SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO _________
Commission File No. 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.)
One Commerce Green, 515 W. Greens Rd.,
Suite 720, Houston, Texas 77067
(Address of Principal Executive Offices) (Zip Code)
281-872-1170
-------------------------
Issuer's telephone number
N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act 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 ___
Applicable only to corporate issuers:
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
12,134,677 as of October 30, 1998
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
September 30, December 31,
1998 1997
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents....................... $ 2,385,000 $ 1,667,000
Accounts receivable............................. 266,000 507,000
Prepaid expenses................................ 86,000 --
------------ ------------
Total Current Assets......................... 2,737,000 2,174,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method.................... 26,159,000 27,822,000
Office and other................................ 384,000 383,000
------------ ------------
26,543,000 28,205,000
Less--accumulated depletion, depreciation
and amortization (20,383,000) (18,403,000)
------------ ------------
6,160,000 9,802,000
------------ ------------
OTHER ASSETS:
Materials, supplies and other .................. 86,000 124,000
Debt issuance costs (net of accumulated
amortization of $446,000 and $93,000 at
September 30, 1998 and December 31, 1997,
respectively)................................. 173,000 526,000
------------ ------------
259,000 650,000
------------ ------------
TOTAL ASSETS....................................... $ 9,156,000 $ 12,626,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
1998 1997
------------ ------------
CURRENT LIABILITIES:
Current portion of long-term debt............... $ 10,000 $ --
Accounts payable................................ 183,000 279,000
Accrued expenses................................ 378,000 407,000
Royalties and working interests payable......... 10,000 36,000
Accrued interest................................ -- 76,000
------------ ------------
Total Current Liabilities.................... 581,000 798,000
------------ ------------
LONG-TERM DEBT..................................... 3,225,000 3,775,000
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value:
Authorized--2,000,000 shares
Issued and outstanding--None.................. -- --
Common stock, $.01 par value :
Authorized--40,000,000 shares
Issued and outstanding 12,134,678 and
12,118,982 at September 30, 1998 and
December 31, 1997, respectively 121,000 121,000
Capital in excess of par value.................. 30,171,000 30,283,000
Accumulated deficit............................. (24,942,000) (22,313,000)
Treasury Stock, at cost (9,769 shares at
December 31, 1997) -- (38,000)
------------ ------------
NET STOCKHOLDERS' EQUITY........................... 5,350,000 8,053,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $ 9,156,000 $ 12,626,000
============ ============
</TABLE>
See accompanying notes to financial statements.
2
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
For the Nine Months Ended
---------------------------
September 30, September 30,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties ............... $ 1,511,000 $ 2,870,000
Other income ......................................... 118,000 137,000
------------ ------------
1,629,000 3,007,000
COSTS AND EXPENSES
Production and operating ............................. 477,000 940,000
Provision for depletion, depreciation and amortization 1,120,000
1,609,000
Impairment to oil and gas properties ................. 860,000 3,200,000
General and administrative ........................... 1,142,000 1,481,000
Debt conversion expense .............................. -- 316,000
Stock offering cost .................................. -- 323,000
Interest paid in cash ................................ 306,000 160,000
Interest - amortization of deferred financing cost ... 353,000 62,000
------------ ------------
4,258,000 8,091,000
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES .................. (2,629,000) (5,084,000)
PROVISION FOR INCOME TAXES .............................. -- --
------------ ------------
NET LOSS ................................................ $ (2,629,000) $ (5,084,000)
============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING ............................. 12,130,015 12,074,959
============ ============
NET LOSS PER COMMON SHARE (BASIC AND DILUTED) ........... $ (0.22) $ (0.42)
============ ============
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
For the Three Months Ended
---------------------------
September 30, September 30,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties ............... $ 388,000 $ 1,066,000
Other income ......................................... 42,000 29,000
------------ ------------
430,000 1,095,000
------------ ------------
COSTS AND EXPENSES
Production and operating ............................. 118,000 204,000
Provision for depletion, depreciation and amortization 290,000
640,000
Impairment to oil and gas properties ................. 600,000 --
General and administrative ........................... 328,000 467,000
Stock offering cost .................................. -- 54,000
Interest paid in cash ................................ 97,000 57,000
Interest - amortization of deferred financing cost ... 162,000 35,000
------------ ------------
1,595,000 1,457,000
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES .................. (1,165,000) (362,000)
PROVISION FOR INCOME TAXES .............................. -- --
------------ ------------
NET LOSS ................................................ $ (1,165,000) $ (362,000)
============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING ............................. 12,134,222 12,124,862
============ ============
NET LOSS PER COMMON SHARE (BASIC AND DILUTED) ........... $ (0.10) $ (0.03)
============ ============
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1997
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1998
Capital in Stock-
Common Stock Excess of Accumulated Treasury holders'
Shares Amount Par Value Deficit stock Equity
---------- -------- ------------ ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1996.......... 11,853,663 $119,000 $ 29,273,000 $(16,355,000) $ -- $13,037,000
Common stock issued for
exercise of stock options......... 6,400 -- 18,000 -- -- 18,000
Common stock issued for
exercise of warrants.............. 45,000 -- 89,000 -- -- 89,000
Common stock issued in exchange
for debentures, net of
offering costs.................... 218,858 2,000 889,000 -- -- 891,000
Common stock contributed to
Company 401(k) Plan............... 4,835 -- 14,000 -- -- 14,000
Common stock repurchased in
odd-lot buyback................... (9,769) -- -- -- (38,000) (38,000)
Common stock returned to treasury... (5) -- -- -- -- --
Net loss............................ -- -- -- (5,958,000) -- (5,958,000)
---------- -------- ----------- ------------ ---------- -----------
BALANCE, December 31, 1997.......... 12,118,982 $121,000 30,283,000 $(22,313,000) $ (38,000) $ 8,053,000
Common stock issued for
exercise of warrants and options.. 5,512 -- 13,000 -- -- 13,000
Common stock contributed to
Company 401(k) Plan............... 10,185 -- 24,000 -- -- 24,000
Cancellation of treasury stock..... -- -- (38,000) -- 38,000 --
Voluntary exchange of public
warrants for private warrants..... -- -- (59,000) -- -- (59,000)
Repurchase of outstanding
private warrants.................. -- -- (52,000) -- -- (52,000)
Common stock returned to treasury... (1) -- -- -- -- --
Net loss............................ -- -- -- (2,629,000) -- (2,629,000)
---------- -------- ------------ ------------ ---------- -----------
BALANCE, September 30, 1998
(Unaudited)....................... 12,134,678 $121,000 $ 30,171,000 $(24,942,000) $ -- $ 5,350,000
========== ======== ============ ============ ========== ===========
</TABLE>
See accompanying notes to financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
For the Nine Months Ended
---------------------------
September 30, September 30,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................... $ (2,629,000) $ (5,084,000)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depletion, depreciation and amortization ................ 1,120,000 1,609,000
Non-cash compensation expense ........................... 20,000 57,000
Amortization of deferred financing cost ................. 353,000 62,000
Impairment of oil and gas assets ........................ 860,000 3,200,000
Debt conversion expense ................................. -- 316,000
Stock offering cost ..................................... -- 323,000
Changes in assets and liabilities:
Accounts receivable ..................................... 241,000 (300,000)
Prepaids ................................................ (86,000) 18,000
Accounts payable and accrued expenses ................... (125,000) 713,000
Royalties and working interest payable .................. (26,000) (52,000)
Accrued interest ........................................ (76,000) (46,000)
Other assets ............................................ 24,000 --
------------ ------------
Net cash (used in) provided by operating activities ........ (324,000) 816,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties .................... (3,032,000) (3,414,000)
Restricted cash used ....................................... -- 138,000
Return of exploration venture restricted cash .............. -- 2,154,000
Proceeds from sale of properties and equipment ............. 4,695,000 203,000
Net changes in other property and equipment and other assets 17,000 (26,000)
------------ ------------
Net cash provided by (used in) investing activities ........ 1,680,000 (945,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ................... -- 65,000
Repayment of long term debt ................................ (540,000) (450,000)
Proceeds from issuance of common stock ..................... 13,000 103,000
Expenditures for debenture exchange and other offerings .... (59,000) (353,000)
Expenditures for debt refinancing .......................... -- (171,000)
Repurchase of private warrants ............................. (52,000) --
------------ ------------
Net cash used in financing activities ...................... (638,000) (806,000)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......... 718,000 (935,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................ 1,667,000 2,174,000
------------ -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................... $ 2,385,000 $ 1,239,000
============ ============
Supplemental information:
Interest paid in cash ...................................... $ 382,000 $ 160,000
Non-cash transactions
Common stock issued for conversion of debt ................. -- 975,000
Common stock issued for 401(k) Plan contribution ........... 24,000 14,000
</TABLE>
See accompanying notes to financial statements
6
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
September 30, 1998
(1) Line of Business and Summary of Significant Accounting Policies and
Procedures
The condensed financial statements at September 30, 1998, and for the three
months and nine months ended September 30, 1998 and 1997 included herein have
been prepared by Fortune Natural Resources Corporation ("Fortune" or the
"Company"), without audit, pursuant to the Rules and Regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
Rules and Regulations, although the Company believes that the disclosures are
adequate to make the information presented not misleading. These condensed
financial statements should be read in conjunction with the financial statements
and the notes thereto included in the Company's latest annual report on Form
10-K. Certain reclassifications have been made to prior period amounts to
conform to presentation in the current period. In the opinion of the Company,
the financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial position of the
Company as of September 30, 1998 and December 31, 1997, the results of its
operations for the three months and nine months ended September 30, 1998 and
1997, and cash flows for the nine months ended September 30, 1998 and 1997. The
results of the operations for such interim periods are not necessarily
indicative of the results for the full year.
(2) Long-Term Debt
At September 30, 1998, a summary of long-term debt is as follows:
September 30, December 31,
1998 1997
---------- ----------
Convertible Subordinated Notes
due December 31, 2007.................. $3,225,000 $3,225,000
Credit Lyonnais credit facility
due July 11, 1999...................... 10,000 550,000
---------- ----------
Total long-term debt..................... 3,235,000 3,775,000
Less current installments................ 10,000 -
---------- ----------
Long-term debt, excluding current
installments........................... $3,225,000 $3,775,000
========== ==========
The Convertible Subordinated Notes (the "Notes)" are currently convertible
into the Company's Common Stock at a conversion price of $3.00 per share,
subject to adjustment. The Notes are convertible by the holders after May 1,
1999, subject to a one-time option by the holders to convert at a lower
conversion price prior to that date in the event that the Company issues shares
of its Common Stock at a price below the conversion price. (See note 7 regarding
transactions that may trigger this option.) The Notes are redeemable by the
Company after May 1, 1999, at a premium that reduces monthly from 10% to zero
over an 18-month period. Any such premium on redemption is waived in the event
that the Company's Common Stock price averages at least $4.50 per share for 30
consecutive trading days. The holders of the Notes will be entitled to receive
additional shares upon conversion in the event that the Company's Common Stock
price averages less than the conversion price for a certain period prior to May
1, 1999. The Company determined at the time of issuance of the Notes that the
value of the potential adjustments to the conversion price was not material. The
Notes are subordinate to all of the Company's secured debt, including the credit
facility with Credit Lyonnais. The Notes bear interest at a rate of 12% per
year, payable quarterly. The costs incurred to issue the Notes are being
amortized as additional interest expense over the 18-month period ending May 1,
1999, the first date that the Notes are convertible. As a result of this
amortization of issuance costs, the effective interest rate of the Notes over
this 18-month period is 21.2%. If the Notes were held to maturity, the effective
interest rate over the life of the Notes would be 13.4%.
7
<PAGE>
The Company has in place a $20 million credit facility with Credit Lyonnais
New York Branch ("Credit Lyonnais"). The Credit Lyonnais facility is due July
11, 1999, extendable for one year upon mutual consent. On March 31, 1998, the
Company repaid all but $10,000 of the outstanding balance of the credit facility
with a portion of the proceeds from the sale of East Bayou Sorrel. (See note 6).
Prior to the Company's sale of its interest in the East Bayou Sorrel field, the
Company's borrowing base was $2 million. The bank has not completed its
redetermination of the borrowing base subsequent to this sale; consequently, the
Company does not know how much, if any, is currently available for borrowing
under this credit facility. Once the borrowing base is redetermined, the Company
may borrow up to such pre-determined borrowing base, for acquisitions and
development projects approved by Credit Lyonnais at either 1.25% above Credit
Lyonnais' base rate or 4% above LIBOR. The Credit Lyonnais facility is secured
by a mortgage on all of the Company's existing proved oil and gas properties.
The Company is also required to pay a commitment fee of 0.5% on the unused
portion of the borrowing base. Primarily as a result of lower oil and gas prices
and lower production after the sale of East Bayou Sorrel, the Company was unable
to meet the 3 to 1 coverage ratio of cash flow to fixed-charges which is
required by the credit facility for the twelve-month period ended September 30,
1998. The Company has received a waiver of this covenant from the bank for the
period ended September 30, 1998.
The Company's maturities of long-term debt over the next two years are as
follows:
Year Debt
---- --------
1998 $ --
1999 10,000
--------
$ 10,000
========
(3) Income Tax Expense
No provision for income taxes was required for the three months and nine
months ended September 30, 1998.
At September 30, 1998, the Company estimates it had cumulative net
operating loss carryforwards for federal income tax purposes of $14 million
which are significantly restricted under IRC Section 382. These carryforwards
are available to offset future federal taxable income, if any, with various
expirations through 2013. The Company is uncertain as to the recoverability of
the above deferred tax assets and has therefore applied a 100% valuation
allowance.
The Company has available IRC Section 29 Tax Credits that may be used to
reduce or eliminate any corporate taxable income in future years. It is
uncertain at this time to what extent the Company will be able to utilize these
federal tax credits, as their utilization is dependent upon the amount, if any,
of future federal income tax incurred, after application of the Company's net
operating loss carryforwards.
(4) Legal Proceedings
There are no material pending legal proceedings involving any of the
Company's properties or which involve a claim for damages which exceed 10% of
the Company's current assets.
8
<PAGE>
On April 16, 1996, Fortune was served with two lawsuits which had been
filed in the Federal District Court in New York by purchasers of its Common
Stock in an offering in December 1995 under Regulation S. Under the terms of the
subscription agreement pursuant to which the plaintiffs acquired their shares,
each was entitled to receive additional shares of Common Stock if the market
price fell below a stated level during a specified period following the 40-day
holding period prescribed by Regulation S. Fortune responded to the suits,
admitting that the stock price declined but alleged that suspicious trading
activity in its Common Stock occurred immediately prior to and during the time
period in which the additional-share allocation was computed. Fortune believes
that it has discovered evidence of active market manipulation in the Common
Stock by these plaintiffs. Accordingly, it has commenced a countersuit for
damages suffered by the Company and its shareholders as a result of these acts
and has also received leave of court to add third-party defendants whose actions
furthered this market manipulation. Discovery has been stayed pending a
determination of objections filed by one of these third-party defendants.
Fortune intends to resume both the defense of plaintiffs' claims and the
aggressive prosecution of its own counterclaims as soon as it is entitled to do
so.
(5) Computation of Loss Per Share
Net loss per common share is computed by dividing net loss by the weighted
average number of common shares outstanding. Diluted earnings per common share
are not presented because the issuance or conversion of additional securities
would have an anti-dilutive effect.
(6) Sale of East Bayou Sorrel
On March 31, 1998, the Company sold its interest in the East Bayou Sorrel
field, Iberville Parish, Louisiana to National Energy Group, Inc. for cash in
the amount of $4,695,000. The properties sold consisted of the Company's
interest in the Schwing #1 and #2 wells and all of the Company's leases,
facilities and interests in the East Bayou Sorrel area of mutual interest, as
such area is defined in the East Bayou Sorrel operating agreement. The sale was
effective April 1, 1998. The sale closed on March 31, 1998, whereupon the
Company received $4,535,000, which is net of ordinary closing adjustments.
The Company's interest in the two productive wells at East Bayou Sorrel
were pledged to secure the Company's Credit Facility with Credit Lyonnais. The
total balance outstanding under the Credit Facility prior to this sale was
$550,000. Concurrently with closing the sale of the East Bayou Sorrel field, the
Company paid down the outstanding balance of the Credit Facility by $540,000.
The Schwing #1 and #2 wells began producing from permanent production
facilities in January 1997 and June 1997, respectively. Although both wells were
shut-in from March 13, 1998 through the date of the sale to repair production
facilities, they accounted for a significant portion of the Company's oil and
gas revenues during 1997 and proved reserves as of December 31, 1997. A third
well in the field, the Schwing #3, which was spudded October 9, 1997, was
temporarily plugged and abandoned on March 5, 1998 pending further evaluation of
the well's potential. During 1997 and 1998, the Company incurred approximately
$1 million in connection with drilling and attempting to complete this well as a
result of difficult drilling conditions and mechanical problems. Selected
financial information attributable to the Company's interest in the East Bayou
Sorrel field as reported in its 1997 and year-to-date operating and financial
results is as follows:
9
<PAGE>
Year Ended Nine Months Ended
December 31, 1997 September 30, 1998 **
----------------- -----------------
Production
Oil (Bbls) 55,000 12,000
Gas (Mcf) 78,000 18,000
Oil and Gas Revenues $1,241,000 $231,000
Production and Operating Expense 205,000 60,000
Provision for Depletion, Depreciation
and Amortization* 430,000 54,000
As of
December 31, 1997
-----------------
Estimated Net Reserve Quantities
of Total Proved Reserves
Oil (Bbls) 152,000
Gas (Mcf) 204,000
- ----------
* Represents the estimated reduction in depreciation, depletion and
amortization expense reported by the Company in 1997 and 1998 that
would have resulted from excluding the East Bayou Sorrel production
and proved reserves.
** Amounts in this column represent 1998 production, revenues and related
expenses through March 31, 1998, the date of sale of the East Bayou
Sorrel interests.
This represents 32% and 30% of the Company's oil and gas revenues and
equivalent oil production and 23% of the Company's estimated quantities of
equivalent proved oil reserves as of December 31, 1997. Consequently, the
Company's revenues and cash flow from operations have decreased significantly
since the sale.
Under the full cost method of accounting for oil and gas operations,
dispositions of oil and gas properties are recorded as adjustments to
capitalized costs, with no gain or loss recognized unless such adjustment would
significantly alter the relationship between capitalized costs and proved
reserves. A significant alteration would not ordinarily be expected to occur for
sales involving less than 25 percent of the reserve quantities in a given cost
center. Because the sale of East Bayou Sorrel represents less than 25% of the
Company's reserve quantities, the entire proceeds of $4,695,000 was credited to
capitalized oil and gas properties as of March 31, 1998. Subsequent to charging
these proceeds against capitalized oil and gas property costs, the Company
recorded impairments to oil and gas properties. Consequently, if the Company had
reported a gain on the sale of this property, it would have been completely
offset by additional impairments to oil and gas properties.
(7) Subsequent Events
On November 2, 1998, the Company executed a letter of intent with 3DX
Technologies Inc., a NASDAQ-traded exploration and production company that uses
state-of-the-art geophysical interpretation and processing technology in its oil
and gas activities. On November 4, 1998, the Company executed a second letter of
intent with Petro-Guard Company, Inc. and Petro-Guard Production LLC, two
privately-held operating and production companies that operate producing
properties and exploratory projects along the Gulf Coast. The boards of
directors of each of the four entities have approved the letters of intent,
which provide for the merger of both 3DX and the Petro-Guard group into Fortune.
Each of the transactions is conditioned upon, among other things, the
preparation and approval of definitive merger agreements and the approval of the
shareholders of each of the companies.
Petro-Guard Company, Inc. and Petro-Guard Production LLC (collectively,
Petro-Guard) are both privately owned companies held principally by Dewey A.
Stringer, III, a director of Fortune. Petro-Guard also operates and participates
in Fortune's Espiritu Santo Bay project in Calhoun County, Texas.
10
<PAGE>
The terms of the 3DX acquisition provide for the issuance initially of up
to 6,965,431 shares of Fortune stock. 3DX shareholders could also receive up to
3,862,605 additional Fortune stock on or about two years after closing if
additional reserves attributable to the exploration properties acquired from 3DX
contribute disproportionately to the total of all reserves added by Fortune from
all exploration properties. No such additional shares will be issued, however,
if Fortune's closing common stock price averages at least $3.50 per share for a
thirty-day consecutive period any time prior to December 31, 2000. The letter of
intent with Petro-Guard provides for Fortune to issue three million shares of
its common stock to the Petro-Guard shareholders in exchange for the assets of
those companies. The Company expects to mail proxies by February 1, 1999 seeking
shareholder approval of these transactions. The Company expects to close the
transactions before the end of the first quarter of 1999. Fortune has also
obtained a conditional commitment from a private investor for an additional $5
million dollars in capital, on terms to be agreed upon, to facilitate the
additional exploration capital requirements of the combined companies. The terms
of this conditional commitment will be reported when they are finalized.
3DX reported total revenues for the six months ended June 30, 1998, of $2.1
million and a net loss for the same period of $6.4 million. The Petro-Guard
companies report their financial results on a tax basis; consequently,
accounting information prepared on a generally accepted accounting basis is not
currently available.
In the event that the Company issues common stock at a price below $3.00
per share prior to May 1, 1999, the holders of the Convertible Subordinated
Notes discussed in note 2 have a one-time option to convert the Notes at a
conversion price lower than $3.00 per share. At the holders option, the current
$3.00 per share conversion price is reduced by an amount obtained by multiplying
the difference between $3.00 and the price at which new shares are issued by the
ratio of total new shares issued over total shares outstanding after the new
issuance. If these proposed acquisition transactions are consummated prior to
May 1, 1999, this one-time conversion option may be triggered.
11
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Comparison of 1998 Operating Results to 1997.
Third Quarter 1998 vs. 1997
During the third quarter of 1998, Fortune's net loss increased to
$1,165,000 compared to a net loss of $362,000 for the same 1997 period. The
higher 1998 loss was primarily attributable to the $600,000 non-cash impairments
to oil and gas properties recorded in the third quarter of 1998.
The sale of East Bayou Sorrel as well as significantly lower oil prices and
lower oil and gas production resulted in net oil and gas revenues decreasing by
$678,000 (64%) in the third quarter of 1998, compared to the same 1997 period.
The Company's oil production decreased 73% to 7,500 barrels during the third
quarter of 1998 versus 1997. Gas production decreased 39% to 142,800 MCF during
the third quarter of 1998 versus 1997. Oil and gas production decreased
primarily as a result of the Company's sale of its entire interest in East Bayou
Sorrel effective April 1, 1998. See note 6 to the financial statements for a
discussion of this sale and the impact on the Company's operating results.
Additional production declines in 1998 resulted from shutting in South Timbalier
76 for approximately one-half of September 1998 because of tropical storms in
the Gulf of Mexico.
Gas prices on the Company's production averaged $2.09 per MCF for the third
quarter of 1998 as compared to $2.36 per MCF for the same 1997 period (an 11%
decrease). Oil prices averaged $11.75 per barrel for the third quarter of 1998
compared to $18.46 per barrel for the same 1997 period (a 36% decrease).
Production and operating expense decreased by $86,000 (42%) during the
third quarter of 1998 over 1997 primarily because of the sale of East Bayou
Sorrel.
General and administrative expense decreased $139,000 (30%) during the
third quarter of 1998 versus 1997 primarily because of lower litigation costs in
1998 in connection with the 1995 Regulation S offering (discussed in note 4 to
the financial statements) and lower personnel costs.
Interest expense paid in cash increased by $40,000 (70%) during the third
quarter of 1998 over 1997 due to the higher debt balance. The higher debt
balance results from the Company's issuance of subordinated convertible Notes in
December 1997. A portion of the proceeds of this issuance were used to repay all
of the Company's outstanding debentures due December 31, 1997 and to pay down a
portion of its bank debt. Bank debt was further reduced by $540,000 on March 31,
1998 with a portion of the proceeds of the sale of East Bayou Sorrel. Non-cash
amortization of debt financing costs increased by $127,000 during 1998 because
of the Company's Notes offering in December 1997 and credit facility refinancing
in July 1997.
Fortune incurred a $600,000 non-cash impairment to oil and gas properties
expense during the third quarter 1998 as a result of its full cost accounting
ceiling test. The Company's provision for depletion, depreciation and
amortization (DD&A) decreased by $350,000 (55%) in the third quarter of 1998 as
compared to 1997 primarily because of the impact of impairments to oil and gas
properties and the sale of East Bayou Sorrel.
Because the Company is currently not profitable and has not been so for
over five years, Fortune is below the continued listing requirements of the AMEX
and there can be no assurance that the Company will remain listed on the
exchange. Based upon discussions with AMEX officials, management believes that
the mergers with 3DX and the Petro-Guard companies discussed in Item 5 of Part
II herein will reflect favorably upon future decisions regarding continued
listing.
12
<PAGE>
Nine Months Ended September 30, 1998 vs. 1997
During the nine months ended September 30, 1998, Fortune had a net loss of
$2,629,000 compared to a net loss of $5,084,000 for the same 1997 period. The
higher 1997 loss was primarily attributable to the $316,000 non-cash debt
conversion expense incurred in connection with closing the Company's Exchange
Offer on February 26, 1997, the $269,000 of stock offering costs incurred in
1997 for the public offering which was withdrawn in April 1997, the $3,200,000
non-cash impairments to oil and gas properties recorded in 1997 and increased
depreciation, depletion and amortization expense in 1997.
Net oil and gas revenues in the first nine months of 1998 decreased by
$1,359,000 (47%) compared to the same 1997 period. The decrease primarily
resulted from significantly lower oil and gas prices and oil and gas production
in 1998. 1997 revenues included revenues from the Company's East Bayou Sorrel
field that was sold effective April 1, 1998. South Timbalier Block 76 was
shut-in for 26 days in 1997 for a workover, adversely affecting 1997 revenues
and partially offsetting the decrease from 1997 to 1998.
Oil production decreased 44% to 35,600 barrels during the first nine months
of 1998 versus 1997 as a result of the sale of East Bayou Sorrel. Gas production
decreased 28% to 462,700 MCF during the first nine months of 1998 versus 1997,
also primarily because of the sale of East Bayou Sorrel.
For the first nine months of 1998, the Company's natural gas prices
averaged $2.23 per MCF as compared to $2.56 per MCF for the same 1997 period (a
13% decrease). Oil prices averaged $13.38 per barrel for the first nine months
of 1998 compared to $19.20 per barrel for the same 1997 period (a 30% decrease).
Production and operating expense decreased by $463,000 (49%) for the first
nine months of 1998 over 1997. Production and operating expense in 1997 included
approximately $400,000 of costs attributable to a workover at South Timbalier
Block 76.
General and administrative expense decreased $339,000 (23%) for the first
nine months of 1998 versus 1997 primarily because of lower litigation costs in
1998 in connection with the 1995 Regulation S offering (discussed in note 4 to
the financial statements) and lower personnel costs.
Interest expense paid in cash increased by $146,000 (91%) for the first
nine months of 1998 versus 1997 due to the higher debt balance. Non-cash
amortization of debt financing costs increased by $292,000 during 1998 because
of the Company's Notes offering in December 1997 and credit facility refinancing
in July 1997. The Company's provision for depletion, depreciation and
amortization (DD&A) decreased by $489,000 (30%) in the first nine months of 1998
as compared to 1997 because of the impact of impairments to oil and gas
properties and the sale of East Bayou Sorrel.
Liquidity and Capital Resources
Cash Balance, Working Capital and Cash Flows from Operating Activities
Cash flow from operating activities declined in 1998; however, working
capital increased significantly at September 30, 1998. Fortune's operating
activities during the first nine months of 1998 generated negative cash flow in
the amount of $324,000 as compared to cash flow provided from operating
activities of $816,000 for the first nine months of 1997. This decrease results
primarily from the significant increase in payables in 1997 versus a decrease in
1998. Before considering the effect of changes in assets and liabilities,
operating cash flow was a negative $276,000 for 1998 as compared to a positive
$483,000 for 1997. Lower oil and gas revenues and higher cash interest expense
were the primary contributors to the 1998 decrease in cash flow. The Company's
significantly higher working capital balance of $2,156,000 at September 30,
compares to a December 31, 1997 balance of $1,376,000. The proceeds received
from the sale of East Bayou Sorrel were the primary contributor to this
significant increase in working capital. Management believes that, even in the
face of fluctuating commodity prices, this increase in cash and working capital
as a result of the sale of East Bayou Sorrel provides the Company with adequate
capital to fully fund its capital program during 1998.
13
<PAGE>
Fortune's internal liquidity and capital resources in the near term will
consist of working capital and cash flow from its oil and gas operations and its
unused borrowing capacity, if any, under its bank credit facility.
Cash Used in Investing Activities - Capital Expenditures
Cash expenditures for oil and gas properties for the first nine months of
1998 were $3,032,000 as compared to $3,414,000 for the same period in 1997. The
1998 expenditures have been incurred primarily in connection with the Company's
projects at LaRosa, Espiritu Santo Bay, East Bayou Sorrel, Whiskey Pass, Sea
Serpent and Southwest Segno.
The Company has been involved in two significant proprietary 3D seismic
projects along the Texas coast. The LaRosa project, a 24 square mile proprietary
3D seismic survey over one of the Company's existing producing fields in Refugio
County, Texas has been shot and drilling operations have commenced. The Company
sold one-half of its interest in the non-producing portion of this field in
exchange for the acquiring parties paying 100% of the Company's 3D seismic
costs. Seven wells have been drilled based upon the 3D seismic through September
30, 1998. Four wells have been completed as producers and three wells have been
plugged and abandoned. Additional drilling is expected in 1999. During 1998, the
Company has incurred $750,000 of seismic interpretation, leasing and drilling
and completion costs through the third quarter. The Company holds a 37.5%
working interest in the producing wells and an 18.75% working interest in the
prospective projects covered by this 3D seismic survey.
The second project is offshore Texas in the intracoastal waters of Espiritu
Santo Bay, Calhoun County. This involves a 135 square mile proprietary 3D
seismic survey in which the Company owns a 12.5% working interest. The area
covered by the survey also includes producing fields. This survey was completed
in 1997 and drilling has commenced. Three wells have been spud based upon the 3D
seismic through September 30, 1998. The first well has been plugged and
abandoned and the other two wells are being evaluated. A fourth well was spud in
October and is currently being evaluated. During 1998, the Company has incurred
$725,000 of seismic interpretation, leasing costs and drilling and completion
for this project through the third quarter.
During the second quarter of 1998, the Company entered into agreements to
participate in three wells on prospects in the transition zone offshore
Louisiana. Two of the wells are on the Whiskey Pass prospect and the third is on
the Sea Serpent prospect. The prospects were identified by another company on a
25 square mile transition zone 3D seismic survey which Fortune also owns. All
three wells have been drilled and plugged and abandoned. Through September 30,
1998, the Company has incurred approximately $731,000 of seismic, leasehold and
drilling costs for these projects. The Company also incurred $166,000 in 1998 in
connection with its dry hole at the Southwest Segno prospect in Liberty County,
Texas.
The Company continually reviews exploration, development and acquisition
opportunities and expects to participate in additional projects in 1998.
Cash Used in Financing Activities
On March 31, 1998, the Company repaid all but $10,000 of its bank credit
facility using $540,000 of the proceeds from the sale of East Bayou Sorrel. The
Company's other debt, all of which is subordinated convertible debt, is not due
until 2007. Primarily as a result of the lower revenues in the current quarter,
the Company was unable to meet the 3 to 1 coverage ratio of cash flow to
fixed-charges which is required by the credit facility for the twelve-month
period ended September 30, 1998. The Company has received a waiver of this
covenant from the bank for the period ended September 30, 1998.
14
<PAGE>
Oil and Gas Prices
Conditions outside of the Company's control influence the price it receives
for oil and gas. The Company's revenues, profitability and future rate of growth
are substantially dependent upon prevailing market prices for natural gas and
oil, which can be extremely volatile and in recent years have been depressed by
excess domestic and imported supplies. These fluctuating oil and gas prices have
contributed to impairments to oil and gas properties such as the $3.2 million
impairment recorded in 1997 and the $860,000 of impairment recorded during the
first nine months of 1998. As of November 10, 1998, the Company was receiving an
average of approximately $11.00 per barrel for its oil production and $2.15 per
MCF for its gas production.
"Year 2000" Compliance
The Company is aware of the issues associated with the inability of many
computer systems worldwide to recognize dates beyond December 31, 1999 and that
a failure to correct this problem could result in significant disruption to
those systems. The Company has reviewed its internal and accounting systems and
believes that they are "year 2000 compliant." The Company currently does not
operate any of its producing properties; accordingly it does not use any
operating systems internally that must be evaluated for compliance. The
Company's concerns regarding year 2000 compliance rests almost solely with its
third party business associates. The Company has been assessing the readiness of
the third parties that it believes are important to its business, such as:
operators of its properties, its oil and gas product purchasers, its accounting
system providers, consultants, communication systems providers, etc. The third
parties contacted thus far have represented either to be in compliance or have
communicated their plans and timetables for compliance. This process, however,
is ongoing. The Company has begun making contingency plans in the event that its
third parties are unable to achieve compliance. With respect to product
purchasers, systems providers, consultants, its bank, and its stock transfer
agent, for example, the Company does not have any contracts that extend beyond
January 1999 and it will change to goods and service providers who are year 2000
compliant, if necessary. With respect to operators of its properties, the
Company believes that a failure to comply by the operator or its critical
suppliers would generally not be material except at South Timbalier Block 76.
CNG Producing Company ("CNG") operates South Timbalier Block 76 and the Company
is reviewing CNG's compliance efforts. The Company does not believe that the
direct, out-of-pocket cost of its year 2000 compliance requirements will be
significant. There are, however, numerous parties with whom the Company has no
direct contact but who nonetheless could have a significant impact on the
Company's business activities if such parties do not achieve compliance. These
indirect third parties include oil and gas refiners, gas and oil transmission
companies, third party banking institutions, suppliers of supplier, etc.
Although the Company has no practical way of assessing the viability of these
companies, Fortune believes that its risk are no greater in this regard than
businesses and the public in general. The Company will continue to monitor the
status of year 2000 compliance issues to determine the impact, if any, on its
operations.
Proposed merger and acquisition transactions
See note 7 to the financial statements and Item 5 of Part II herein for a
discussion of the proposed acquisitions of 3DX Technologies Inc. and the
Petro-Guard companies. As is discussed in Item 5, there are conditions that
could prevent these mergers from closing. However, if they do close, the Company
expects that its proved reserves, revenues, operating costs and overhead costs
will increase significantly after closing.
Forward Looking Statements
This Report on Form 10-Q 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. Forward looking statements include statements
regarding: future oil and gas production and prices, future exploration and
development spending, future drilling and operating plans and expected results,
reserve and production potential of the Company's properties and prospects,
"Year 2000" compliance issues and the Company's strategy. Actual events or
results could differ materially from those discussed in the forward-looking
statements as a result of various factors including, without limitation, the
factors set forth below and elsewhere in this 10-Q, and in the Company's annual
report on Form 10-K.
15
<PAGE>
Exploration and Development Risks. The business of exploring for and, to a
lesser extent, of acquiring and developing oil and gas properties is an
inherently speculative activity that involves a high degree of business and
financial risk. Although available geological and geophysical information can
provide information with respect to a potential oil or gas property, it is
impossible to determine accurately the ultimate production potential, if any, of
a particular property or well.
Dependence on a Limited Number of Wells. Through the first nine months of
1998, over 58% of the Company's oil and gas revenues and cash flow was accounted
for by three wells, the South Timbalier Block 76 well and the two East Bayou
Sorrel wells. The Company sold all of its interest in the East Bayou Sorrel
wells effective April 1, 1998. For the three months ended September 30, 1998,
50% of the Company's oil and gas revenues was accounted for by the South
Timbalier 76 well. The South Timbalier Block 76 well was shut-in for repairs for
one month in 1997 and for over two months in 1996 as the result of mechanical
failures. The well was also shut in for approximately one-half of September 1998
because of tropical storms. A significant curtailment or loss of production from
the South Timbalier well 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 operating results in 1998.
Volatility of Oil and Gas Prices. The Company's revenues, profitability and
future rate of growth are substantially dependent upon prevailing market prices
for natural gas and oil, which can be extremely volatile and in recent years
have been depressed by excess domestic and imported supplies.
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.
Estimating quantities of proved reserves is inherently imprecise. Such estimates
are based upon certain assumptions about future production levels, future
natural gas and crude oil prices and future operating costs made using currently
available geologic engineering and economic data, some or all of which may prove
to be incorrect over time.
Operating and Weather Hazards. The cost and timing of drilling, completing
and operating wells is often uncertain. Drilling operations may be curtailed,
delayed or canceled as a result of a variety of factors, including regulatory
and environmental constraints, unexpected drilling conditions, equipment
failures, accidents, adverse weather conditions, encountering unexpected
formations or pressures in drilling and completion operations, encountering
corrosive or hazardous substances, mechanical failure of equipment, blowouts,
cratering and fires. These conditions 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.
Additional factors. Additional factors that could cause actual events to
vary from those discussed above and elsewhere in this report include, among
others: loss of key company personnel; adverse change in governmental
regulation; regulatory and/or environmental constraints; inability to obtain
critical supplies and equipment, personnel and consultants; and inability to
access capital to pursue the Company's plans.
16
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
PART II - OTHER INFORMATION
ITEM 5. Other Information
On November 2, 1998, the Company executed a letter of intent with 3DX
Technologies Inc., a NASDAQ-traded oil and gas exploration and production
company that uses state-of-the-art geophysical interpretation and processing
technology in its oil and gas activities. On November 4, 1998, the Company
executed a second letter of intent with Petro-Guard Company, Inc. and
Petro-Guard Production LLC, two privately-held operating and production
companies that operate producing properties and exploratory projects along the
Gulf Coast. The boards of directors of each of the four entities have approved
the letters of intent, which provide for the merger of both 3DX and the
Petro-Guard group into Fortune. Each of the transactions is conditioned upon,
among other things, the preparation and approval of definitive merger agreements
and the approval of the shareholders of each of the companies. The Company
expects to mail proxies by February 1, 1999 seeking shareholder approval of
these transactions. The Company expects closing to occur before the end of the
first quarter of 1999. This summary of the proposed transactions is qualified in
its entirety by the letters of intent between the Company and the sellers
attached as exhibits hereto.
Proposed transaction with 3DX -
Upon closing the acquisition of 3DX, Fortune will:
(i) issue to the 3DX shareholders up to 0.75 share of the $.01 par value
common stock of Fortune (the "Fortune Common") for each share of the
outstanding common stock of 3DX, not to exceed 6,965,431 shares of
Fortune common stock;
(ii) reserve up to an additional 923,778 shares of Fortune common stock
to be issued upon the exercise of outstanding 3DX options and
warrants; and
(iii) reserve, up to 3,862,605 additional shares of Fortune Common, to be
earned and distributed on or about two years after closing, if
certain disproportionate contributions to Fortune's proved reserves,
as established by its independent petroleum engineers, are made in
accordance with the following formula.
If Fortune books proved reserves attributable to the exploration
properties acquired from 3DX prior to January 1, 2001 that exceed proved
reserves Fortune books for other exploration projects, the difference (the
"3DX Exploration Reserves") will be used to calculate the number of
additional shares to be issued. Such shares shall be issued at the rate of
one (1) share for every nine (9) MCFE of 3DX Exploration Reserves. However,
no such shares will be issued if Fortune's closing common stock price
averages $3.50 for any consecutive thirty-day period between closing and
December 31, 2000.
3DX reported total revenues for the six months ended June 30, 1998, of $2.1
million and a net loss for the same period of $6.4 million.
Fortune has also obtained a conditional commitment from a private investor
for an additional $5 million dollars in capital, on terms to be agreed upon, to
facilitate the additional exploration and capital requirements of the combined
companies. The terms of this conditional commitment will be reported when they
are finalized.
Proposed transaction with the Petro-Guard companies-
Petro-Guard Company, Inc. and Petro-Guard Production LLC (collectively,
Petro-Guard) are both privately owned companies held principally by Dewey A.
Stringer, III, a director of Fortune. Petro-Guard also operates and participates
in Fortune's Espiritu Santo Bay project in Calhoun County, Texas.
17
<PAGE>
Upon closing the proposed transaction with Petro-Guard, Fortune will issue
to the owners of Petro-Guard three million shares of the $.01 par value common
stock of Fortune (the "Fortune Stock") in exchange for 100% of Petro-Guard and
100% of Mr. Stringer's interest in certain other oil and gas assets. The
Petro-Guard companies report their financial results on a tax basis;
consequently, accounting information prepared on a generally accepted accounting
basis is not currently available.
Any additional financial information, including any necessary pro forma
information, relating to these transactions which may be required under
generally accepted accounting principles and Securities and Exchange Commission
guidelines will be reported when such information becomes available.
ITEM 6. Exhibits and Reports on Form 8-K
(a) EXHIBITS
Exhibit No. Description
10.1* Letter of Intent dated November 2, 1998 between Registrant and 3DX
Technologies Inc.
10.2* Letter of Intent dated November 4, 1998 between Registrant
and Dewey A. Stringer, III, Petro-Guard Company, Inc. and
Petro-Guard Production LLC.
27.1* Financial Data Schedule.
(b) REPORTS ON FORM 8-K / 8K-A
None.
*Filed herewith.
18
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FORTUNE NATURAL RESOURCES CORPORATION
By: /s/ TYRONE J. FAIRBANKS
--------------------------------------
Tyrone J. Fairbanks
President and Chief Executive Officer
By: /s/ J. MICHAEL URBAN
--------------------------------------
J. Michael Urban
Vice President and Chief Financial
and Accounting Officer
Date: November 12, 1998
19
<PAGE>
[Letterhead of Fortune Natural Resources Corporation]
November 2, 1998
Ronald Nowak
President and Chief Executive Officer
3DX Technologies Inc.
12012 Wickchester, Suite 250
Houston, TX 77079
Dear Ron:
This letter of intent shall set forth the current understandings and
initial agreements which have been reached between our respective companies,
pursuant to which Fortune will acquire 3DX via a tax-free merger transaction.
We have agreed that, in consideration for the acquisition of 3DX, Fortune
will, at the closing of the transaction contemplated herein, (i) issue to the
shareholders of 3DX three-quarters (0.75) of a share of the $.01 par value
common stock of Fortune (the "Fortune Common") for each share of the outstanding
common stock of 3DX, not to exceed 6,865,431 shares of Fortune common stock plus
an additional 100,000 shares of Fortune common stock to be issued for
obligations undertaken by 3DX in the normal course of business prior to the date
of this agreement, (ii) reserve an additional 923,778 shares of Fortune common
stock to be issued upon the exercise of outstanding 3DX options and warrants and
(iii) provide for an incentive, up to a maximum aggregate additional 3,862,605
shares of Fortune Common, to be earned and distributed on or about two years
from closing, if certain disproportionate contributions to Fortune's proved
reserves are made in future years, as established by its independent petroleum
engineers, in accordance with the following formula.
In the event that proved reserves attributable to the exploration
properties acquired by Fortune from 3DX are booked by Fortune during or at the
end of the two-year period and such proved reserves exceed proved reserves
booked by Fortune and attributable to exploration properties other than those
exploration properties acquired from 3DX, the difference (the "3DX Exploration
Reserves") will be used to calculate the number of additional shares to be
issued. Such shares shall be issued at the rate of one (1) share for every nine
(9) MCFE of 3DX Exploration Reserves. No such shares, however, will be issued in
the event the closing price of Fortune Common averages $3.50 for any consecutive
thirty-day period prior to December 31, 2000.
In addition to the additional contingencies discussed below, such merger
shall be subject to approval by the boards of directors of both Fortune and 3DX,
the filing by Fortune and effectiveness of a registration statement under the
Securities Act of 1933, clearance for the transaction under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976 ("HSR"), and the approval
of this transaction by the shareholders of Fortune and 3DX.
<PAGE>
Mr. Ronald Nowak
November 2, 1998
Page 2 of 4
Concurrently with the execution of the definitive merger agreement
contemplated hereby, all officers and directors of 3DX and any entities which
such officers and directors control or represent shall execute (i) stock voting
agreements binding each to vote in favor of this proposal and (ii) a "lock-up"
agreement, whereby the ability of each to trade the Fortune common stock
received by each in consideration of this merger shall be restricted during the
six-month period following the closing of the transaction contemplated hereby.
All such stock shall bear appropriate legends regarding the terms of the
lock-up.
The parties hereto contemplate that, following approval of this letter of
intent, they will enter in good faith into a period of completing due diligence
reviews and will commence the preparation of the documents, agreements,
applications, proxies, and other documents necessary to implement their mutual
intent hereunder. The parties contemplate that this transaction will require the
approval of the shareholders of both Fortune and 3DX pursuant to proxy
statements calling special meetings of shareholders. Such proxy statements will
be included in the registration statement to be filed with the Securities and
Exchange Commission covering the shares of Fortune common stock to be issued in
connection with this transaction. Each party will bear and pay its own costs and
expenses incurred by it in connection with this transaction, including the
preparation of all documents and agreements associated therewith.
The parties further contemplate that each will move forward in good faith
toward finalizing their respective due diligence, preparing the definitive
merger agreement and other necessary closing documents, obtaining HSR clearance,
and obtaining the approval of their respective boards of directors and
shareholders. Upon approval of the transaction contemplated hereby by each board
of directors, the parties shall endeavor, not later than December 1, 1998, to
enter into the definitive merger agreement and, as quickly thereafter as
possible, file the proposed registration statement with the SEC. The
registration statement shall include the recommendation of each board of
directors to their respective shareholders for approval of the transaction
contemplated hereby. It is anticipated that the shareholders of each party will
be asked on or before February 1, 1999 to approve this transaction.
The definitive merger agreement covering the transaction contemplated
hereby will include standard form representations and warranties, substantially
alike for Fortune and 3DX in those instances where necessary or required,
appropriate for transactions of a similar nature, including, but not limited to,
disclosure of all material liabilities and existence of good title to all
assets. 3DX recognizes, however, that the nature of the merger transaction
contemplated hereby may dictate that not all provisions of the definitive merger
agreement be reciprocal. The definitive merger agreement shall also provide for
the integration into Fortune's benefit plans of all 3DX employees retained by
Fortune, counting the tenure of such employees with 3DX as tenure with Fortune.
<PAGE>
Mr. Ronald Nowak
November 2, 1998
Page 3 of 4
As an inducement to Fortune to proceed with the preparation of definitive
agreements to implement the arrangements contemplated by this letter of intent,
3DX will not, directly or indirectly, through any employee, officer, director,
agent or otherwise, (i) solicit or initiate, or encourage submission of,
inquiries, proposals or offers from any potential acquiror relating to any sale
of all or substantially all of the assets of 3DX or any merger, consolidation or
other similar transaction involving 3DX, or (ii) participate in any discussions
or negotiations regarding, or furnish to any person or entity any information
with respect to, any such transaction. In the event that 3DX, at any time after
the execution of this letter of intent and its approval by the board of 3DX,
breaches the provisions of the preceding sentence or is involuntarily acquired
by a third party, then Fortune shall be entitled to the payment, within five (5)
days, of the sum of $1,000,000 as liquidated damages. If, following the
execution of the definitive merger agreement, the merger contemplated hereby is
not consummated due to the failure or inability of either party to proceed
(except as provided in the preceding portion of this paragraph), the failure of
the representations or warranties made by either party, or the breach by either
party of any of the terms or provisions of the agreement between the parties,
the non-breaching party shall be entitled to the immediate payment by the
breaching party of the sum of $500,000 as liquidated damages.
Each party agrees that it remains bound by the terms of the
confidentiality agreements previously entered into by each. Each party will
issue a press release acceptable in form and substance to the other upon
approval of this letter of intent by their respective boards of directors.
Further, each party shall file a Form 8-K with the SEC disclosing the material
terms of this transaction.
The parties will each continue to operate their businesses and operations
from the date hereof through the closing of the transaction contemplated hereby
in a reasonable and prudent manner so as to not cause or allow a material loss
or decline in the value, use, or contemplated benefit of their respective assets
or any portion thereof. Further, neither party shall take any action to enter
into any agreement prior to the closing of the transaction contemplated hereby
for the issuance of a significant number of additional shares of stock or
securities convertible into stock or otherwise take steps to alter their capital
structure without the prior written consent of the other. 3DX shall not sell or
encumber, or enter into any agreement to sell or encumber, any of its
properties, leases, prospects, or other assets without the prior written
approval of Fortune. Fortune shall, prior to the sale, acquisition, or
encumbrance of any assets, advise 3DX of its intention and shall provide it with
the details of the transaction.
This letter of intent may be terminated either by the mutual consent of
3DX and Fortune or by either party if a definitive merger agreement has not been
entered into prior to December 31, 1998 (unless extended by mutual agreement)
and the failure to do so was not the result of the terminating party's failure
to negotiate in good faith. In the event the failure to reach such agreement is
the result of bad faith by one party hereto, the non-breaching party shall be
entitled to recover from the breaching party as liquidated damages,
<PAGE>
Mr. Ronald Nowak
November 2, 1998
Page 4 of 4
following termination of this letter of intent, the greater of $100,000 or the
actual costs incurred by the non-breaching party in attempting to negotiate the
terms of the definitive merger agreement.
The parties understand that the merger agreement to be prepared will be
the definitive agreement and hereby stipulate that this letter is not intended
to be and shall not be construed as a binding agreement between the parties.
Notwithstanding the foregoing, the parties acknowledge that each, by entering
into this letter of intent, will begin to expend considerable sums in commencing
due diligence, preparing and negotiating the definitive merger agreement, and
preparing and filing appropriate documents with the SEC. The terms of this
letter of intent shall not survive the execution of the definitive merger
agreement and, except for the specific provisions concerning confidentiality and
the payment of liquidated damages, neither party hereto shall be bound to any of
the terms or provisions herein set forth until the formal agreements reflecting
this transaction are prepared and are duly approved by each party's respective
board of directors and shareholders, as necessary.
Fortune has received a commitment from a third party investor for funds to
be used by Fortune for the acquisition of 3DX and to facilitate the exploration
and development of the acquired 3DX properties. However, Fortune and 3DX
acknowledge that Fortune, after the merger, shall exercise prudence in all
decisions concerning the acquisition of properties and their subsequent
exploration and development.
If this letter correctly sets forth our discussions to date and you accept
the offer which has presented by Fortune, please date, sign, and return one copy
of it to the undersigned immediately.
Very truly yours,
/s/ Tyrone J. Fairbanks
- -------------------------------------
Tyrone J. Fairbanks
President and Chief Executive Officer
ACCEPTED AND AGREED TO
this 2nd day of November, 1998
3DX TECHNOLOGIES INC.
By: /s/ Ronald Nowak
--------------------------------
Ronald Nowak
President and Chief Executive Officer
[LETTERHEAD OF FORTUNE NATURAL RESOURCES CORPORATION]
November 3, 1998
Mr. Dewey A. Stringer, III
Petro-Guard Company, Inc.
Petro-Guard Production LLC
5858 Westheimer, Suite 400
Houston, TX 77057
Dear Dewey:
This letter of intent is intended to set forth the understandings and
agreements which have been reached between Fortune Natural Resources Corporation
("Fortune") and Dewey A. Stringer, III, Petro-Guard Company, Inc., and
Petro-Guard Production LLC (the later two entities are hereinafter collectively
referred to as "Petro-Guard") pursuant to which Petro-Guard and Fortune
contemplate entering into a transaction, more fully discussed below, in which
Petro-Guard and all its assets, subject to existing and disclosed liabilities,
will be acquired through a merger with Fortune.
Through our mutual discussions, we have agreed that in consideration for
the acquisition of Petro-Guard and the assets owned individually by Mr. Stringer
listed on Exhibit "A" hereto, Fortune will, at the closing of the transaction
contemplated herein.
1. Fortune will issue to the shareholders of record of common stock of
Petro-Guard three million shares of the $.01 par value common stock of
Fortune (the "Fortune Stock") in exchange for 100% of the ownership
and voting rights of Petro-Guard and 100% of Mr. Stringer's interest
in such other assets.
2. The consideration payable by Fortune herein is conditional upon Mr.
Stringer withdrawing no more than $2,000,000 in cash from Petro-Guard
prior to closing this transaction.
3. The Fortune Stock will be issued by Fortune pursuant to a private
placement upon the approval of this transaction by the board of
directors of Fortune.
4. Upon closing, Fortune agrees to file a Registration Statement under
the Securities Act of 1933 to register all shares issued.
5. Prior to the closing of the transaction contemplated hereby, Mr.
Stringer and John Jackson shall enter into "lock-up" agreements,
whereby their ability to trade the Fortune Stock shall be restricted
upon mutually-acceptable terms and for not more than two years. All
such stock shall bear appropriate legend regarding the terms of the
lock-up agreement.
6. Additionally, Mr. Stringer will enter into a mutually acceptable
voting agreement with Fortune, in a customary form, providing for him
to vote a declining percentage of his shares in accordance with the
directions of the board of directors of Fortune each year for five
years.
<PAGE>
Mr. Dewey Stringer
November 3, 1998
Page 2 of 3
The parties hereto contemplate that, following their mutual approval of
this letter, they will, in good faith, enter into a period of completing any
final due diligence reviews and will commence the drafting and preparation of
the documents, agreements and applications necessary for carrying out their
mutual intent hereunder. Each party will bear and pay its costs and expenses
which may be incurred in connection with this transaction and the preparation of
the documents and agreements associated with it.
The definitive merger agreement covering the transaction contemplated
hereby will include standard forms of representations and warranties appropriate
for transactions of a similar nature, including, but not limited to, disclosure
of all material liabilities and good title to the assets of Petro-Guard.
The parties contemplate that this transaction will also require the
approval of the shareholders of Fortune pursuant to a proxy statement calling
for a meeting of shareholders for the issuance of the Fortune Stock. Once such
approval has been obtained, Fortune shall use its best efforts to promptly
obtain a listing of the Fortune Shares on the American Stock Exchange.
The parties contemplate that each will move forward in good faith toward
conducting their respective remaining due diligence, preparing the definitive
merger agreement and other necessary closing documents, and obtaining all
necessary approvals. Upon approval of the transaction contemplated hereby by
Fortune's board of directors, the parties will enter into a definitive merger
agreement and associated closing documents. Immediately thereafter the
transaction shall be closed and the Fortune Shares and other consideration shall
be distributed to the shareholders of the Petro-Guard common stock. As quickly
thereafter as possible, Fortune shall file the proposed registration statement
referred to herein with the Securities and Exchange Commission and the listing
agreement referred to herein with the American Stock Exchange.
Each party agrees to maintain the confidentiality of any and all
documentation, records, data, and all other information provided by one to the
other in the course of completing the transaction contemplated hereby. Neither
party shall disclose any portion of such information to any third party except
for those individuals who have a need to know such information or with the
express written consent of the other. Each party further agrees to disclose only
such portion of such information to such of its employees, officers, directors,
and consultants as are necessary to carry out such party's due diligence and to
carry forward the transaction contemplated hereby. Each party agrees that it
will neither use nor allow to be used any portion of information learned during
the course hereof for any purpose other than the good-faith consideration and
pursuit of this transaction.
Petro-Guard recognizes that Fortune is publicly held and agrees to refrain
from, and to instruct its owners, officers, directors, employees and consultants
to refrain from, engaging in any transaction in the publicly-traded securities
of Fortune. Each party further agrees that, considering Fortune is a publicly
held corporation, an event may occur which would require Fortune to disclose
information regarding the merger during the course of this transaction. The
parties agree that, notwithstanding anything else contained herein to the
contrary, Fortune may make such disclosure as is required under applicable law,
rule, or regulation. Should Fortune determine that it is required to make such a
disclosure, it agrees to use its best efforts to advise Petro-Guard thereof,
including the matters requiring disclosure, prior to making such disclosure.
<PAGE>
Mr. Dewey Stringer
November 3, 1998
Page 3 of 3
The parties understand that the merger agreement will be the definitive
agreement and hereby stipulate that this letter is not intended to be and shall
not be construed as a binding agreement between the parties regarding the
transaction contemplated hereby, except that this letter shall be binding with
regard to the provisions concerning confidentiality, above. Except for such
specific provisions, neither party hereto shall be bound to any of the terms or
provisions herein set forth until the formal agreements reflecting this
transaction are prepared and are duly approved by each party's respective board
of directors and shareholders, as necessary. The parties will each continue to
operate their business and operations from the date hereof through the closing
of the transaction contemplated hereby in a reasonable and prudent manner and
that there is no other material adverse loss or decline in the value, use, or
contemplated benefit of their respective assets or any portion thereof.
If this letter correctly sets forth our discussions to date, please date,
sign, and return one copy of it to the undersigned immediately.
Very truly yours,
/s/ Tyrone J. Fairbanks
- ---------------------------------
Tyrone J. Fairbanks
President and CEO
TJF:mjk
AGREED AND ACCEPTED
this 4th day of November, 1998
DEWEY A. STRINGER, III
By: /s/ Dewey A. Stringer, III
- ---------------------------------
PETRO-GUARD COMPANY, INC.
By: /s/ Dewey A. Stringer, III
- ---------------------------------
PETRO-GUARD PRODUCTION LLC
By: /s/ Dewey A. Stringer, III
- ---------------------------------
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