary and may not be reasonable as a measure of the
relative risk inherent in realizing future net oil and gas revenues; and (4)
future net revenues may be subject to different rates of income taxation.
Under the Standardized Measure, future cash inflows were estimated by
applying period-end oil and gas prices adjusted for fixed and determinable
escalations to the estimated future production of period-end proved reserves.
Future cash inflows were reduced by estimated future development, abandonment
and production costs based on period-end costs in order to arrive at net cash
flow before tax. Future income tax expense has been computed by applying
period-end statutory tax rates to aggregate future pre-tax net cash flows,
reduced by the tax basis of the properties involved and tax carryforwards. FAS
69 requires use of a 10% discount rate.
Management does not rely solely upon the following information in making
investment and operating decisions. Such decisions are based upon a wide range
of factors, including estimates of probable as well as proved reserves and
varying price and cost assumptions considered more representative of a range of
possible economic conditions that may be anticipated.
F-20
<PAGE>
The standardized measure of discounted future net cash flows relating to
proved oil and gas reserves is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Future cash inflows.................... $ 12,717 $ 19,751 $ 19,531
Future costs:
Production............................ (3,346) (4,026) (6,050)
Development........................... (961) (1,613) (881)
-------- -------- --------
Future net inflows before income taxes.. 8,410 14,112 12,600
Future income taxes..................... - - -
-------- -------- --------
Future net cash flows................... 8,410 14,112 12,600
10% discount factor..................... (1,907) (3,292) (3,658)
-------- -------- --------
Standardized measure of
discounted net cash flows............. $ 6,503 $ 10,820 $ 8,942
======== ======== ========
</TABLE>
The average gas prices received by the Company were approximately
$2.60, $4.04 and $2.32 per Mcf at year end 1997, 1996 and 1995, respectively.
The average oil prices received by the Company were approximately $16.90, $22.79
and $16.10 per Bbl at year end 1997, 1996 and 1995, respectively. As of February
1998, the Company was receiving an average of approximately $2.10 per Mcf for
its gas production and $14.70 per Bbl for its oil production. These current
prices represent declines from December 1997 prices and the Company expects
further price declines through the spring and summer of 1997.
Changes in Standardized Measure of Discounted Future Net Cash Flows from Proven
Reserve Quantities
A summary of the changes in the standardized measure of discounted future
net cash flows applicable to proved oil and gas reserves is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Standardized Measure:
Beginning of period.................................. $ 10,820 $ 8,942 $ 8,148
Increases (decreases):
Sales and transfers, net of production costs......... (2,757) (2,653) (1,445)
Extensions and discoveries........................... 1,571 1,532 -
Net change in sales and transfer prices,
net of production costs............................ (4,643) 5,233 460
Changes in estimated future development costs........ 245 (332) 500
Development costs incurred during the period......... 400 - -
Revisions of quantity estimates...................... 630 (1,473) (871)
Accretion of discount................................ 1,082 894 814
Purchases of reserves in place....................... 191 - 5,329
Sales of reserves in place*.......................... (199) (1,612) (3,024)
Changes in production rates (timing) and other....... (837) 289 (969)
-------- -------- --------
Standardized Measure:
End of period........................................ $ 6,503 $ 10,820 $ 8,942
======== ======== ========
</TABLE>
*During 1995, the Company's interests in its California properties that were
sold in February 1996 were transferred to oil and gas properties held for sale.
F-21
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
June 30, December 31,
1998 1997
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ...................... $ 3,530,000 $ 1,667,000
Accounts receivable ............................ 435,000 507,000
Prepaid expenses ............................... 99,000 --
------------ ------------
Total Current Assets ....................... 4,064,000 2,174,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method ................... 24,838,000 27,822,000
Office and other ............................... 384,000 383,000
------------ ------------
25,222,000 28,205,000
Less--accumulated depletion,
depreciation and amortization ................ (19,493,000) (18,403,000)
------------ ------------
5,729,000 9,802,000
------------ ------------
OTHER ASSETS:
Materials, supplies and other .................. 86,000 124,000
Debt issuance costs (net of accumulated
amortization of $285,000 and $93,000
at June 30, 1998 and December 31,
1997, respectively) .......................... 335,000 526,000
------------ ------------
421,000 650,000
------------ ------------
TOTAL ASSETS ........................................ $ 10,214,000 $ 12,626,000
============ ============
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
1998 1997
------------ ------------
<S> <C> <C>
CURRENT LIABILITIES:
Accounts payable................................ $ 175,000 $ 279,000
Accrued expenses................................ 280,000 407,000
Royalties and working interests payable......... 11,000 36,000
Accrued interest................................ - 76,000
------------ ------------
Total Current Liabilities................... 466,000 798,000
------------ ------------
LONG-TERM DEBT....................................... 3,235,000 3,775,000
------------ ------------
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 12,133,479 and
12,118,982 at June 30, 1998 and
December 31, 1997, respectively........... 121,000 121,000
Treasury Stock, at cost (9,769 shares at
December 31, 1997)............................ - (38,000)
Capital in excess of par value.................. 30,169,000 30,283,000
Accumulated deficit............................. (23,777,000) (22,313,000)
------------ ------------
NET STOCKHOLDERS' EQUITY............................. 6,513,000 8,053,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........... $ 10,214,000 $ 12,626,000
============ ============
</TABLE>
See accompanying notes to financial statements.
F-22
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
For the Six Months Ended
---------------------------
June 30, June 30,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties.......... $ 1,123,000 $ 1,804,000
Other income.................................... 76,000 106,000
------------ ------------
1,199,000 1,910,000
------------ ------------
COSTS AND EXPENSES
Production and operating........................ 359,000 736,000
Provision for depletion, depreciation
and amortization.............................. 830,000 969,000
Impairment to oil and gas properties............ 260,000 3,200,000
General and administrative...................... 813,000 1,012,000
Debt conversion expense......................... - 316,000
Stock offering cost............................. - 269,000
Interest paid in cash........................... 209,000 103,000
Interest - amortization of deferred
financing cost................................ 192,000 27,000
------------ ------------
2,663,000 6,632,000
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES............... (1,464,000) (4,722,000)
PROVISION FOR INCOME TAXES........................... - -
------------ ------------
NET LOSS ............................................ $ (1,464,000) $ (4,722,000)
============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING.......................... 12,127,877 12,049,593
============ ============
NET LOSS PER COMMON SHARE............................ $ (0.12) $ (0.39)
============ ============
</TABLE>
See accompanying notes to financial statements.
F-23
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1997
AND THE SIX MONTHS ENDED JUNE 30, 1998
Common Stock Capital in Stock-
---------------------- Excess of Treasury Accumulated holders'
Shares Amount Par Value Stock Deficit Equity
---------- ---------- ----------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
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 repurchased in
odd-lot buyback........................ (9,769) - - (38,000) - (38,000)
Common stock returned to treasury......... (5) - - - - -
Net loss.................................. - - - - (5,958,000) (5,958,000)
---------- --------- ----------- -------- ------------ ------------
BALANCE, December 31, 1997................ 12,118,982 $ 121,000 $30,283,000 $(38,000) $(22,313,000) $ 8,053,000
Common stock issued for
exercise of warrants................... 4,312 - 11,000 - - 11,000
Common stock contributed to
Company 401(k) Plan.................... 10,185 - 24,000 - - 24,000
Cancellation of treasury stock............ - - (38,000) 38,000 - -
Voluntary exchange of public
warrants for private warrants.......... - - (59,000) - - (59,000)
Repurchase of outstanding
private warrants....................... - - (52,000) - - (52,000)
Net loss.................................. - - - - (1,464,000) (1,464,000)
---------- --------- ----------- -------- ------------ ------------
BALANCE, June 30, 1998
(Unaudited)............................ 12,133,479 $ 121,000 $30,169,000 $ - $(23,777,000) $ 6,513,000
========== ========= =========== ======== ============ ============
</TABLE>
See accompanying notes to financial statements.
F-24
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
For the Six Months Ended
--------------------------
June 30, June 30,
1998 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss...................................................... $(1,464,000) $(4,722,000)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depletion, depreciation and amortization.................. 830,000 969,000
Non-cash compensation expense............................. 20,000 42,000
Amortization of deferred financing cost................... 192,000 28,000
Impairment of oil and gas assets.......................... 260,000 3,200,000
Debt conversion expense................................... - 316,000
Stock offering cost....................................... - 269,000
Changes in assets and liabilities:
Accounts receivable....................................... 72,000 225,000
Prepaids.................................................. (99,000) 18,000
Accounts payable and accrued expenses..................... (231,000) 1,227,000
Royalties and working interest payable.................... (25,000) (47,000)
Accrued interest.......................................... (76,000) (41,000)
Other assets.............................................. 23,000 -
----------- -----------
Net cash (used in) provided by operating activities........... (498,000) 1,484,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties....................... (1,711,000) (2,124,000)
Restricted cash used.......................................... - 138,000
Return of exploration venture restricted cash................. - 2,154,000
Proceeds from sale of properties and equipment................ 4,695,000 203,000
Net changes in other property and equipment and other assets.. 17,000 (129,000)
----------- -----------
Net cash provided by investing activities..................... 3,001,000 242,000
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long term debt................................... (540,000) (450,000)
Proceeds from issuance of common stock........................ 11,000 103,000
Expenditures for debenture exchange and other offerings....... (59,000) (294,000)
Repurchase of private warrants................................ (52,000) -
----------- -----------
Net cash used in financing activities......................... (640,000) (641,000)
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS.......................... 1,863,000 1,085,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD..................... 1,667,000 2,174,000
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD........................... $ 3,530,000 $ 3,259,000
=========== ===========
Supplemental information:
Interest paid in cash.......................................... $ 209,000 $ 103,000
Non-cash transactions
Common stock issued for conversion of debt..................... - 975,000
Common stock issued for 401(k) Plan contribution............... 24,000 -
</TABLE>
See accompanying notes to financial statements
F-25
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NOTES TO FINANCIAL STATEMENTS
June 30, 1998
(1) LINE OF BUSINESS AND SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES AND PROCEDURES
The condensed financial statements at June 30, 1998, and for the three
months and six months ended June 30, 1998 and 1997 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 herein. 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 June 30, 1998 and December 31, 1997, the results
of its operations for the three months and six months ended June 30, 1998 and
1997, and cash flows for the six months ended June 30, 1998 and 1997. The
results of the operations for such interim periods are not necessarily
indicative of the results for the full year.
(2) LONG-TERM DEBT
At June 30, 1998, a summary of long-term debt is as follows:
June 30, December 31,
1998 1997
------------ ------------
Convertible Subordinated Notes
due December 31, 2007............... $ 3,225,000 $ 3,225,000
Credit Lyonnais credit facility
due July 11, 1999................... 10,000 550,000
------------ ------------
Total long-term debt.................. 3,235,000 3,775,000
Less current installments............. - -
------------ ------------
Long-term debt,
excluding current installments...... $ 3,235,000 $ 3,775,000
============ ============
The Convertible Subordinated Notes (the "Notes)" are currently 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 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 Company determined at the time of
issuance of the Notes that the value of the potential adjustments to the
conversion price was not material. 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 costs
incurred to issue the Notes are being amortized as additional interest expense
over the 18-month period ending May 1, 1999, the first date that the Notes are
convertible. As a result of this amortization of issuance costs, the effective
interest rate of the Notes over this 18-month period is 21.2%. If the Notes were
held to maturity, the effective interest rate over the life of the Notes would
be 13.4%.
F-26
<PAGE>
The Company has in place 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. On March 31, 1998, the
Company repaid all but $10,000 of the outstanding balance of the credit facility
with a portion of the proceeds from the sale of East Bayou Sorrel. (See note 6).
Prior to the Company's sale of its interest in the East Bayou Sorrel field, the
Company's borrowing base was $2 million. The bank has not completed its
redetermination of the borrowing base subsequent to this sale; consequently, the
Company does not know how much, if any, is currently available for borrowing
under this credit facility. Under the credit facility, once the borrowing base
is redetermined, the Company may 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 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. Primarily as a result of the lower
revenues in 1998 as a result of lower oil and gas prices and the sale of East
Bayou Sorrel, the Company was unable to meet the 3 to 1 coverage ratio of cash
flow to fixed-charges which is required by the credit facility for the
twelve-month period ended June 30, 1998. The Company has requested a waiver of
this covenant from the bank for the period ended June 30, 1998. Although a
waiver has not been received from the bank as of the date hereof, the Company
has not reclassified the $10,000 outstanding balance on such debt to current
liabilities because the amount is not material.
The Company's maturities of long-term debt over the next three years are as
follows:
Year Debt
-------- --------
1998 $ -
1999 10,000
2000 -
--------
$ 10,000
========
(3) INCOME TAX EXPENSE
No provision for income taxes was required for the three months and six
months ended June 30, 1998.
At June 30, 1998, 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 2013. 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 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.
F-27
<PAGE>
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 its 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 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 its Common 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. Discovery has been stayed pending a
determination of objections filed by one of these third-party defendants.
Fortune intends to resume both the defense of plaintiffs' claims and the
aggressive prosecution of its own counterclaims as soon as it is entitled to do
so.
(5) COMPUTATION OF LOSS PER SHARE
Net loss per common share is computed by dividing net loss by the weighted
average number of common shares outstanding. Diluted earnings per common share
are not presented because the issuance or conversion of additional securities
would have an anti-dilutive effect.
(6) SALE OF EAST BAYOU SORREL
On March 31, 1998, the Company sold its interest in the East Bayou Sorrel
field, Iberville Parish, Louisiana to National Energy Group, Inc. for cash in
the amount of $4,695,000. The properties sold consisted of the Company's
interest in the Schwing #1 and #2 wells and all of the Company's leases,
facilities and interests in the East Bayou Sorrel area of mutual interest, as
such area is defined in the East Bayou Sorrel operating agreement. The sale was
effective April 1, 1998. The sale closed on March 31, 1998, whereupon the
Company received $4,535,000, which is net of ordinary closing adjustments.
The Company's interest in the two productive wells at East Bayou Sorrel
were pledged to secure the Company's Credit Facility with Credit Lyonnais. The
total balance outstanding under the Credit Facility prior to this sale was
$550,000. Concurrently with closing the sale of the East Bayou Sorrel field, the
Company paid down the outstanding balance of the Credit Facility by $540,000.
The Company plans to reinvest the remaining proceeds from the sale of East Bayou
Sorrel into its exploration, development and property acquisition activities,
including, for example, future anticipated exploration and development wells at
its Espiritu Santo Bay and LaRosa 3D seismic exploration projects.
The Schwing #1 and #2 wells began producing from permanent production
facilities in January 1997 and June 1997, respectively. Although both wells were
shut-in from March 13, 1998 through the date of the sale to repair production
facilities, they accounted for a significant portion of the Company's oil and
gas revenues during 1997 and proved reserves as of December 31, 1997. A third
well in the field, the Schwing #3, which was spudded October 9, 1997, was
temporarily plugged and abandoned on March 5, 1998 pending further evaluation of
the well's potential. During 1997 and 1998, the Company incurred approximately
$1 million in connection with drilling and attempting to complete this well as a
result of difficult drilling conditions and mechanical problems. Selected
financial information attributable to the Company's interest in the East Bayou
Sorrel field as reported in its 1997 and year-to-date operating and financial
results is as follows:
F-28
<PAGE>
Year Ended Six Months Ended
December 31, 1997 June 30, 1998 **
----------------- ----------------
Production
Oil (Bbls) 55,000 12,000
Gas (Mcf) 78,000 18,000
Oil and Gas Revenues $1,241,000 $231,000
Production and Operating Expense 205,000 60,000
Provision for Depletion, Depreciation
and Amortization* 430,000 54,000
As of
December 31, 1997
-----------------
Estimated Net Reserve Quantities
of Total Proved Reserves
Oil (Bbls) 152,000
Gas (Mcf) 204,000
- ----------
* Represents the estimated reduction in depreciation, depletion and
amortization expense reported by the Company in 1997 and 1998 that would
have resulted from excluding the East Bayou Sorrel production and proved
reserves.
** Amounts in this column represent 1998 production, revenues and related
expenses through March 31, 1998, the date of sale of the East Bayou Sorrel
interests.
This represents 32% and 30% of the Company's oil and gas revenues and
equivalent oil production and 23% of the Company's estimated quantities of
equivalent proved oil reserves as of December 31, 1997. Consequently, the
Company's revenues and cash flow from operations will decrease significantly in
1998 unless the production is replaced through successful exploration and
development activities or through the acquisition of producing properties.
Under the full cost method of accounting for oil and gas operations,
dispositions of oil and gas properties are recorded as adjustments to
capitalized costs, with no gain or loss recognized unless such adjustment would
significantly alter the relationship between capitalized costs and proved
reserves. A significant alteration would not ordinarily be expected to occur for
sales involving less than 25 percent of the reserve quantities in a given cost
center. Because the sale of East Bayou Sorrel represents less than 25% of the
Company's reserve quantities, the entire proceeds of $4,695,000 was credited to
capitalized oil and gas properties as of March 31, 1998.
(7) WARRANT EXCHANGE OFFER
On February 12, 1998, the Company commenced a voluntary exchange offer of
its outstanding publicly traded Common Stock purchase warrants and certain
private warrants (collectively referred to herein as the old warrants) for new
private warrants. The old warrants include 1,917,000 publicly traded warrants
and the right to acquire 63,000 private warrants currently held by unitholders,
all of which expire September 28, 1998. Under the terms of the exchange offer,
holders of the old warrants had until April 15, 1998, to exchange their old
warrants for an equal number of new private warrants that expire September 28,
1999. 1,779,713 warrants were tendered and accepted by the Company, representing
93% of the outstanding public warrants. An additional 3,000 public warrants were
exercised by warrantholders during the exchange offer period. The new private
warrants will not be listed for trading, are restricted from transfer and do not
contain the same anti-dilution provisions as the public warrants. Otherwise, the
new private warrants generally contain the same terms and conditions as the old
warrants. The Company did not receive any proceeds as a result of this exchange
offer. $59,000 of costs incurred by the Company in connection with the exchange
offer were charged to Shareholders' Equity during the second quarter of 1998.
F-29
<PAGE>
================================================================================
UNTIL ___________, 1998, ALL DEALERS THAT EFFECT TRANSACTIONS IN THESE
SECURITIES, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO
DELIVER A PROSPECTUS. THIS IS IN ADDITION TO THE DEALERS' OBLIGATION TO DELIVER
A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENT OR SUBSCRIPTIONS.
TABLE OF CONTENTS
Page
Prospectus Summary 2
Risk Factors 6
Dividend Policy 12
Use of Proceeds 12
Price Range of Securities 13
Selected Financial and Operating Data 14
Management's Discussion and
Analysis of Financial Condition
And Results of Operations 15
Business and Properties 22
Management 35
Certain Relationships and Related
Transactions 38
Principal Stockholders 40
The Selling Holders 42
Description of the Notes 44
Description of Securities 48
Certain Federal Income Tax Considerations 49
Plan of Distribution 52
Legal Matters 52
Experts 52
Available Information 53
Glossary of Oil and Gas Terms 54
Index to Financial Statements F-1
$3,325,000
12% CONVERTIBLE
SUBORDINATED NOTES
DUE
DECEMBER 31, 2007
FORTUNE NATURAL
RESOURCES CORPORATION
-----------------------
P R O S P E C T U S
-----------------------
OCTOBER ___, 1998
================================================================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The Registrant estimates that expenses in connection with the offering
described in the Registration Statement will be as follows:
Securities and Exchange Commission Registration Fee $
Accountants' Fees and Expenses $
Legal Fees and Expenses $
American Stock Exchange fees $ -
Printing and Engraving Expenses $
Miscellaneous $ -
-----------
$
===========
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law permits the
indemnification of officers, directors, employees and agents of Delaware
corporations. The Certificate of Incorporation and Bylaws of the Company provide
that the corporation shall, to the fullest extent permitted by Section 145 of
the General Corporation Law of the State of Delaware as it may be amended from
time to time, indemnify and hold harmless each person who was or is a party or
is threatened to be made a party to or is involved in any action, suit or
proceeding, whether civil, criminal, administrative or investigative
(hereinafter a "proceeding"), by reason of the fact that he or she, or a person
whom he or she is a legal representative, is or was a director or officer of the
Company or is or was serving at the request of the Company as director, officer,
employee or agent of another corporation or of a partnership, joint venture,
trust or other enterprise, including service with respect to employee benefit
plans, whether the basis of such proceeding is alleged action or inaction in an
official capacity or in any other capacity while serving as a director, officer,
employee or agent, against all costs, charges, expenses, liabilities and losses
(including attorney's fees, judgments, fines, ERISA excise taxes or penalties
and amounts paid or to be paid in settlement) reasonably incurred or suffered by
such person in connection therewith, and such indemnification shall continue as
to persons who have ceased to be a director, officer, employee or agent and
shall inure to the benefit of his or her heirs, executors and administrators.
ITEM 16. EXHIBITS
Number Description
4.1 Form of Note between Registrant and holders of 12% Convertible
Subordinated Notes due December 31, 2007 (incorporated by
reference to Registrant's quarterly report on Form 10-Q filed on
November 14, 1997.
4.2 Form of Warrant Certificate representing Common Stock
(incorporated by reference to Registrant's Registration
Statement on Form S-2/A filed on February 11, 1998.
4.3 Rights Agreement dated March 21, 1997 between the Company and
U.S. Stock Transfer Corporation, including the form of rights
certificate (incorporated by reference to Registrant's quarterly
report on Form 10-Q filed on July 29, 1997.
4.4 Credit Agreement dated as of July 11, 1997 among Registrant,
Credit Lyonnais New York Branch, as agent for itself and the
other lenders now or hereafter party thereto (incorporated by
reference to Registrant's quarterly report on Form 10-Q filed on
July 29, 1997.
4.5 Amendment dated November 3, 1997 to Credit Agreement among
Registrant, Credit Lyonnais New York Branch, as agent for
itself and the other lenders now or hereafter party thereto
(incorporated by reference to Registrant's quarterly report
on Form 10-Q filed on November 14, 1997.
5.1 * Opinion of Mr. Dean W. Drulias, General Counsel of the
Registrant, regarding legality of securities.
18.1 Letter from KPMG Peat Marwick LLP regarding change in accounting
method (incorporated by reference to Fortune's Registration
Statement on Form S-2, Registration No. 333-22599 filed on
February 28, 1997)
23.1 * Consent of KPMG Peat Marwick LLP
23.2 * Consent of Huddleston & Co., Inc.
23.4 * Consent of Mr. Dean W. Drulias (included in Exhibit 5.1).
25.1 Power of Attorney (included on signature page)
- ----------
* Filed herewith.
II-1
<PAGE>
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file during any period in which offers or sales are being made, a
post effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3)
of the Securities Act;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or the most
recent post effective amendment thereof) which, individually or in the
aggregate represent fundamental change in the information set forth in
the registration statement;
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement;
(5) That, for the purpose of determining any liability under the Securities
Act, each such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
(4) The undersigned registrant hereby undertakes to deliver or cause to be
delivered with the prospectus, to each person to whom the prospectus is sent or
given, the latest annual report to security holders that is incorporated by
reference in the prospectus and furnished pursuant to and meeting the
requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of
1934; and, where interim financial information required to be presented by
Article 3 of Regulation S-X are not set forth in the prospectus, to deliver, or
cause to be delivered to each person to whom the prospectus is sent or given,
the latest quarterly report that is specifically incorporated by reference in
the prospectus to provide such interim financial information.
(5) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(6) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering there.
(7) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers, and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Commission such indemnification is
against public policy as expressed in the Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the registrant of expenses incurred or paid by a director,
officer of controlling person of the registrant in the successful defense of any
action, suit of proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the registrant will,
unless in the opinion of its counsel the matter has been settled by a
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
II-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly authorized this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Houston, State of Texas, on October 16, 1998.
FORTUNE NATURAL RESOURCES CORPORATION
By: /s/ Tyrone J. Fairbanks
---------------------------------------
Tyrone J. Fairbanks
President and Chief Executive Officer
By: /s/ J. Michael Urban
---------------------------------------
J. Michael Urban
Vice President and Chief Financial
and Accounting Officer
Each person whose signature appears below constitutes and appoints Tyrone
J. Fairbanks and Dean W. Drulias, and each of them, as his true and lawful
attorneys-in-fact with full power of substitution and resubstitution, for him
and his name, place and stead, in any and all capacities, to sign any or all
amendments (including post effective amendments) to this Registration Statement,
and to file the same, with all exhibits hereto, and other documents in
connection therewith, with the Securities and Exchange Commission granting unto
said attorney-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the foregoing, as fully to all intents and purposes as he might or
could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents, or any of them, or their substitutes, may lawfully
do or cause to be done by virtue hereof.
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following person in the capacities
and on the dates stated.
Name Title Date
---- ----- ----
/s/ Tyrone J. Fairbanks
- ----------------------------
Tyrone J. Fairbanks Chief Executive Officer
and Director October 16, 1998
/s/ Dean W. Drulias
- ----------------------------
Dean W. Drulias Executive Vice President,
General Counsel,
Corporate Secretary
and Director October 16, 1998
/s/ Graham S. Folsom
- ----------------------------
Graham S. Folsom Director October 16, 1998
/s/ Barry Feiner
- ----------------------------
Barry Feiner Director October 16, 1998
/s/ Gary Gelman
- ----------------------------
Gary Gelman Director October 16, 1998
/s/ D. R. Shaughnessy
- ----------------------------
D. R. Shaughnessy Director October 16, 1998
/s/ Dewey A. Stringer, III
- ----------------------------
Dewey A. Stringer, III Director October 16, 1998
II-3
<PAGE>
October 16, 1998
Fortune Natural Resources Corporation
One Commerce Green
515 W. Greens Road, Suite 720
Houston, Texas 77067
Attn: Mr. Tyrone J. Fairbanks
President and Chief Executive Officer
Gentlemen:
As set forth in the Registration Statement on Form S-2 filed with the
Securities and Exchange Commission (the "Commission") under the Securities Act
of 1933, as amended (the "Securities Act"), on October 16, 1998 by Fortune
Natural Resources Corporation, a Delaware corporation (the "Company"), in
connection with the registration of $3,225,000 of 12% Convertible Subordinated
Notes due December 31, 2007 (the "Notes") and the shares of the Company's Common
Stock, $.01 par value (the "Common Stock"), issuable on conversion of the Notes
or the warrants (the "Warrants") issued by the Company to the placement agent in
the offering of the Notes (together with the notes, the "Securities") to be sold
by the selling security holders listed in the Registration Statement from time
to time pursuant to Rule 415 under the Securities Act (the "Selling Holders"),
certain legal matters in connection with the Securities are being passed on for
the Company by the undersigned.
In my capacity as General Counsel for the Company, I have examined the
Certificate of Incorporation of the Company, as filed with the Secretary of
State of Delaware and the Bylaws of the Company, both as amended to date; the
stock transfer records of the Company and the records of the official
proceedings of its board of directors through the date of this opinion; the
Notes and the Subscription Agreement and Investment Letter between the Company
and each of the Selling Holders; and, such other documents as I have deemed
necessary for the expression of the opinions contained herein.
Based upon the foregoing, and having regard for such legal
considerations as I deem relevant, I am of the opinion (limited, in all
respects, to the laws of the State of Delaware and federal law) that:
<PAGE>
Fortune Natural Resources Corporation
October 16, 1998
Page 2
(1) The Company is a corporation duly organized, validly existing
and in good standing under the laws of the State of Delaware;
(2) The Notes have been validly issued, and constitute valid and
binding obligations of the Company enforceable against it in
accordance with their terms, except as such enforcement is
subject to any applicable bankruptcy, insolvency,
reorganization, fraudulent conveyance or transfer, moratorium
or other laws relating to or affecting creditors' rights
generally and (ii) general principles of equity (regardless of
whether such enforceability is considered is a proceeding in
equity or at law).
(3) The shares of Common Stock to be sold by the Company upon the
conversion of the Notes and Warrants, when issued in
accordance with the terms and conditions of the Notes or
Warrants, as the case may be, have been duly authorized and
reserved for issuance and, will be validly issued, fully paid
and nonassessable.
I hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and the use of my name in the related Prospectus under
the caption "Legal Matters".
Very truly yours,
/s/ Dean W. Drulias
- ---------------------
General Counsel
DWD:mjk
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Fortune Natural Resources Corporation:
We consent to the use of our reports included herein and to the reference to our
firm under the heading "Experts" in the prospectus.
/s/ KPMG Peat Marwick LLP
- -------------------------
Houston, Texas
October 16, 1998
HUDDLESTON & CO., INC.
PETROLEUM AND GEOLOGICAL ENGINEERS
1111 FANNIN-SUITE 1700
HOUSTON, TEXAS 77002
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(281) 658-0248
CONSENT OF INDEPENDENT PETROLEUM ENGINEER
October 16, 1998
Fortune Natural Resources Corporation
One Commerce Green
515 W. Greens Rd., Suite 720
Houston, Texas 77067
Dear Sirs:
We hereby consent to the filing of this consent as an exhibit to the
Registration Statement on Form S-2 of Fortune Natural Resources Corporation
("Fortune") to be filed with the Securities and Exchange Commission on or about
October 16, 1998, to the use of our name therein, and to the inclusions of or
reference to our report of Fortune's estimated future reserves and revenues
effective December 31, 1995, December 31, 1996 and December 31, 1997.
HUDDLESTON & CO., INC.
/s/ Peter D. Huddleston, P.E.
-----------------------------
