1997
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER: 1-12334
FORTUNE NATURAL RESOURCES CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 95-4114732
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
515 W. Greens Road, Suite 720
Houston, Texas 77067
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (281) 872-1170
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of exchange on which registered
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Common Stock, $.01 par value American Stock Exchange
Common Stock Purchase Warrants American Stock Exchange
Securities registered pursuant to section 12(g) of the Act: None
- --------------------------------------------------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes x No ___
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. [ x ]
State the aggregate market value of the voting stock held by non-affiliates
of the registrant. The aggregate market value shall be computed by reference to
the price at which the stock was sold, or the average bid and asked price of
such stock, as of a specified date within 60 days prior to the date of filing.
The aggregate market value of voting stock held by non-affiliates at
January 30, 1998: $23,804,000
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Shares of common stock outstanding as of January 30, 1998: 12,129,167
DOCUMENTS INCORPORATED BY REFERENCE
List hereunder the following documents if incorporated by reference and the
Part of Form 10-K into which the document is incorporated: (1) Any annual report
to security holders; (2) Any proxy or information statement; and (3) Any
prospectus filed pursuant to Rule 424(b) or (c) of the Securities Act of 1933.
The listed documents should be clearly described for identification purposes
(e.g., annual report to security holders for fiscal year ended December 24,
1980).
None
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PART I
ITEMS 1 AND 2. BUSINESS AND PROPERTIES
GENERAL
Fortune 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.
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
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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 Interpretation 3, 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.
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 additional interest in the East Bayou
Sorrel field in early 1997 as well as 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.
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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. It is expected that exploration drilling
activities will begin in early 1998. Over a dozen prospects have been delineated
to date, however, no assurance can be given that any commercial quantities of
hydrocarbons will be discovered.
On March 13, 1997, each of the Espiritu Santo Bay 3-D Seismic Project joint
venture partners, including Fortune, elected to acquire their pro-rata shares of
the Steamboat Pass Field, Calhoun County, Texas from Neumin Production Company
("Neumin"). The Steamboat Pass Field is 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 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 commencing 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 and
the second on January 12, 1998. The first was a new discovery and is currently
producing approximately 540 MCFD and 20 BOPD. The second was drilled into a
depleted fault block and was plugged and abandoned as a dry hole.
East Bayou Sorrel Field, Iberville Parish, Louisana
The East Bayou Sorrel field currently accounts for approximately one-third
of the Company's revenues and proved reserves. Fortune and its partners drilled
and completed their exploratory discovery well in this field, the Schwing #1, in
1996. Fortune's share of the initial costs to acquire, evaluate and drill this
well was approximately $312,000. The Schwing #1 began producing in December 1996
and has been producing from permanent facilities since January 22, 1997.
Although the well reached production rates as high as 1,711 BOPD and 1,710 MCFD
during February 1997 on a 12/64" choke, production will be limited to 1,400 BOPD
under the State of Louisiana allowance for the producing reservoir. There is
currently no limitation on gas production from this reservoir. This well is in
an AMI totaling approximately 3,500 acres. In early 1997, the Company acquired
an additional 1.5% working interest in the field for $357,000, bringing its
total working interest in the field to approximately 12.9%.
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The Schwing #1 is producing from the lowest of seven potential oil and/or
gas zones which were encountered when drilling. The remaining zones have not
been tested in the Schwing #1. The second well at East Bayou Sorrel, the Schwing
#2, was completed and placed on permanent production facilities on June 23,
1997. This well was completed as a dual producer, however, the shallow
completion in this well was shut in on September 19, 1997 because of equipment
erosion resulting from excessive sand production. Current plans are to continue
to produce the well as a single completion to avoid similar problems. The
Company is participating in a third well, the Schwing #3, that is currently
being tested. There can be no assurance that additional production will be
discovered by this well. The Company's working interests in the East Bayou
Sorrel producing units range from approximately 12.2% to 12.9% (approximately
8.7% to 9.2% net revenue interest) before payout and from approximately 10.7% to
11.3% (approximately 7.6% to 8.1% net revenue interest) after payout.
Southwest Segno, Liberty County, Texas
On September 24, 1997, the Company entered into a Participation Agreement
to drill a well on the Southwest Segno Prospect in Liberty County, Texas. The
Company paid $36,000 to acquire an undivided 30% before-payout working interest
in this prospect. Drilling on the initial well commenced January 15, 1998.
Although drilling operations are currently still in progress, preliminary
information indicates that the well may not be economic to complete. The cost of
drilling this well is currently estimated to be $165,000 to Fortune's working
interest.
South Lake Arthur, Jefferson Davis Parish, Louisiana
In 1996, the Company participated in an exploratory well on the South Lake
Arthur prospect in Jefferson Davis Parish, Louisiana. The Company had acquired
an interest in approximately 1,900 acres of mineral leases, with rights to
participate in additional leases acquired in an AMI covering approximately 2,800
acres.
The test well on this prospect was commenced on January 9, 1997 and was
temporarily plugged and abandoned in late April 1997 after it was determined
that the well crossed a fault and failed to reach the primary objective target.
Fortune's working interest in the well was 12.5% before payout. Fortune
estimates its share of the total cost of drilling and temporarily plugging and
abandoning the well to be approximately $440,000. Although the well encountered
hydrocarbons in a shallower reservoir, Fortune did not believe the hydrocarbons
were sufficient to justify a completion attempt. Accordingly, Fortune sold its
interest in the shallow zone to the other parties who elected to complete the
well. Fortune retained its interest in the deeper primary objective target.
South Timbalier Block 76 - federal waters, offshore Louisiana
South Timbalier Block 76 is the Company's most prolific producer, currently
accounting for over one-third 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. Therefore, Fortune received the net cash flow from
the well to its interest from June 1, 1995. The effective date for financial
reporting purposes was November 1, 1995. The Company initially paid $2.2 million
for its interest in Block 76 plus 150,000 common stock purchase warrants at
prices from $4.625 to $6.00 per share, all of which expired unexercised in
December 1997. In the acquisition, Fortune granted an option, exercisable until
March 11, 1996, to a third party to acquire a 4.167% working interest in the
property for $790,000 plus the retention by Fortune of a
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$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, 1997 to April 19, 1997 for a
workover to repair a leak that caused the well to lose casing pressure. The
Company's share of the costs of this second workover was approximately $360,000.
Notwithstanding these shut-ins, the well has already returned Fortune's
investment, and the Company is evaluating the possibilities for additional
wells.
In order to finance the acquisition of the South Timbalier Block and to
provide the Company with additional working capital, Fortune issued 1,321,117
shares of its Common Stock to a group of overseas investors in a transaction
which qualified for an exemption from the registration requirements of the
Securities Act 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.")
Joint Venture with Zydeco
Fortune owns varying interests in several 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.
The Company does not currently expect that wells will be drilled on all of
the Joint Venture Projects or that it will retain a working interest of more
than 25% in any wells that are drilled, except in certain circumstances. 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.
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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.
Rio Arriba County, New Mexico - San Juan Basin
On June 24, 1994, Fortune concluded the purchase of a 25% interest in
EnRe-1, LLC, a newly formed Texas limited liability company, which owned three
Jicarilla Apache Minerals Development Agreements ("MDAs") covering 60,000
producing, development and exploratory acres in Rio Arriba County, New Mexico
and associated tangible property, and an approximately 22% working interest in
certain mineral, oil and gas leasehold interests in an additional 10,000
exploratory acres in 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.
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Webb County, Texas - Belle Pepper and Belle Jeffers Fields
On October 5, 1993, the Company completed the acquisition of certain
mineral, oil and gas leasehold interests and associated tangible property from
Michael Petroleum Corporation, Brazos Resources, Inc., Pioneer Drilling Company
and Endowment Energy Partners. The mineral, oil and gas leasehold interests
include working interests in producing and non-producing oil and gas properties
located in Webb County, Texas, known as the Belle Pepper and Belle Jeffers
Fields. The Company acquired interests in approximately 2,300 acres of mineral
leases, including 10 producing gas wells. The Lobo sand in this area has very
low permeability (under one millidarce) which has qualified all the acquired
production as a "tight" gas sand. As a tight gas sand, the production from wells
drilled before January 1, 1993 (which includes 9 of the wells on the property)
is exempt from Texas state severance tax. 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.
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
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sale was effective December 31, 1995. In connection with the sale, Fortune paid
commissions and expenses of approximately $75,000. The Company sold its
remaining California property, the Sespe Field, Ventura County, California, to
Seneca Resources for approximately $300,000 net of closing adjustments in April
1996. The Company recorded a loss on sale of $3.6 million in 1995 as a result of
these divestitures.
All of the Company's California properties were pledged to secure the
Company's bank debt. Concurrently with the closing of the sale of the non-Sespe
properties, Fortune reduced its bank debt by $1.1 million, representing the
entire indebtedness secured by the Company's California properties. The closing
of the sales of the California properties and the relocation of the Company's
headquarters to Houston completed the Company's strategic move to focus its
efforts on exploration in the Gulf Coast.
Prior to 1994, the Company made various other acquisitions, primarily of
producing properties located in California, which have since been sold.
OIL AND GAS OPERATIONS
Drilling Activities
The following table sets forth information regarding development and
exploratory wells drilled by Fortune in the years ended December 31, 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
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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.
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.
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.
11
<PAGE>
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%.
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:
12
<PAGE>
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>
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.
13
<PAGE>
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>
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)
14
<PAGE>
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 February 28, 1998, the Company employed eight persons, all in
management and administration. In addition, the Company utilizes the services of
outside consultants in certain technical aspects of the Company's business.
Fortune utilizes these consultants to aid in the evaluation of Company projects
and to evaluate oil and gas assets for potential acquisitions.
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.
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. For example, production from the East Bayou
Sorrel Schwing #1 well is currently restricted to approximately 1,400 Bbl of oil
per day because of such a state mandated restriction. (See "Business and
Properties - Significant Properties and Activities - East Bayou Sorrel Field,
Iberville Parish, Louisiana.")
15
<PAGE>
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. For example, the Company's working
interest in certain reservoirs in the East bayou Sorrel field was reduced from
12.9% to 12.2% as a result of such unitization rulings.
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 forms 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.
ITEM 3. LEGAL PROCEEDINGS
On March 26, 1996, Fortune was served with a lawsuit which had been filed
in the Federal District Court in Delaware by one of the purchasers of Fortune
common stock in an offering in December 1995 under Regulation S 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 is continuing in these cases and a consolidated trial is expected in
1998.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None during the fourth quarter of 1997.
16
<PAGE>
PART II
ITEM 5 . MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth the high and the low closing prices of the
Common Stock and certain publicly traded warrants of the Company on the American
Stock Exchange ("AMEX") for the periods indicated.
<TABLE>
<CAPTION>
Common Stock Warrants
------------------- -------------------
High Low High Low
-------- -------- -------- --------
<S> <C> <C> <C> <C>
1996
First Quarter ................ $5 $2 $3 3/16 $1 3/8
Second Quarter ............... 4 2 5/8 3 1 3/8
Third Quarter ................ 3 11/16 2 1/4 2 3/8 1 1/4
Fourth Quarter ............... 3 1/2 2 1/4 1 3/4 1
1997
First Quarter ................ 3 1/4 2 1/4 1 7/8 1
Second Quarter ............... 2 7/16 1 5/8 1 7/16
Third Quarter ................ 2 1/2 1 9/16 3/4 1/2
Fourth Quarter ............... 3 3/16 2 3/8 1 3/8 1/2
1998
First Quarter
(through February 27)........ 2 5/8 1 9/16 7/16 3/16
</TABLE>
At February 27, 1998 the closing price of the Common Stock was $1.875 per
share and the closing price for the warrants was $0.375 per warrant. At January
30, 1998, there were 12,129,167 shares of the Company's Common Stock outstanding
held of record by approximately 3,000 stockholders. 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.
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 rights to purchase 63,000 warrants through exercise of representatives'
units currently held by certain unitholders, all of which expire September 28,
1998. 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 Old 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.
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 offering of the Notes was conducted under
Regulation D of the Securities Act of 1933. The facts relied upon are those set
forth in Rule 506 of Regulation D.
17
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following Summary Condensed Financial Data for each of the years in the
five-year period ended December 31, 1997, are derived from, and qualified by
reference to, the Company's audited financial statements, appearing elsewhere
herein. The Selected Financial Data should be read in conjunction with the
financial statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing in Item 7.
(dollars and shares in thousands, except per share data)
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Total Revenues .................................. $ 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 ............ 3,650 -- -- 3,347 2,993
Net Loss ........................................ (5,958) (1,330) (5,876) (4,453) (3,703)
Net Loss per share .............................. (0.49) (0.12) (0.90) (1.69) (2.09)
Net weighted average shares outstanding ......... 12,086 11,351 6,556 2,639 1,773
Operating Data:
Net Production:
Oil, condensate and
gas liquids (Bbl) ......................... 87,000 57,000 92,000 88,000 79,000
Gas (Mcf) ................................... 821,000 1,038,000 909,000 1,017,000 724,000
Gas equivalent (MCFE) ....................... 1,343,000 1,383,000 1,461,000 1,542,000 1,196,000
Average Sales Price:
Oil, condensate and
gas liquids ($ per Bbl) ................... $ 19.04 $ 20.24 $ 14.66 $ 14.14 $ 14.33
Gas ($ per Mcf) ............................. 2.66 2.56 1.77 2.09 2.28
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------
1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Total Assets .................................... $ 12,626 $ 16,335 $ 17,800 $ 10,066 $ 10,429
Total Debt ...................................... 3,775 2,933 4,897 7,123 3,003
Net Stockholders' Equity ........................ 8,053 13,037 12,314 2,130 6,588
Reserves:
Estimated Net Proved Reserves(1):
Oil and condensate (MBbl) ................... 257 249 347 1,647 813
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 are based in part on the sales price at
December 31 of the respective year. To the extent that the cost of
producing the oil and gas, plus applicable taxes, from any particular
property exceeds the sales price, the quantity of proved reserves is
reduced. (See Items 1 and 2. Business and Properties - Oil and Gas
Operations - Oil and Gas Reserves.)
18
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
All of the Company's operating revenues are derived from the production 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. 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
anticipates that general and administrative expense may increase further as the
scope of the Company's oil and gas exploration activities are expanded in future
years.
The Company experienced substantial net losses in 1997 and 1995 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. 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. For the three
years 1995 through 1997, the Company's primary sources of capital have been the
sale of equity and proceeds from the sale of the California properties. During
this same period, the Company reduced its total debt by $3.3 million (almost
50%) 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. 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.
19
<PAGE>
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 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. A third well at East Bayou Sorrel is currently
being tested.
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.")
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.
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." Although the Company believes that
these issues will not adversely impact its operations, there can be no assurance
that disruption or expenses will not occur as a result of the inability of the
Company's vendors or customers to deal with this problem on a timely basis. The
Company will continue to monitor the status of these issues to determine the
impact, if any, on its operations.
20
<PAGE>
Years ended December 31, 1996 and 1995
Fortune had a net loss of $1.3 million in 1996 compared to a net loss of
$5.9 million in 1995. The higher net loss in 1995 is primarily attributable to a
$3.6 million loss on the sale of the California properties.
Net revenues from sales of oil and gas increased 29% to $3.8 million for
1996 compared to 1995. The increase resulted primarily from the combination of
higher gas prices and a full year of production from South Timbalier Block 76.
The 1995 production was adversely affected by a 5 1/2 month shut down of the
Company's Hopper Canyon, California oil field due to storm damage. 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 and Working Capital
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.
21
<PAGE>
Cash Flows from Operating Activities
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. The third well at East Bayou Sorrel is
currently being tested.
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
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.")
22
<PAGE>
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
The Company borrowed $3.3 million of new debt in 1997 while reducing other
debt by $1.8 million. In connection with issuing new debt, the Company
significantly increased the maturity of its debt, $0.6 million of which is due
in 1999 and the remaining $3.2 million of which is due in 2007. At the beginning
of 1997, all of the Company's debt was due in 1997. Total debt at December 31,
1997 stood at $3.8 million, $3.2 million of which is subordinated convertible
debt. Furthermore, this represents a significant decrease in debt since January
1, 1995 when debt stood at $7.1 million.
- 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 Notes are convertible into the Company's Common Stock at a conversion
price of $3.00 per share, subject to adjustment. The Notes are convertible by
the holders after May 1, 1999, subject to a one-time option by the holders to
convert at a lower conversion price prior to that date in the event that the
Company sells shares of its Common Stock at a price below the conversion price.
The Notes are redeemable by the Company after May 1, 1999, at a premium that
reduces monthly from 10% to zero over an 18-month period. Any such premium on
redemption is waived in the event that the Company's Common Stock price averages
at least $4.50 per share for 30 consecutive trading days. The holders of the
Notes will be entitled to receive additional shares upon conversion in the event
that the Company's Common Stock price averages less than the conversion price
for a certain period prior to May 1, 1999. The Notes are subordinate to all of
the Company's secured debt, including the credit facility with Credit Lyonnais.
The Notes bear interest at a rate of 12% per year, payable quarterly.
The 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.
23
<PAGE>
- Credit Facility
Prior to July 1997, the Company's bank debt was incurred under a $10
million secured master revolving credit facility with Bank One, Texas, N.A.
("Bank One") which had been in place since January 14, 1994. The Bank One credit
facility was a reserve-base borrowing facility secured by substantially all of
the Company's proved oil and gas reserves. The Bank One facility contained
various financial covenants, was due October 1, 1997, bore interest at 1.5% over
Bank One's prime rate and required monthly principal payments of $75,000. On
July 11, 1997, the Company refinanced its debt under the Bank One credit
facility by entering into a $20 million credit facility with Credit Lyonnais New
York Branch ("Credit Lyonnais"). The Credit Lyonnais facility is due July 11,
1999, and can be extended for one year upon mutual consent. Under the new credit
facility, the Company may initially borrow up to a pre-determined borrowing
base, for general corporate purposes at either 1.25% above Credit Lyonnais' base
rate or 4% above LIBOR. The borrowing base, currently set at $2.0 million, was
calculated based upon the Company's July 1, 1997 oil and gas reserves and is
subject to semi-annual review. The unused portion of the borrowing base, which
is currently approximately $1.4 million, is to be used only for acquisitions of
producing properties or development projects approved in advance by Credit
Lyonnais. The Company is also required to pay a commitment fee of 0.5% on the
unused portion of the borrowing base. The Credit Lyonnais facility is secured by
a mortgage on all of the Company's existing proved oil and gas properties.
- 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.")
24
<PAGE>
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 " - Forward Looking Statements -
Volatility of Oil and Gas Prices".) Following is a summary of the average prices
the Company was receiving for its oil and gas production as of the dates
indicated:
<TABLE>
<CAPTION>
As of February As of December 31,
-------------------- --------------------
1998 1997 1996 1995
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Oil price per Bbl ........ $ 14.70 $ 16.90 $ 22.79 $ 16.10
Gas price per MCF ........ 2.10 2.60 4.04 2.32
</TABLE>
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.")
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS 130"), which establishes
standards for reporting and display of comprehensive income and its components.
The components of comprehensive income refer to revenues, expenses, gains and
losses that are excluded from net income under current accounting standards,
including foreign currency translation items, minimum pension liability
adjustments and unrealized gains and losses on certain investments in debt and
equity securities. SFAS 130 requires that all items that are recognized under
accounting standards as components of comprehensive income be reported in a
financial statement displayed in equal prominence with the other financial
statements; the total of other comprehensive income for a period is required to
be transferred to a component of equity that is separately displayed in a
statement of financial position at the end of an accounting period. SFAS 130 is
effective for both interim and annual periods beginning after December 15, 1997.
The Company does not believe that this SFAS will have any significant impact on
its financial statements.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("SFAS 131"). SFAS 131 establishes standards for the way public enterprises are
to report information about operating segments in annual financial statements
and requires the reporting of selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. SFAS 131 is effective for periods beginning after December 15, 1997.
The Company does not believe that this SFAS will currently result in any
significant new disclosures in its financial statements.
25
<PAGE>
FORWARD LOOKING STATEMENTS
This annual report contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Such forward-looking statements may be found in this
section, under Items 1 and 2. Business and Properties and elsewhere. Forward
looking statements include, among others, 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, the Company's strategy and the Company's competitive
and regulatory environment. Actual events or results could differ materially
from those discussed in the forward-looking statements as a result of various
factors including, without limitation, the factors set forth below and elsewhere
in this annual report.
Exploration Risks. The business of exploring for and, to a lesser extent,
of acquiring and developing oil and gas properties is an inherently speculative
activity that involves a high degree of business and financial risk. Although
available geological and geophysical information can provide information with
respect to a potential oil or gas property, it is impossible to determine
accurately the ultimate production, if any, which will result from a particular
property or well.
Dependence on Limited Number of Wells. Over 70% of the Company's oil and
gas revenues, cash flow and proved oil and gas reserves is currently accounted
for by three wells, the South Timbalier Block 76 well and the two East Bayou
Sorrel wells. The South Timbalier Block 76 well was recently shut-in for repairs
and was shut-in for over two months during 1996 as the result of a mechanical
failure. A significant curtailment or loss of production from these wells for a
prolonged period before the Company could replace the reserves through new
discoveries or acquisitions would have a material adverse effect on the
Company's future operating results and financial condition.
Volatility of Oil and Gas Prices. The Company's revenues, profitability and
future rate of growth are substantially dependent upon prevailing market prices
for oil and gas, which can be extremely volatile. In addition to market factors,
actions of state and local agencies, the United States and foreign governments,
and international cartels affect oil and gas prices. All of these factors are
beyond the control of the Company. These external factors and the volatile
nature of the energy markets make it difficult to estimate future prices of oil
and gas. 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. 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 1998.
Uncertainty of Estimates of Proved Reserves and Future Net Revenues. There
are numerous uncertainties inherent in estimating quantities of proved reserves
and in projecting future rates of production and timing of development
expenditures, including many factors beyond the control of the producer. The
reserve data set forth in this annual report represent only estimates.
Estimating quantities of proved reserves is inherently imprecise. Such estimates
are based upon certain assumptions about future production levels, future gas
and oil prices and future operating costs made using currently available
geologic engineering and economic data, some or all of which may prove to be
incorrect over time. 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. As a result of changes in these
assumptions that may occur in the future, and based upon further production
history, results of future exploration and development, future gas and oil
prices
26
<PAGE>
and other factors, the quantity of proved reserves may be subject to downward or
upward adjustment. In addition, the estimates of future net revenues from proved
reserves of the Company and the present value thereof are based on certain
assumptions about future production levels, prices, and costs that may not prove
to be correct over time.
Operating and Weather Hazards. The cost 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.") 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.
Additional factors. Additional factors that could cause actual events to
vary from those discussed above and elsewhere in this annual report include,
among others: loss of key company personnel; adverse change in governmental
regulation; inability to obtain critical supplies and equipment, personnel and
consultants; and inability to access capital to pursue the Company's plans.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted beginning at page 40.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON AUDITING
AND FINANCIAL DISCLOSURE
None.
27
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The directors and executive officers of the Company are as follows:
<TABLE>
<CAPTION>
Director
Executive Officer Age Since Title
------------------------------- --- -------- ------------------------------------------------
<S> <C> <C> <C>
Tyrone J. Fairbanks............ 41 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)............ 40 1992 Director
William T. Walker, Jr.(1)...... 66 1993 Director
Barry Feiner(1)................ 63 1995 Director
Gary Gelman(2)................. 32 1995 Director
Daniel Shaughnessy(2).......... 47 1997 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 is a
wholly owned subsidiary of Norcen Energy Resources Limited, a Canadian public
company. Mr. Urban had been with Norcen since March 1986. Mr. Urban is also a
director of Community Bank, a private commercial bank located in the Houston
area. Mr. Urban received his B.B.A. in Accounting from the University of Texas
in 1976 and has been a Certified Public Accountant in the State of Texas since
1978.
28
<PAGE>
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.
William T. Walker, Jr. founded Walker Associates, a corporate finance
consulting firm for investment banking, in 1985 and has participated in or been
instrumental in completing over $250 million in public and private offerings
since its inception. He also serves on the board of directors of Go Video, Inc.
(AMEX) and Aviation Distributors, Inc. (NMS).
Barry Feiner is a member of the Bar of the State of New York. He has
practiced law in the State of New York since 1965. His practice concentrates on
the areas of corporate and securities law. Prior to beginning private practice,
Mr. Feiner served on the staff of the Securities and Exchange Commission. He is
Chairman of the Company's Compensation Committee. Mr. Feiner also serves on the
board of directors of Intile Design, Inc. Mr. Feiner represented the placement
agent with respect to certain legal matters relating to the 1997 offering of the
Notes. Furthermore, Mr. Feiner serves as legal counsel to Mr. Blank, managing
director for the placement agent for the 1997 Notes offering and a beneficial
owner of more than 5% of the Company's stock. (See "Item 13 - Certain
Relationships and Related Transactions.")
Gary Gelman has served as president of GAR-COR Holding Corporation, a real
estate management and brokerage firm, since 1989. Mr. Gelman is a principal of
and serves as a loan consultant for National Bank of New York City.
Daniel R. Shaughnessy is a geologist and geophysicist. He is the founder
and president of Interpretation3, a company that specializes in interpretation
of 2D and 3D seismic data. His firm provides consultation services to Fortune.
Prior to organizing Interpretation3, Mr. Shaughnessy served as a consultant with
Interactive Exploration Solutions, Inc. (INXES) for approximately one year. For
most of the period from 1980 through 1993, he worked for Mobil Oil, most
recently as Exploration Supervisor in Louisiana. (See "Business and Properties -
Strategy".)
29
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table lists the total compensation paid by the Company to
persons who served in the capacity of chief executive officer during the periods
indicated and to the three other executive officers 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 - - 56,000(2) - 1,643
J. Michael Urban............ 1997 120,000 5,000 - - 100,000 - 4,750
Chief Financial Officer 1996 97,308 - - - 55,000(3) - 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 $2.5625 per share (the market price of the
Common Stock on March 11, 1996, the date of issue) and expiring on March
11, 2001.
30
<PAGE>
The following table lists the outstanding options held on December 31, 1997
by the Company's executive officers under Company's Stock Option Plans:
AGGREGATE OPTIONS EXERCISES IN 1997 AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Number of Value of Unexercised
Unexercised Options/ in the Money Options
Warrants at FY-End at FY-End (1)
Shares Acquired Exercisable/ Exercisable/
Name on Exercise Value Realized ($) 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 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 three Stock Option Plans. All existing plans cover officers and
employees of the Company; those effective in 1993 and 1998 also provide for
options for directors of the Company. Awards are made by the board of directors
upon recommendations of its Compensation Committee. There is no performance
formula or measure. Options granted under the 1988 plan must be exercised within
ten years of the date of grant or they are forfeited. Options granted under the
1993 and 1998 plans must be exercised within five years of the date of grant or
they are forfeited.
31
<PAGE>
All options available under the 1988 plan have been granted, and no shares
remain on which options may be granted. Options have been granted as follows:
(1) under the 1988 plan, options for 27,500 shares at $2.60 per share and (2)
under the 1993 plan, options for 75,000 shares at $5.00 per share granted in
1993, options for 263,000 shares at $5.48 per share granted in 1994, options for
264,000 shares at $6.03 per share granted in 1995, options for 450,000 shares at
$3.125 per share granted in 1996, and options for 595,000 shares at $3.00 per
share granted in 1997. The exercise prices of all options granted in 1993, 1994
and 1995 were reduced to $2.75 on January 12, 1995. No shares have been granted
to date under the 1998 plan.
The following table shows the grants of stock options during 1997 to each
of the executives named in the Summary Compensation Table.
OPTION GRANTS IN 1997
<TABLE>
<CAPTION>
Individual Grants
----------------------------------------------------------------------
Number of % of Total Potential Realizable Value At
Securities Options Assumed Annual Rates Of
Underlying Granted to Exercise or Stock Price Appreciation
Options Employees in Base Price Expiration For Option Term
Name Granted Fiscal Year ($/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 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.
32
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table contains information at January 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) 1,067,687 8.1%
William D. Forster
237 Park Ave, New York, NY (2)(3) 715,000 5.7%
BSR Investments, Inc.
Paris, France(2)(4) 715,000 5.7%
Klein Ventures, Inc.
1307 E. Pine St., Lodi, CA(5) 640,017 5.2%
Tyrone J. Fairbanks (Director, President and CEO)
515 W. Greens Rd., Houston, TX(6) 431,521 3.4%
John L. Collins (Vice President)
515 W. Greens Rd., Houston TX(6) 288,467 2.3%
William T. Walker, Jr. (Director)
515 W. Greens Rd., Houston TX(6) 227,278 1.8%
Dean W. Drulias (Director, Executive Vice President,
General Counsel and Corporate Secretary)
515 W. Greens Rd., Houston, TX(6) 183,841 1.5%
J. Michael Urban (Vice President and CFO)
515 W. Greens Rd., Houston, TX(6) 173,701 1.4%
Graham S. Folsom (Director)
515 W. Greens Rd., Houston, TX(6)(7) 134,751 1.1%
Gary Gelman (Director)
515 W. Greens Rd., Houston, TX(6) 94,083 *
Barry Feiner (Director)
515 W. Greens Rd., Houston, TX(6)(8) 90,493 *
Daniel R. Shaughnessy (Director)
515 W. Greens Rd., Houston, TX(6) 34,900 *
All Officers and Directors
as a group of nine (9) persons 1,659,035 12.3%
=========== =======
</TABLE>
* indicates less than 1%.
(1) Includes 90,000 shares of Common Stock and an additional 777,687 shares of
Common Stock which underlie 541,000 Common Stock purchase warrants held by
Mr. Blank, 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 and registered representative with J. Robbins
Securities, L.L.C.
33
<PAGE>
(2) Mr. Forster and BSR are the record holders of these shares issued in
connection with the Company's acquisition of Lagniappe Exploration, Inc. in
1995
(3) Includes 515,000 shares of Common Stock underlying stock purchase warrants
exercisable at $4.75 per share and expiring April 2000.
(4) Includes 515,000 shares of Common Stock underlying stock purchase warrants
exercisable at $4.75 per share and expiring April 2000. Based on
information provided to the Company by BSR, voting and dispositive power is
exercised by Samyr Souki, the president of BSR.
(5) Klein Ventures, Inc. is owned by Mr. Bud Klein. The number of shares shown
includes 138,888 shares underlying stock purchase warrants issued in a 1992
acquisition and 115,000 shares underlying 80,000 stock purchase warrants
acquired in the Company's 1993 public equity offering exercisable at $3.75
per warrant. The number shown also includes an aggregate of 88,629 shares
of stock owned by Klein Bros. Holdings, Ltd. Each record owner possesses
sole voting and disposition power over such shares, and Klein Ventures,
Inc. and Mr. Bud Klein disclaim beneficial ownership of shares owned by
Klein Bros. Holdings, Ltd. which is owned by Klein Ventures, Inc. and five
of Mr. Klein's children and relatives. However, Klein Ventures, Inc., Klein
Bros. Holdings, Ltd. and Bud Klein may be considered a "group" under
regulations of the Commission.
(6) Includes 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 and issued to a
director in connection with a 1993 public offering:
Common Stock Average Weighted
Issuable Exercise Price
------------ ----------------
Tyrone J. Fairbanks 406,999 $2.90
William T. Walker, Jr. 217,778 3.07
John L. Collins 197,000 3.08
J. Michael Urban 155,000 2.92
Dean W. Drulias 151,000 2.96
Graham S. Folsom 110,975 2.96
Gary Gelman 74,250 3.06
Barry Feiner 74,250 3.06
Daniel R. Shaughnessy 10,000 3.00
(7) Includes 7,187 shares issuable upon exercise of 5,000 stock purchase
warrants (at $3.75 per warrant).
(8) All shares shown are owned by Mrs. Barry Feiner, wife of Barry Feiner; Mr.
Feiner disclaims beneficial ownership of all such shares. The number shown
includes 14,375 shares issuable upon exercise of 10,000 stock purchase
warrants (at $3.75 per warrant).
34
<PAGE>
ITEM 13. 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.
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 a principal stockholder and former director of Fortune,
and John E. McConnaughy, Jr., formerly a principal stockholder of the Company.
Each of Mrs. Forster and Mr. McConnaughy loaned LEX $100,000 and received from
LEX, as an inducement to make the loan, 33,333 shares of Common Stock and 33,333
stock purchase warrants out of 170,000 shares and 170,000 warrants issued to LEX
prior to the closing of the acquisition. W. Forster & Co., Inc., a corporation
wholly owned by William D. Forster, received a $30,000 placement fee from the
Company for assistance in arranging the $300,000 bridge loan. As a result of its
acquisition of LEX, Fortune was required, at the time the bridge loan was
repaid, to accelerate the amortization of the value of the shares paid by LEX to
the lenders in connection with the bridge loan in the amount of $150,000.
In order to provide additional capital for development activities, in
December 1994, the Company borrowed an aggregate of $750,000 from certain
principal stockholders and from each of its directors then serving (Messrs.
Champion, Drulias, Fairbanks, Folsom and Walker). The directors loaned $175,000
to the Company in the aggregate. $375,000 was obtained from Klein Ventures,
Inc., and $200,000 was obtained from Jack Farber.
35
<PAGE>
(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, 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'
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.
36
<PAGE>
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.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as part of the report:
(1) Financial Statements
Page
----
Independent Auditors' Report--KPMG Peat Marwick LLP.............. 41
Balance Sheets--December 31, 1997 and 1996....................... 42
Statements of Operations for the years ended
December 31, 1997, 1996 and 1995............................... 43
Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995............................... 44
Statements of Cash Flows for the years ended December 31,
1997, 1996 and 1995............................................ 45
Notes to Financial Statements.................................... 46
(2) Financial Statement Schedules
None
(3) Exhibits
Number Description
------ -----------
3.1 Certificate of Incorporation of Registrant
(filed as Exhibit 3.1 to Registrant's
Quarterly Report Form 10-Q for the quarter
ended June 30, 1997 and incorporated herein
by reference).
3.2 By-laws of Registrant (filed as Exhibit 3.3
to Registrant's Quarterly Report Form 10-Q
for the quarter ended June 30, 1997 and
incorporated herein by reference)
4.1 Warrant Agreement by and between Registrant
and U.S. Stock Transfer Corporation, as
warrant agent (filed as Exhibit 4.1 to
Registrant's Registration Statement on Form
S-2 (333-45469) and incorporated herein by
reference)
4.2 Form of Warrant Certificate (filed as
Exhibit 4.2 to Registrant's Registration
Statement on Form S-2 (333-45469) and
incorporated herein by reference)
37
<PAGE>
4.3 Form of Note between Registrant and holders
of Convertible Subordinates Notes due
December 31, 2007 (filed as Exhibit 4.1 to
Registrant's Quarterly Report Form 10-Q for
the quarter ended September 30, 1997 and
incorporated herein by reference)
4.4 Form of Placement Agent Warrant Agreement
between Registrant and J. Robbins
Securities, L.L.C. (filed as Exhibit 4.2 to
Registrant's Quarterly Report Form 10-Q
for the quarter ended September 30, 1997 and
incorporated herein by reference)
4.5 Shareholder Rights Plan of Registrant dated
March 21, 1997 (filed as Exhibit 4.1 to
Registrant's Form 10-Q for the quarter ended
June 30, 1997 and incorporated herein by
reference)
4.6 Form of Exchange Warrant exercisable at
$4.00 per share (filed as Exhibit 4.2 to
Registrant's Registration Statement on Form
S-2 (333-00087) and incorporated herein by
reference)
4.7 Form of Exchange Warrant exercisable at
$5.00 per share (filed as Exhibit 4.3 to
Registrant's Registration Statement on Form
S-2 (333-00087) and incorporated herein by
reference)
4.8 Form of Co-Conversion Agent warrant
exercisable at $3.4965 per share (filed as
Exhibit 4.4 to Registrant's registration
Statement on Form S-2 (333-00087) and
incorporated herein by reference)
4.9 Form of Warrant Agreement between Registrant
and U.S. Stock Transfer Corporation
(incorporated by reference to Registrant's
Registration Statement on Form SB-2,
Registration No. 33-88452)
10.1 Amendment dated November 3, 1997 to Credit
Agreement between Registrant and Credit
Lyonnais New York Branch and Certain Lenders
(filed as Exhibit 10.1 to Registrant's Form
10-Q for the quarter ended September 30,
1997 and incorporated herein by reference)
10.2 Participation Agreement by and between Registrant
and Smith Management Company, Inc.
et al. to acquire a 12.5% working interest in
Espiritu Santo Bay (filed as Exhibit
10.1 to Registrant's Registration Statement on
Form S-2 (333-22599) and incorporated
herein by reference)
10.3 Credit Agreement between Registrant and
Credit Lyonnais New York Branch and Certain
Lenders dated July 11, 1997 (filed as
Exhibit 10.1 to Registrant's Form 10-Q for
the quarter ended June 30, 1997 and
incorporated herein by reference)
10.4 Employment Agreement dated June 1, 1997 by
and between Registrant and Tyrone J.
Fairbanks (filed as Exhibit 10.2 to
Registrant's Form 10-Q for the quarter ended
June 30, 1997 and incorporated herein by
reference)
10.5 Employment Agreement dated August 1, 1996 by
and between Registrant and Dean W. Drulias
(filed as Exhibit 10.2 to Registrant's
Registration Statement on Form S-2
(333-22599) and incorporated herein by
reference)
10.6 1993 Stock Option Plan (filed as an Exhibit
to Registrant's Registration Statement on
Form SB-2 (33-64600) and incorporated herein
by reference)
10.7 1988 Stock Option Plan (filed as Exhibit 10.8
to Registrant's Pre-Effective Amendment
No. 1 to the Registration Statement on Form S-1
(33-49190) and incorporated herein by
reference)
10.8* 1998 Stock Option Plan
38
<PAGE>
10.9 Lease Agreement for 515 W. Greens Road,
Houston, Texas 77067 (filed as Exhibit 10.3
to Registrant's Form 10-KSB for the year
ended December 31, 1995 and incorporated
herein by reference)
10.10 Sublease Agreement with Animation Magazine
(filed as Exhibit 10.4 to Registrant's Form
10-KSB for the year ended December 31, 1995
and incorporated herein by reference)
10.11 Fairbanks Loan Documents (filed as Exhibit
10.5 to the Registrant's Form 10-KSB for the
year ended December 31, 1995 and
incorporated herein by reference)
10.12 Agreement dated December 8, 1995, between
Whitechappel Management Ltd. and Registrant
to act as distributor of the Common Stock
under Regulation S (filed as Exhibit 10.1 to
Registrant's Current Report on Form 8-K
dated December 26, 1995, and incorporated
herein by reference)
10.13 Regulation S Subscription Agreements and
related Joint Escrow Instructions for the
sale of 627,450 shares of Common Stock
(filed as Exhibit 10.2 to Registrant's
Current Report on Form 8-K dated December
26, 1995, and incorporated herein by
reference)
10.14 Offshore Securities Subscription Agreements
and related Joint Escrow Instructions for
the sale of 602,897 shares of Common Stock
(filed as Exhibit 10.3 to the Registrant's
Current Report on Form 8-K dated December
26, 1995, and incorporated herein by
reference)
23.1* Consent of KPMG Peat Marwick LLP
23.2* Consent of Huddleston & Co., Inc.
27.1* Financial Data Schedule
(b) Reports on Form 8-K
A report on Form 8-K dated December 1, 1997 was filed with the Securities
and Exchange Commission (the "Commission") to report that Fortune had commenced
a private placement of up to $4.5 million of 12% Convertible Subordinated Notes
due December 31, 2007.
- ----------------
* Filed herewith
39
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
Independent Auditors' Report - KPMG Peat Marwick LLP............ 41
Balance Sheets - December 31, 1997 and 1996..................... 42
Statements of Operations for the years ended
December 31, 1997, 1996 and 1995............................. 43
Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995.............................. 44
Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995.............................. 45
Notes to Financial Statements................................... 46
40
<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
41
<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.
42
<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.
43
<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 fo
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.
44
<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.
45
<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.
46
<PAGE>
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.
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.
47
<PAGE>
(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.
(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
48
<PAGE>
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).
(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>
49
<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%.
50
<PAGE>
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.
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
51
<PAGE>
<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.
52
<PAGE>
(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.
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.
53
<PAGE>
(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.
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
54
<PAGE>
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.
(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.
55
<PAGE>
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
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.
56
<PAGE>
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
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.
57
<PAGE>
(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.
(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 COSTINFORMATION
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.
58
<PAGE>
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>
<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.
59
<PAGE>
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.
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.
60
<PAGE>
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.
61
<PAGE>
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the Registrant
has duly caused this Report to be signed on its behalf by the undersigned,
thereunto duly authorized, in the city of Houston, State of Texas, on March 3,
1998.
FORTUNE NATURAL RESOURCES CORPORATION
By: /s/ Tyrone J. Fairbanks
----------------------------------------
Tyrone J. Fairbanks
President, Chief Executive Officer and Director
By: /s/ J. Michael Urban
----------------------------------------
J. Michael Urban
Vice President, Chief Financial Officer and
Chief Accounting Officer
In accordance with the Exchange Act, this report has been signed below by
the following persons on behalf of the Registrant and in the capacities and on
the dates stated.
Signature Title Date
--------- ----- ----
/s/ Tyrone J. Fairbanks
- ----------------------------
Tyrone J. Fairbanks President, Chief Executive March 3, 1998
Officer and Director
/s/ Dean W. Drulias
- ----------------------------
Dean W. Drulias Executive Vice President, March 3, 1998
General Counsel, Corporate
Secretary and Director
/s/ Graham S. Folsom
- ----------------------------
Graham S. Folsom Director March 3, 1998
/s/ William T. Walker, Jr.
- ----------------------------
William T. Walker, Jr. Director March 3, 1998
/s/ Barry Feiner
- ----------------------------
Barry Feiner Director March 3, 1998
/s/ Gary Gelman
- ----------------------------
Gary Gelman Director March 3, 1998
/s/ D. R. Shaughnessy
- ----------------------------
D. R. Shaughnessy Director March 3, 1998
62
<PAGE>
1998 INCENTIVE STOCK OPTION PLAN
OF
FORTUNE NATURAL RESOURCES CORPORATION
A DELAWARE CORPORATION
1. PURPOSE.
The purpose of this Plan is to strengthen Fortune Petroleum Corporation
(the "Company") by providing an additional means of retaining competent
management personnel and by providing to participating directors, officers and
other key employees added incentive for high levels of performance and for
unusual efforts to increase the earnings of the Company. The Plan seeks to
accomplish these purposes and results by providing a means whereby such
directors, officers and other key employees may purchase shares of the capital
stock of the Company pursuant to options.
2. ADMINISTRATION.
This Plan shall be administered by the Compensation Committee (the
"Committee") consisting of members selected by, and serving at the pleasure of,
the Board of Directors of the Company (the "Board"). Any action of the Committee
with respect to the administration of the Plan shall be taken pursuant to a
majority vote, or to the written consent of a majority of its members.
Subject to the express provisions of the Plan, the Committee shall have
the authority to construe and interpret the Plan, and to define the terms used
therein, to prescribe, amend, and rescind rules and regulations relating to the
administration of the Plan, to determine the duration and purposes of leaves of
absence which may be granted to participants without constituting a termination
of their employment for the purposes of the Plan, and to make all other
determinations necessary or advisable for the administration of the Plan. The
determinations of the Committee on the foregoing matters shall be conclusive.
Subject to the express provisions of the Plan, the Committee shall determine
from the eligible class the individuals who shall receive options, and the terms
and provisions of the options (which need not be identical); provided, however,
that all grants of options shall be by the Board.
3. PARTICIPATION.
Directors, officers and other key employees of the Company or of any
subsidiary corporation shall be eligible for selection to participate in the
Plan. An individual who has been granted an option may, if otherwise eligible,
be granted an additional option or options if the Board shall so determine.
<PAGE>
Any individual who, at the time the option is granted, owns stock
representing more than ten percent (10%) of the total combined voting power of
all classes of stock of the Company of its parent or any subsidiary shall not be
eligible to participate in the Plan, unless at the time an option is granted to
such person the option price is at least one hundred ten percent (110%) of the
fair market value of the stock subject to the option and such option is not
exercisable after 5 years from the date such option is granted.
4. STOCK SUBJECT TO THE PLAN.
Subject to adjustments as provided in Section 11 hereof, the stock to
be offered under the Plan shall be shares of the Company's authorized but
unissued Common Stock (hereinafter called "stock") and the aggregate amount of
stock to be delivered upon the exercise of all options granted under the Plan
shall not exceed the following:
YEAR IN WHICH OPTIONS GRANTED SHARES AVAILABLE
1998 2,000,000
1999 10% of outstanding stock on
December 31, 1998
2000 10% of outstanding stock on
December 31, 1999
2001 10% of outstanding stock on
December 31, 2000
2002 10% of outstanding stock on
December 31, 2001
Of the options available for grant each year, 60% of the available options
shall be available for grant to executive personnel, 30% shall be available for
grant to employees and 10% to outside directors of the Company. If any option
granted hereunder shall expire or terminate for any reason without having been
exercised in full, the unpurchased shares subject thereto shall again be
available for the purposes of this Plan.
Subject to the general limitations contained in this Plan, the Board may
make any adjustment in the exercise price or the number of shares subject to, or
the term of an option, by cancellation of an outstanding option and a subsequent
regranting of an option which may have an exercise price which is higher or
lower than the prior option, provide for a greater or lesser number of shares
subject to the option, or provide for a longer or shorter term than the prior
option.
2
<PAGE>
5. OPTION PRICE.
The purchase price of stock covered by each option shall be determined
by the Committee but shall not be less than the following prices:
YEAR IN WHICH OPTIONS GRANTED OPTION PRICES
1998 100% of fair market value on January 1, 1998
1999 110% of fair market value on January 1, 1998
2000 110% of fair market value on January 1, 1999
2001 110% of fair market value on January 1, 2000
2002 110% of fair market value on January 1, 2001
provided, however, that in no event shall the option price be less than the fair
market value of the Company's common stock on the date of grant of the option.
The purchase price of any shares purchased shall be paid in full in cash or by
check at the time of each purchase unless the Committee approves an alternative
type of consideration.
6. OPTION PERIOD.
Each option and all rights or obligations thereunder shall expire on
such date as the Committee or the Board shall determine, but not later than the
fifth anniversary of the date on which the option is granted, and shall be
subject to earlier termination as hereinafter provided.
7. EXERCISE OF OPTION: CONTINUATION OF EMPLOYMENT.
Each person to whom an option is granted must agree to remain as a
director or otherwise in the continuous employ of the Company, or its parent or
subsidiary corporation, during the period beginning on the date of grant of the
option and ending on the day one year before the date of his or her exercise of
an incentive stock option. No disposition of the stock that is transferred to
such person pursuant to his or her exercise of an incentive stock option may be
made by such person within 2 years from the date of the granting of the option
and within one year after the transfer of such share to him or her unless the
stock is currently included in, or subsequently made a part of, an effective
registration statement. Nothing contained in the Plan (or in any option granted
pursuant to the Plan) shall confer upon any employee any right to continue in
the employ of the Company or of any subsidiary or parent corporation of the
Company or shall impair the right of the Company to reduce such person's
compensation from the rate in
3
<PAGE>
existence at the time of the granting of an option or to terminate such person's
employment, but nothing contained herein or in any option agreement shall affect
any contractual rights of an employee.
Each option shall become exercisable and the total number of shares
subject thereto shall be purchasable, in such installments, which need not be
equal, as the Committee shall determine; provided, however, that if the holder
of an option shall not in any given installment period purchase all of the
shares that such holder is entitled to purchase in such installment period, such
holder's right to purchase any shares not purchased in such installment period
shall continue until the expiration or sooner termination of such holder's
option. No option or installment thereof shall be exercisable except in respect
of whole shares, and fractional share interests shall be disregarded except that
they may be accumulated in accordance with the next preceding sentence. No less
than ten (10) shares may be purchased at one time unless the number purchased is
at the time the total number available for purchase under the option.
The employee shall have the right to receive property at the time of
exercise of the option so long as the property is subject to inclusion in income
under Internal Revenue Code Section 83.
8. NONTRANSFERABILITY OF OPTION.
An option granted under this Plan shall, by its terms, be
nontransferable by the option holder other than by will or the laws of descent
an distribution, and shall be exercisable during the life of the option holder
only by such holder.
9. TERMINATION OF EMPLOYMENT.
If the option holder ceases to be a director of or employed by the
Company or any subsidiary or parent because of discharge for cause (the term
"cause" as used herein with respect to the discharge by the Company of any
option holder shall mean failure by such option holder to perform in a
satisfactory manner such holder's duties as an employee of the Company, as
determined by the Board in its discretion, or conduct on the part of such option
holder which the Board, in good faith shall determine would reflect so seriously
upon the public reputation of the option holder, if such conduct became publicly
known, as to prejudice substantially the Company's interest if such option
holder were retained as an employee of the Company of any subsidiary or parent),
such holder's option shall expire concurrently with such discharge for cause. If
the option holder ceases to be a director of or employed by the Company or any
subsidiary or parent for any reason other than death or discharge for cause,
such holder's option shall, subject to earlier termination pursuant to Section
6, expire upon the later of (a) one year thereafter or (b) one year from the
effective date of a registration statement covering such shares unless a shorter
period is provided in the option and during such period after such holder ceases
to be an employee such option shall be exercisable only as to those shares with
respect to which installments as had accrued as of the date of such cessation of
employment.
4
<PAGE>
10. DEATH OF EMPLOYEE.
If any option holder dies (a) while a director of or employed by the
Company or any subsidiary or parent or (b) during the period referred to in
Section 9 hereof, such holder's option shall, subject to earlier termination
pursuant to Section 6 above, expire one year after the date of such death.
During the period after such death such option may, to the extent that
installments, if any, had accrued as of the date of death, be exercised by the
person or persons to whom the option holder's right under the option shall pass
by will or by the applicable laws of descent and distribution.
11. ADJUSTMENTS UPON CHANGES IN CAPITALIZATION.
If the outstanding shares of the stock of the Company are increased,
decreased, or changed into or exchanged for a different number or kind of shares
or securities of the Company through reorganization, merger, recapitalization,
reclassification, stock split-up, stock dividend, stock consolidation, or
otherwise, an appropriate and proportionate adjustment shall be made in the
number and kind of shares as to which options may be granted. A corresponding
adjustment changing the number or kind of shares and the exercise price per
share allocated to unexercised options or portions thereof, which shall have
been granted prior to any such change, shall likewise be made. Any such
adjustment, however, in an outstanding option shall be made without change in
the total price applicable to the unexercised portion of the option but with a
corresponding adjustment in the price for each share covered by the option.
Upon the dissolution or liquidation of the Company, or upon a
reorganization, merger, or consolidation of the Company with one or more
corporations as a result of which the Company is not the surviving corporation,
or upon a sale of substantially all the property of the Company to another
corporation, this Plan shall terminate, and any option theretofore granted
hereunder shall terminate, unless provision be made in connection with such
transaction for the assumption of options theretofore granted, or the
substitution for such options of new options covering the stock of a successor
employer corporation, or a parent or subsidiary thereof, with appropriate
adjustments as to number and kind of shares and prices.
Adjustments under this section shall be made by the Board, whose
determination as to what adjustments shall be made, and the extent thereof,
shall be final, binding, and conclusive. No fractional shares of stock shall be
issued under the Plan on account of any such adjustment.
12. AMENDMENT AND TERMINATION.
The Board may at any time suspend, amend, or terminate this Plan and
may, with the consent of an option holder, make such modifications of the terms
and conditions of such holder's option as it shall deem advisable. No option may
be granted during any suspension of the Plan or after such termination. The
amendment, suspension, or termination of the Plan shall not, without the consent
of the option holder, alter or impair any rights or obligations under any option
theretofore granted under the Plan.
5
<PAGE>
13. TIME OF GRANTING OF OPTIONS.
The granting of an option pursuant to the Plan shall take place at the
time of the Board's action, as described in the second paragraph of Section 2
hereof: provided, however, that if the appropriate resolutions of the Board
indicate that an option is to be granted as of and at some future date, the date
of grant shall be such future date.
14. PRIVILEGES OF STOCK OWNERSHIP; NONDISTRIBUTIVE INTENT.
The holder of an option shall not be entitled to the privilege of stock
ownership as to any shares of stock not actually issued and delivered to him.
Upon the exercise of an option at a time when there is not in effect under the
Securities Act of 1933 a registration statement relating to the stock issuable
upon exercise thereof and available for delivery a prospects meeting the
requirements of Section 10(a)(3) of said Act, the option holder shall represent
and warrant in writing to the Company that the shares purchased are not being
acquired with a view to the distribution thereof. No shares shall be issued upon
the exercise of any option unless and until any then applicable requirements of
the Securities and Exchange Commission and other regulatory agencies having
jurisdiction and of any exchanges upon which stock of the Company may be listed
shall have been fully complied with.
15. EFFECTIVE DATE OF THE PLAN.
This Plan shall be effective upon approval thereof by the vote or
written consent to the holders of a majority of the Company's outstanding stock
entitled to vote thereon.
16. TERMINATION.
Unless previously terminated by the Board of Directors, this Plan shall
terminate at the close of business on December 31, 2002, and no options shall be
granted under it thereafter, but such termination shall not affect any option
theretofore granted.
6
<PAGE>
ACCOUNTANT'S CONSENT
The Board of Directors
Fortune Natural Resources Corporation:
We consent to incorporation by reference in registration statement No.
33-58790 on Form S-8 of Fortune Natural Resources Corporation of our report
dated February 20, 1998, relating to the balance sheets of Fortune Natural
Resources Corporation as of December 31, 1997 and 1996, and the related
statements of operations, stockholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1997, which report appears in
the December 31, 1997 annual report on Form 10-K of Fortune Natural Resources
Corporation.
/s/ KPMG Peat Marwick LLP
Houston, Texas
March 3, 1998
HUDDLESTON & CO., INC.
PETROLEUM AND GEOLOGICAL ENGINEERS
1111 FANNIN-SUITE 1700
HOUSTON, TEXAS 77002
-----
(281) 658-0248
CONSENT OF INDEPENDENT PETROLEUM ENGINEER
February 27, 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
Annual Report on Form 10-K of Fortune Natural Resources Corporation to be filed
with the Securities and Exchange Commission on or about March 2, 1998, to the
use of our name therein, and to the inclusions of or reference to our reports of
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.
-----------------------------
Peter D. Huddleston, P.E.
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<FISCAL-YEAR-END> DEC-31-1997
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