1998
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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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, 1998
[ ] 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
- ------------------------------ ------------------------------------
Common Stock, $.01 par value 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
February 26, 1999: $2,998,000
(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 February 26, 1999: 12,134,675
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 is an independent public oil and gas
exploration and production company. We primarily explore, develop and produce
oil and gas properties onshore and offshore Louisiana and Texas.
During 1995, we implemented a program to explore for significant oil and
gas reserves using state-of-the-art 3D seismic and computer aided exploration
technology. Fortune believes that the use of 3D seismic and CAEX technology
provides more accurate and comprehensive geological data for evaluating drilling
prospects than traditional 2D evaluation methods. Since implementing this
program in early 1995, Fortune has been acquiring interests in oil and gas
prospects in the Gulf Coast and is continually evaluating 3D and 2D exploration
projects.
Fortune also seeks to acquire producing properties at attractive prices.
In furtherance of that objective, Fortune 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. Fortune subsequently sold its
entire interest at East Bayou Sorrel.
STRATEGY
Fortune's strategy is to invest in a diversified portfolio of oil and gas
exploration and development properties within its area of interest. Fortune
mitigates the risks of exploration drilling by generally taking minority
interests in projects with large potential reserves as well as additional
development potential. Fortune has invested in seismic programs to identify new
exploration prospects, in exploration prospects ready to drill, and in producing
properties with 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. Fortune'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 coast 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 with a more accurate and complete prospect evaluation. These
advancements should materially increase the likelihood of finding commercial
quantities of oil and gas at lower reserve finding costs.
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Although Fortune does not currently operate properties or originate
exploration prospects, it actively participates in the evaluation of those
properties and prospects. 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 and reorganizing by larger oil companies in recent years,
Fortune has found that highly qualified prospect originators and technical
advisors are available as consultants and joint venturers. This enables Fortune
to acquire expert technical assistance in its target geographic areas while
avoiding the overhead associated with a larger number of employees.
Fortune employs the services of Interpretation3, a consulting company
headed by Daniel Shaughnessy, formerly an exploration supervisor with Mobil Oil
Company, to assist in evaluating prospects. Mr. Shaughnessy became a director of
Fortune in early 1997. See "Management." Fortune employs Huddleston & Co., Inc.,
Houston, Texas, independent petroleum engineers, to estimate reserves in
successful wells and in properties being evaluated for acquisition. Fortune does
not have contracts with these consultants that obligate the consultants to
continue their availability to Fortune. However, we believe that these
consultants will continue to provide services to Fortune for the foreseeable
future.
In furtherance of its business strategy, Fortune entered into non-binding
letters of intent with 3DX Technologies Inc., Petro-Guard Company, Inc. and
Petro-Guard Production LLC in November 1998, providing for the merger of each of
these entities into Fortune. Subsequently, merger discussions with each of these
entities were terminated prior to the execution of a definitive merger
agreement.
EXPLORATION ACTIVITIES
Fortune reviews prospects developed by companies that have particular
expertise in specific exploration areas and uses its own consultants and
management knowledge to analyze the exploration data. By taking a minority
non-operating position in such projects, Fortune gains opportunities to
participate in significant discoveries while minimizing its losses if the
exploration wells are unproductive. Recent significant exploration projects
undertaken by Fortune 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, Fortune 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, Fortune made a
strategic decision to shift its emphasis from the acquisition of producing
properties to exploration for oil and gas reserves, although Fortune 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, Fortune sold all of its California
properties and relocated its offices to Houston, Texas in early 1996.
Oil and gas prices are currently depressed and Fortune believes that there
may be opportunities again to acquire proved reserves at very attractive prices.
Accordingly, Fortune closely monitors opportunities to acquire both producing
properties and other oil and gas companies.
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SIGNIFICANT PROPERTIES AND ACTIVITIES
ESPIRITU SANTO BAY PROPRIETARY 3D SEISMIC EXPLORATION JOINT VENTURE,
OFFSHORE CALHOUN COUNTY, TEXAS
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. Fortune owns a 12.5% working interest
in the joint venture which has completed a 135 square mile proprietary 3D
seismic survey. Fortune and its working interest partners currently own 19,090
leasehold acres and hold options to acquire leases on an additional 11,322 acres
within the area of the seismic survey.
Seismic acquisition activities commenced in April 1997 and were completed
in September 1997. The seismic data has been processed and is continually being
interpreted. Each partner 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. Over a dozen prospects have been delineated to date,
however no assurance can be given that any commercial quantities of hydrocarbons
will be discovered. Drilling began in September 1998. Five wells have been
drilled to date. Two have been plugged, two are being completed and the fifth is
a potential discovery which may need to be redrilled as the result of
experiencing an underground blowout. The joint venture agreement ends July 15,
2002 but may be extended if necessary.
On April 18, 1997, the Espiritu Santo Bay 3-D Seismic Project joint
venture acquired the Steamboat Pass Field, Calhoun County, Texas from Neumin
Production Company. The Steamboat Pass Field is in Espiritu Santo Bay. As a
result, Fortune owns a 12.5% working interest in the 5,766 acres held by
production in the field and the facilities on the site. The acquisition was made
in exchange for the assumption of Neumin's future obligation to plug and abandon
the field. We do not expect the cost of such abandonment to be material to
Fortune.
LA ROSA PROPRIETARY 3D SEISMIC EXPLORATION PROGRAM, REFUGIO COUNTY, TEXAS
In 1994, Fortune acquired an undivided 50% interest in the LaRosa Field, a
producing oil and gas field. In January 1997, Fortune's working interest was
reduced to a 37.5% working interest as the result of an after-payout back-in. On
February 13, 1997, Fortune and its 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. Fortune farmed out 50%
of its rights in this proprietary seismic program in exchange for the payment of
all of Fortune's costs of such 3D survey. Accordingly, Fortune currently owns an
undivided 18.75% working interest in all newly-generated prospects. Fortune
maintains its 37.5% working interest in all production from wellbores existing
prior to the commencement of the 3D seismic survey.
Fortune and its working interest partners currently own 5,616 acres in the
field and hold seismic options to acquire up to an additional 4,000 acres. The
first well drilled based upon the 3D data was spudded December 2, 1997. Since
then six additional wells have been drilled. Four of these wells have been
completed and three have been plugged and abandoned. Further drilling has been
suspended pending a review of the results obtained from the first phase of this
drilling program.
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DIVESTITURE OF EAST BAYOU SORREL, IBERVILLE PARISH, LOUISIANA
On March 31, 1998, Fortune sold its interest in the East Bayou Sorrel
field to National Energy Group, Inc. for cash in the amount of $4,695,000. The
properties sold consisted of Fortune's interest in the Schwing #1 and #2 wells
and all of Fortune's leases, facilities and interests in the East Bayou Sorrel
area of mutual interest, as defined in the East Bayou Sorrel operating
agreement.
Fortune's interest in the two productive wells at East Bayou Sorrel was
pledged to secure a 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 field, Fortune paid down substantially
all of the outstanding balance of the credit facility.
The Schwing #1 and #2 wells began producing 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 Fortune's oil and gas revenues during 1997 and proved
reserves as of December 31, 1997. A third well in the field, the Schwing #3, was
spudded October 9, 1997, but was temporarily plugged and abandoned on March 5,
1998 pending further evaluation of the well's potential. During 1997 and 1998,
Fortune incurred approximately $1 million to drill and to attempt completion of
this well as a result of difficult drilling conditions and mechanical problems.
SOUTH TIMBALIER BLOCK 76 - FEDERAL WATERS, OFFSHORE LOUISIANA
South Timbalier Block 76 is Fortune's most prolific producer, currently
accounting for over 40% of Fortune's revenues and proved reserves. On December
11, 1995, Fortune acquired a 16.67% working interest in this 5,000 acre
producing oil and gas property. This property includes a producing well which
was completed in 1990, a drilling and production platform and a transmission
line. The effective date of the acquisition was June 1, 1995; accordingly,
Fortune received the net cash flow from the well from that date. The effective
date for financial reporting purposes was November 1, 1995. Fortune initially
paid $2.2 million for its interest in the property plus 150,000 common stock
purchase warrants at prices from $4.625 to $6.00 per share. All the warrants
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 $940,000. The option was timely exercised,
which reduced Fortune's interest in the block to a 12.5% working interest
effective January 1, 1996.
On April 29, 1996, the South Timbalier 76 well was shut in due to a
mechanical failure of downhole equipment. A remedial workover, started June 16,
1996, cost Fortune approximately $300,000. The well was brought back on
production July 6, 1996. The well was also shut-in from March 24 to April 19,
1997 for a workover to repair a leak that caused the well to lose casing
pressure. Fortune's share of the costs of this second workover was approximately
$360,000. Notwithstanding these shut-ins, the well has already returned over two
times Fortune's initial investment, and Fortune is evaluating the possibilities
for additional development.
To finance the acquisition of the South Timbalier well and to provide
Fortune with additional working capital, Fortune sold 1,321,117 shares of its
common stock to a group of overseas investors in a transaction which qualified
for an exemption from the registration requirements of the Securities Act under
Regulation S. From this sale in December 1995, Fortune 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, Fortune does not
expect that it will be required to issue any reset shares. See "- Legal
Proceedings."
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SHIP SHOAL BLOCKS 43 AND 67 - STATE WATERS, OFFSHORE LOUISIANA
On April 24, 1998 and July 1, 1998, Fortune agreed to participate with
Rozel Energy, LLC in Rozel's Whiskey Pass Block 43 and Sea Serpent Block 67,
respectively. The agreement on Block 43 required Fortune to pay $138,000 for an
assignment of a 12.5% working interest in approximately 2,284 acres offshore
Terrebonne Parish. The agreement further provided for the drilling of two wells
to test this acreage. Both wells were drilled at a combined cost to Fortune of
$410,000 and were subsequently plugged and abandoned as dry holes.
The agreement on Block 67 required Fortune to pay $64,000 to acquire a
12.5% working interest in approximately 390 leasehold acres. A single well was
drilled on this prospect in August at a cost to Fortune of approximately
$260,000. Although hydrocarbons were encountered, they were not economic and the
well was plugged and abandoned.
BACON AND WEST BACON PROSPECTS - CHICKASAW COUNTY, MISSISSIPPI
Fortune also participated in two exploration wells in December 1998 in
Mississippi's Black Warrior Basin. The Bacon Prospect Anderson #24-7 was logged
and completed on December 28, 1998 with three pay zones totaling approximately
95' of gross pay and 29' of net pay. The bottom two pay sands (the Lewis and
Evans) are to be dually completed during the first quarter of 1999, weather
permitting. The upper zone of interest (the Abernathy "B" sand) will not be
tested until the lower zones have depleted. Fortune owns a 10% working interest
in the discovery. Its cost for the shallow well was approximately $25,000. This
discovery sets up a development location under our lease block for future
drilling.
Earlier in December 1998, the West Bacon Prospect was drilled as a dry
hole. Fortune owned a 25% working interest in that well; its share of dry hole
and abandonment costs was approximately $36,000.
JOINT VENTURE WITH ZYDECO
Fortune owns varying working or royalty interests in sixteen projects
located in the transition zone and Timbalier Trench regions offshore Louisiana.
These joint venture projects were acquired by a joint venture formed with Zydeco
to identify, evaluate and explore oil and gas prospects in this area. The
projects were identified using a combination of advanced 2D and 3D seismic and
computer aided exploration 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
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. Fortune'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 five of the joint venture projects, retaining overriding royalties
and/or the right to participate as a working interest owner. Fortune also has a
100% working interest on one of the projects.
One of the prospects, located on South Timbalier Block 86, was recently
farmed out to Sonat Exploration Company. Sonat successfully completed a well in
late 1998. Fortune owns a 3.166% override before payout, which converts to a 4%
override after payout, in this project. Fortune expects production to commence
by mid-1999.
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Two other wells have been drilled on joint venture projects. Hydrocarbons
were encountered in both wells, but were of insufficient quantities to justify
completion attempts. A third party drilled one of these wells on the Polaris
Prospect under a farmout for which Fortune received $66,000 in fees. Fortune
incurred approximately $832,000 in 1996 in costs on the initial well on the
Aurora Prospect.
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,
Fortune may not have sufficient resources to participate in any exploration
wells proposed or be able to farmout its interest on favorable terms. The leases
have remaining lease terms varying from 1 to 3 years, during which the venture
must either commence drilling operations or lose the leases. Fortune does not
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. In keeping with its strategy of balancing risk, Fortune intends to farm
out its remaining interest to other oil companies. Under a farmout arrangement,
Fortune 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. Fortune may not be able to
farm out any of the projects or to enter into farmouts on the terms described
above. Each of the parties in the joint venture has a right to farm out any
portion of its interest in any prospect to the other under a "put" arrangement.
Fortune acquired its interest in the joint venture through its acquisition
in May 1995 of Lagniappe Exploration, Inc. 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
Lagniappe.
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
Lagniappe as well as the funds that Fortune 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 Fortune's $3.7 million
impairments to oil and gas properties in 1997.
SOUTHWEST SEGNO, LIBERTY COUNTY, TEXAS
On September 24, 1997, Fortune entered into an agreement to drill a well
on the Southwest Segno Prospect in Liberty County, Texas. Fortune paid $36,000
to acquire an undivided 30% before-payout working interest in this prospect. A
well was drilled in early 1998 at a cost of approximately $166,000 to Fortune.
Testing disclosed that the well was not economic to complete and it was plugged
and abandoned.
SAN JUAN BASIN, RIO ARRIBA COUNTY, NEW MEXICO
On June 24, 1994, Fortune acquired a 25% interest in EnRe-1, LLC, a newly
formed Texas limited liability company, which owned three Jicarilla Apache
Minerals Development Agreements in Rio Arriba County, New Mexico. The
development agreement covered 60,000 producing, development and exploratory
acres and associated tangible property. The acquisition also included an
approximate 22% working interest in 10,000 exploratory acres. 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 development agreements comprising
approximately 20,000 acres terminated, and the acreage reverted to the lessors.
In 1997, approximately 14,000 additional acres also reverted to the lessors
pursuant to the terms of the development agreements. On August 26, 1998 Fortune
sold its entire interest in these properties and in EnRe-1, LLC to the operator
in exchange for the operator assuming all existing liabilities of the operation.
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Of the seven wells drilled on these properties during 1994 and 1995, two
were completed as producing wells. Fortune did not drill any additional wells.
Production revenues from the properties had not exceeded the total cost to
acquire and drill wells on the properties. Fortune's reserve engineers did not
assign 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 did not believe that future
production would be economic. At June 30, 1997, Fortune transferred all of its
remaining $1.3 million of unevaluated costs attributable to these properties to
the evaluated property account.
BELLE PEPPER AND BELLE JEFFERS FIELDS, WEBB COUNTY, TEXAS
On October 5, 1993, Fortune acquired certain producing and non-producing
properties from Michael Petroleum Corporation, Brazos Resources, Inc., Pioneer
Drilling Company and Endowment Energy Partners. The properties included working
interests in the Belle Pepper and Belle Jeffers Fields. Fortune 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 the nine wells drilled before
January 1, 1993 is exempt from Texas state severance tax. Fortune 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. Fortune had a 25% working interest in
this well; dry hole costs to Fortune were $115,000. Fortune 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 this property has not yet returned Fortune's
investment in this area.
AWP FIELD, MCMULLEN COUNTY, TEXAS
In 1992, Fortune acquired a 10% working interest in the AWP Field 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. Fortune has
since sold the California properties and paid off the $2,000,000 note. The Texas
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.
Fortune's estimated share of the drilling and completion costs for each of these
wells is $48,000. In February 1996, developmental drilling resumed with the
Bracken Ranch #47 well 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 Fortune's investment.
DIVESTITURE OF CALIFORNIA PROPERTIES
At December 31, 1995, Fortune owned and operated 39 gross and 29.92 net
wells in California. 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
Fortune's 1995 oil production and about 7% of its gas production.
Despite the high percentage of Fortune's oil production represented by
these properties, the costs of operating the wells in California was, in our
view, disproportionately high in relation to the revenues generated. The high
cost of production in California 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 closed the sale of its interest in all but
one of its California properties for cash in the amount of $840,000. The
properties sold consisted of Fortune's interest in the Hopper Canyon, Holser
Canyon, Oxnard and Sheils Canyon Fields in Ventura County and the Bacon Hills
Field in Kern County. The sale was effective December 31, 1995. Fortune paid
sales commissions and expenses of approximately
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$75,000. In April 1996, Fortune closed the sale of its remaining California
property, the Sespe Field, Ventura County, California, to Seneca Resources for
approximately $300,000 net of closing adjustments. Fortune recorded a loss on
sale of $3.6 million in 1995 as a result of these divestitures.
All of Fortune's California properties were pledged to secure Fortune's
bank debt. Upon closing the sale of the non-Sespe properties, Fortune reduced
its bank debt by $1.1 million, representing the entire indebtedness secured by
Fortune's California properties. The closing of the sales of these properties
and the relocation of Fortune's headquarters to Houston completed Fortune's
strategic move to focus its efforts on exploration in the Gulf Coast.
Prior to 1994, Fortune made various other acquisitions, primarily of
producing properties located in California, which have since been sold.
DRILLING ACTIVITIES
The following table sets forth information regarding wells drilled by
Fortune in the years ended December 31, 1998, 1997 and 1996:
<TABLE>
<CAPTION>
WELL DRILLING ACTIVITY
Year Ended December 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
Gross Net Gross Net Gross Net
----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Exploratory Wells
Productive 8 1.14 - - 1 .11
Dry 11 1.83 1 .13 3 1.21
----- ----- ----- ----- ----- -----
19 2.97 1 .13 4 1.32
===== ===== ===== ===== ===== =====
Development Wells
Productive - - 1 .13 2 .20
Dry - - - - - -
----- ----- ----- ----- ----- -----
- - 1 .13 2 .20
===== ===== ===== ===== ===== =====
</TABLE>
OIL AND GAS RESERVES
Fortune's reserves are located onshore and offshore Texas and 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, 1998, 1997 and 1996 were
determined by Huddleston & Co., Inc., Houston, Texas, independent petroleum
engineers. Such estimates are subject to numerous uncertainties inherent in the
estimation of proved reserves and in the projection of future production, costs
and prices. The accuracy of any reserve estimate is a function of available data
and of engineering and geological interpretation and judgment. Estimates of the
economically recoverable oil and gas reserves and classifications of such
reserves based on risk of recovery by different engineers or by the same
engineers at different times, may vary substantially. The "Standardized Measure
of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves,"
determined from such reserve data, are estimates only. They should
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not be construed to be the current market values of Fortune's oil and gas
reserves or the costs that would be incurred to obtain equivalent reserves.
While these reserve estimates are believed to be reasonable, they should be
viewed with the understanding that future production, development drilling and
changes in pricing will affect the reserve estimate.
The following sets forth estimated proved oil and gas reserves as
determined by Fortune's independent petroleum engineers attributable to
Fortune's interests in oil and gas properties as of December 31, 1998, 1997 and
1996. At December 31, 1997, these figures included 152,000 barrels of oil and
204,000 mcf of gas attributable to Fortune's interest at East Bayou Sorrel.
Fortune sold its entire interest in East Bayou Sorrel effective March 31, 1998.
See note 3 to the December 31, 1998 financial statements.
These estimates are based in part on the price at which the product
was sold as of the end of each year. If the cost of producing the oil and gas
exceeds the sales price, the quantity of "recoverable reserves" is reduced. The
decrease in proved reserves in 1998 versus 1997 was primarily attributable to
the sale of Fortune's interest in East Bayou Sorrel in March 1998, and natural
depletion, partially offset by the exploration discoveries at Espiritu Santo Bay
and LaRosa. The slight decrease in equivalent proved reserves in 1997 versus
1996 was primarily attributable to natural depletion, which was almost offset by
reserve extensions and discoveries.
<TABLE>
<CAPTION>
ESTIMATED NET RESERVE QUANTITIES
December 31,
--------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Total Proved Reserves:
Oil (Bbls)..................... 106,000 257,000 249,000
Gas (Mcf)...................... 3,082,000 3,217,000 3,481,000
Equivalent Mcf
MCFE (oil at 6 MCFE to 1 Bbl)... 3,718,000 4,759,000 4,975,000
Total Proved Developed Reserves:
Oil (Bbls)..................... 47,000 198,000 160,000
Gas (Mcf)...................... 1,413,000 1,548,000 1,749,000
Equivalent Mcf
(MCFE (oil at 6 MCFE to 1 Bbl)... 1,695,000 2,736,000 2,709,000
</TABLE>
DISCOUNTED PRESENT VALUE OF FUTURE NET REVENUES
The following table represents the estimated undiscounted and discounted
future net revenues using unescalated prices from the proved reserves at
December 31, 1998, 1997 and 1996.
<TABLE>
<CAPTION>
FUTURE NET REVENUES
December 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C>
Estimated Future Net Revenue
Undiscounted...................... $ 4,985,000 $ 8,410,000 $ 14,112,000
------------ ------------ ------------
Standardized Measure of Discounted
Future Net Cash Flows............. $ 3,527,000 $ 6,503,000 $ 10,820,000
------------ ------------ ------------
</TABLE>
11
<PAGE>
A significant factor in the decline in reserve values since 1996 is the
decline in prices used in each year end evaluation. The year end prices used
are:
<TABLE>
<CAPTION>
Year end
---------------------------
1998 1997 1996
------- -------- --------
<S> <C> <C> <C>
Oil - $/Bbl....................... $ 9.85 $ 16.90 $ 22.79
Gas - $/Mcf....................... $ 2.25 $ 2.60 $ 4.04
</TABLE>
Other factors in the decline from 1997 to 1998 include -
o The sale of 140,000 Bbls and 186 Mmcf at East Bayou Sorrel in March 1998
o Natural depletion
o Offset partially by exploration discoveries at Espiritu Santo Bay and
LaRosa
PRODUCTION
Fortune's net production for the years ended December 31, 1998, 1997 and
1996 is set forth below:
<TABLE>
<CAPTION>
NET PRODUCTION DATA
December 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Oil (Bbls)........................ 42,000 87,000 57,000
Gas (Mcf)......................... 609,000 821,000 1,038,000
</TABLE>
PRICES AND PRODUCTION COSTS
The following table sets forth Fortune's approximate average sales prices
and production (lifting) costs for the years ended December 31, 1998, 1997 and
1996:
<TABLE>
<CAPTION>
AVERAGE SALES PRICES AND PRODUCTION COSTS
December 31,
----------------------------
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Average Sales Price Received:
Oil (per Bbl)............................ $ 13.08 $ 19.04 $ 20.24
Gas (per Mcf)............................ 2.19 2.66 2.56
Average Production and Operating Cost
per MCFE (including production taxes).. 0.69 0.81 0.85
</TABLE>
12
<PAGE>
PRODUCING WELLS
The following table lists Fortune's total gross and net producing oil and
gas wells at December 31, 1998:
<TABLE>
<CAPTION>
PRODUCING WELLS
Gross Net
------------- -------------
Oil Gas Oil Gas
----- ----- ----- -----
<S> <C> <C> <C> <C>
Texas.............................. 47 44 6.73 11.41
Federal waters - Gulf of Mexico.... - 1 - .13
----- ----- ----- -----
Total........................... 47 45 6.73 11.54
===== ===== ===== =====
</TABLE>
PRINCIPAL CUSTOMERS
Fortune routinely sells more than 10% of its oil and gas production to
single customers. Often, all of the oil or gas production from a field for the
entire year is sold to a single customer. However, there are a large number of
customers that purchase both oil and gas in Fortune's area of operations.
Accordingly, we do not believe that the loss of any of our customers would have
a material adverse effect on our operations.
PROPERTIES
LEASEHOLD ACREAGE
Fortune's approximate holdings of developed and undeveloped leasehold
acreage as of December 31, 1998 were as follows:
<TABLE>
<CAPTION>
LEASEHOLD ACREAGE
Developed Undeveloped
-------------- --------------
Gross Net Gross Net
------ ------ ------ ------
<S> <C> <C> <C> <C>
Louisiana............................. - - 4,081 992
Federal waters - Gulf of Mexico....... 500 63 20,945 7,824
Texas................................. 12,550 1,837 20,835 3,536
Mississippi........................... - - 1,600 304
Oklahoma.............................. - - 80 5
------ ------ ------ ------
Total............................... 13,050 1,900 47,541 12,661
====== ====== ====== ======
</TABLE>
TITLE TO PROPERTIES
Updated title opinions were issued for many of Fortune's properties in
1997 in conjunction with refinancing Fortune's bank credit facility. Fortune
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, Fortune performs only a perfunctory title
examination at the time exploratory oil and gas properties are acquired. Prior
to drilling wells, 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 Fortune's producing leasehold
interests have been pledged to secure Fortune's bank credit facility. Transfers
of many of Fortune's properties are subject to various restrictions.
13
<PAGE>
OFFICE FACILITIES
In February 1996, Fortune relocated its headquarters to Houston, Texas.
Prior to that, Fortune leased office space in Agoura Hills, California. On
February 13, 1996, Fortune entered into an agreement with Animation Magazine to
sublease the Agoura Hills office space, under terms and conditions identical to
those contained in Fortune's lease with its landlord, for the balance of the
term of Fortune's lease. The lease in Agoura Hills, California expired in
January 1999. 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 to the December 31, 1998 financial statements.
COMPETITION
The principal resources necessary to conduct oil and gas exploration and
production activities are:
o leasehold prospects under which oil and gas reserves may be discovered
o drilling and other service contractors to evaluate and explore for such
reserves
o knowledgeable personnel to conduct all phases of oil and gas operations.
Fortune must compete for such resources with both major companies and
independent oil and gas operators. Although demand for these resources is
currently not as great as in the recent past, many of Fortune's competitors are
better equipped to acquire them. Accordingly Fortune may not be able to acquire
any portion of these resources in a timely and economical manner.
EMPLOYEES
As of March 5, 1999 Fortune employed six persons, all in management and
administration. In addition, Fortune engages outside consultants in certain
technical aspects of Fortune's business. Fortune utilizes these consultants to
aid in the evaluation of projects and to evaluate oil and gas assets for
acquisitions.
GOVERNMENTAL REGULATION
Environmental laws and regulations are having an increasing impact on
Fortune's operations. Drilling and production activities are subject to
regulations under federal and state pollution control and environmental laws and
regulations. It is impossible to predict the effect that additional
environmental requirements may have on future earnings and operations, but it
will continue to be necessary to incur costs in complying with these laws and
regulations.
Fortune 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. Fortune believes that it is reasonably likely that the trend in
environmental legislation and regulations will continue toward stricter
standards. Fortune is unaware of future environmental standards that are
reasonably likely to be adopted that will have a material effect on Fortune's
financial position or results of operations, but cannot rule out the
possibility.
Fortune has never had a material environmental problem, but if one of its
properties is found to be contaminated, Fortune could be required to participate
in a "clean up" program. Such a clean up, depending on its magnitude and
Fortune's ownership interest therein, could require undetermined amounts of
capital and exceed Fortune's ability to pay. Fortune has obtained insurance
against certain environmental hazards providing $11,000,000 of coverage with a
$5,000 deductible.
14
<PAGE>
Fortune's operating activities must comply with spacing and other
conservation rules of various state commissions, the United States Geological
Survey or the Bureau of Land Management. 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 Fortune to produce
certain wells at less than their maximum flow rate.
State law also governs unitization proceedings, which apportion production
among property owners and producers where numerous wells may be producing from a
single reservoir. Unitization rulings may allocate production in a particular
reservoir in a manner that decreases Fortune's share of production.
Other regulations prevent Fortune from freely conducting operations at
certain times during the year, such as those which protect the whooping crane
habitat which occupies a portion of Fortune's Espiritu Santo Bay prospect. There
is no assurance that laws and regulations enacted in the future will not
adversely affect Fortune's oil and gas activities. From time to time, proposals
are introduced in Congress or by the Administration that could affect Fortune'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 Fortune and its shareholders as a result of
these acts and has also received leave of court to add third-party defendants
whose actions furthered this market manipulation. Fortune intends to continue to
vigorously defend plaintiffs' actions and prosecute its own counterclaims.
Discovery has been stayed pending a ruling by the court on a motion filed by one
of these third-party defendants.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None during the fourth quarter of 1998.
15
<PAGE>
PART II
ITEM 5 . MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS
The following table sets forth the high and the low closing prices of
Fortune's common stock on the AMEX for the periods indicated. In February 1999,
the AMEX notified Fortune that the stock would be delisted beginning March 1,
1999 because of noncompliance with listing guidelines. Fortune is appealing this
decision; accordingly, Fortune's common stock remains listed on the AMEX as of
the date hereof. If Fortune stock is delisted, trades in its common stock will
be reported on the OTC Bulletin Board or regional exchanges.
<TABLE>
<CAPTION>
Common Stock
--------------------
High Low
-------- --------
<S> <C> <C>
1996
First Quarter.................... 5 2
Second Quarter................... 4 2 5/8
Third Quarter.................... 3 11/16 2 1/4
Fourth Quarter................... 3 1/2 2 1/4
1997
First Quarter.................... 3 1/4 2 1/4
Second Quarter................... 2 7/16 1 5/8
Third Quarter.................... 2 1/2 1 9/16
Fourth Quarter................... 3 3/16 2 3/8
1998
First Quarter.................... 2 5/8 1 1/2
Second Quarter................... 1 11/16 1 3/16
Third Quarter.................... 1 7/16 11/16
Fourth Quarter................... 1 5/8 3/8
1999
First Quarter (through March 12). 1/2 3/16
</TABLE>
At March 12, 1999, the closing price of the common stock was $0.13 per
share. At February 26, 1999, there were 12,134,675 shares of common stock
outstanding held of record by approximately 3,000 stockholders.
Fortune has not paid dividends on its stock and does not intend to pay
dividends in the foreseeable future. Under its credit facility, Fortune may not
pay dividends on its capital stock without the prior written consent of its
bank.
16
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The following Summary Condensed Financial Data for each of the years in
the five-year period ended December 31, 1998, are derived from, and qualified
by, reference to Fortune's financial statements appearing elsewhere herein. This
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,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Total revenues............................. $ 2,023 $ 4,005 $ 4,040 $ 3,143 $ 3,397
Loss on sale of oil and gas properties..... - - - 3,607 -
Impairment to oil and gas properties....... 960 3,650 - - 3,347
Net loss................................... (3,275) (5,958) (1,330) (5,876) (4,453)
Net loss per share......................... (0.27) (0.49) (0.12) (0.90) (1.69)
Net weighted average shares outstanding.... 12,132 12,086 11,351 6,556 2,639
Operating Data:
Net Production:
Oil (Bbl)............................... 42,000 87,000 57,000 92,000 88,000
Gas (Mcf)............................... 609,000 821,000 1,038,000 909,000 1,017,000
Gas equivalent (MCFE)................... 859,000 1,343,000 1,383,000 1,461,000 1,542,000
Average Sales Price:
Oil ($ per Bbl)......................... $ 13.08 $ 19.04 $ 20.24 $ 14.66 $ 14.14
Gas ($ per Mcf)......................... 2.19 2.66 2.56 1.77 2.09
</TABLE>
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Total assets............................... $ 8,492 $ 12,626 $ 16,335 $ 17,800 $ 10,066
Total debt................................. 3,235 3,775 2,933 4,897 7,123
Net stockholders' equity................... 4,704 8,053 13,037 12,314 2,130
</TABLE>
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 "Business and
Properties - Oil and Gas Operations - Oil and Gas Reserves."
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------
1998 1997 1996 1995 1994
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Reserves:
Estimated Net Proved Reserves:
Oil (MBbl).............................. 106 257 249 347 1,647
Gas (Bcf)............................... 3.1 3.2 3.5 5.9 5.9
Estimated future net revenues before
income taxes............................. $ 4,985 $ 8,410 $ 14,112 $ 12,600 $ 15,932
Standardized measure of future
net cash flow............................ $3,527 $ 6,503 $ 10,820 $ 8,942 $ 8,148
</TABLE>
17
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
OVERVIEW
Fortune primarily explores, develops and produces oil and gas
properties in the U.S. Gulf Coast. All of Fortune's operating
revenues are derived from the production and sale of oil and gas.
Operating revenues decreased in 1998 primarily because Fortune sold its
interest in East Bayou Sorrel on March 31, 1998. Although this sale resulted in
lower 1998 revenues and cash flow, the price received was a significant premium
over proved reserve value. Furthermore, the cash proceeds strengthened Fortune's
balance sheet and allowed a very active exploration program in 1998.
Operating revenues increased slightly from 1996 to 1997, primarily because
production from the East Bayou Sorrel exploration success more than offset
production declines from depletion and the reduced revenues from the effect of
selling a portion of South Timbalier Block 76 in early 1996.
Results in 1998 and 1997 were adversely affected by substantial
impairments to oil and gas properties. Results in 1997 were also adversely
affected by debt conversion expense and stock offering costs. No such expense
was recorded in 1996. General and administrative expense has decreased during
1998 because of lower litigation costs.
Fortune experienced substantial net losses in 1998 and 1997, 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 1998 because of
decreased revenues and low prices.
Fortune made substantial net investments in oil and gas properties in
1997, and somewhat smaller net investments in 1998 and 1996. Fortune's primary
sources of capital have been the sale of equity and proceeds from the sale of
oil and gas properties. Since 1994, Fortune reduced its total debt by $3.9
million and, as a result of restructuring its borrowing relationships,
significantly increased the maturity of its remaining debt obligations. Fortune
believes that it has adequate capital resources to satisfy its obligations over
the short term. Fortune also believes that its operating cash flow will increase
as a result of successful exploitation of its inventory of projects and
prospects or the acquisition of producing properties and that this increased
cash flow will be the basis for future company growth. However, there is no
assurance that Fortune will be successful in exploiting any of its projects.
Furthermore, operating cash flow has decreased significantly in the short term
as the result of the sale of Fortune's interest in East Bayou Sorrel in March
1998. In the event that Fortune's operating cash flow does not increase
significantly, or Management determines to accelerate the growth plans for
Fortune, the company will continue to require equity and debt financing for its
growth.
18
<PAGE>
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 AND 1997
Fortune had a net loss of $3.3 million in 1998 compared to a net loss of
$6.0 million in 1997. The higher 1997 loss was primarily attributable to the
following items recorded in 1997:
o $316,000 non-cash debt conversion expense incurred to exchange a portion
of Fortune's debentures
o $323,000 stock offering costs for an aborted 1997 public offering
o $3.7 million non-cash impairment to oil and gas properties versus $1.0
million in 1998
o higher depreciation, depletion and amortization
Analysis of change in oil and gas revenues -
<TABLE>
<CAPTION>
Percent
1998 1997 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
Production
Oil - MBbl 42 87 (52)%
Gas - Mmcf 609 821 (26)%
- MMCFE 859 1,343 (36)%
Prices
Oil - $/Bbl $ 13.08 $ 19.04 (31)%
Gas - $/Mcf 2.19 2.66 (18)%
Revenues
Oil $ 544 $ 1,663 (67)%
Gas 1,337 2,188 (39)%
</TABLE>
As can be seen in the above table, the revenue decrease primarily resulted
from significantly lower oil and gas prices and oil and gas production in 1998.
1997 revenues included revenues from Fortune'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.
If East Bayou Sorrel production was excluded from both 1998 and 1997, the
decrease in oil and gas production would have been 11% and 20%, respectively.
Notwithstanding the decrease in revenues and cash flow, management believes that
the sale of East Bayou Sorrel was very positive for Fortune. At the time of the
sale, Fortune's reserve report reflected approximately $1.9 million of
discounted proved reserves value for East Bayou Sorrel. 1997 net cash flow from
the property was approximately $1.0 million. Substantially all of this 1997 cash
flow was reinvested in the property to drill the Schwing #3 which was a dry
hole. The $4.7 million sales price represented 250% of the proved reserve and
460% of the 1997 net cash flow for the property. East Bayou Sorrel was primarily
an oil property and oil prices declined significantly in 1998 after the sale.
The cash from the sale enabled Fortune to repay substantially all of its bank
debt and to conduct an active exploration program in 1998.
19
<PAGE>
Analysis of change in selected expenses -
<TABLE>
<CAPTION>
Percent
1998 1997 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
Production and operating expense $ 595 $ 1,094 (46)%
- per MCFE 0.69 0.81 (15)%
Depreciation, depletion and amortization 1,365 2,219 (38)%
- per MCFE 1.59 1.65 (5)%
Impairment to oil and gas properties 960 3,650 (74)%
</TABLE>
Production and operating expense in 1997 included approximately $360,000
of costs attributable to a workover at South Timbalier Block 76. No significant
workovers were undertaken in 1998. The sale of East Bayou Sorrel contributed to
additional decreases.
Fortune's provision for depletion, depreciation and amortization decreased
because of the impact of impairments to oil and gas properties in 1997 and the
sale of East Bayou Sorrel in 1998.
<TABLE>
<CAPTION>
Percent
1998 1997 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
General and administrative expense $ 1,547 $ 1,965 (21)%
Interest - payable in cash 403 249 62 %
- amortization of financing cost 428 147 191 %
</TABLE>
General and administrative expense decreased primarily because of lower
litigation costs in 1998 in connection with the 1995 Regulation S offering,
discussed in note 8 to the December 31, 1998 financial statements, and lower
personnel costs. We are in the process of reducing general and administrative
costs up to an additional 27% in 1999 versus 1998. The 1999 reductions will be
in almost all categories and are in response to continued depressed oil and gas
prices.
Interest expense paid in cash increased due to the higher debt balance.
Non-cash amortization of debt financing costs increased because of Fortune's
notes offering in December 1997 and credit facility refinancing in July 1997.
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:
o $3.7 million non-cash impairments to oil and gas properties
o $316,000 non-cash debt conversion expense incurred to exchange a portion
of Fortune's debentures
o $323,000 of stock offering costs for an aborted 1997 public offering in
April 1997
20
<PAGE>
Analysis of change in oil and gas revenues -
<TABLE>
<CAPTION>
Percent
1997 1996 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
Production
Oil - MBbl 87 57 52 %
Gas - Mmcf 821 1,038 (21)%
- MMCFE 1,343 1,383 (3)%
Prices
Oil - $/Bbl $ 19.04 $ 20.24 (6)%
Gas - $/Mcf 2.66 2.56 4 %
Revenues
Oil $ 1,663 $ 1,162 43 %
Gas 2,188 2,663 (18)%
</TABLE>
1996 revenues included revenues from Fortune'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, Fortune 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 in January 1997. The second well at East Bayou Sorrel was completed
and placed on production on June 23, 1997.
Oil production increased as a result of the Bayou Sorrel discovery. Gas
production decreased primarily because of the reduced ownership interest in 1997
in South Timbalier Block 76, as discussed above, and natural depletion on
Fortune's properties.
Analysis of change in selected expenses -
<TABLE>
<CAPTION>
Percent
1997 1996 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
Production and operating expense $ 1,094 $ 1,172 (7)%
- per MCFE 0.81 0.85 (5)%
Depreciation, depletion and amortization 2,219 1,623 37 %
- per MCFE 1.65 1.17 41 %
Impairment to oil and gas properties 3,650 - N/A
</TABLE>
The decrease in production and operating expenses results primarily from
Fortune selling 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.
Fortune's provision for depletion, depreciation and amortization increased
because of higher average property costs and lower average proved reserves in
1997.
21
<PAGE>
<TABLE>
<CAPTION>
Percent
1997 1996 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
General and administrative expense $ 1,965 $ 1,924 2 %
Interest - payable in cash 249 361 (31)%
- amortization of financing cost 147 74 99 %
</TABLE>
Interest expense payable in cash decreased due to the lower average debt
balance for most of 1997. Non-cash amortization of debt financing costs
increased because of Fortune's notes offering in December 1997 and credit
facility refinancing in July 1997. See "Liquidity."
LIQUIDITY
CASH BALANCE, WORKING CAPITAL AND CASH FLOWS FROM OPERATING ACTIVITIES
- - 1998 and 1997
Analysis of changes in selected liquidity measures -
<TABLE>
<CAPTION>
Percent
1998 1997 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
Cash balance at year end $ 1,452 $ 1,667 (13)%
Net working capital at year end 1,324 1,376 (4)%
Long-term debt 3,225 3,775 (15)%
Cash flow from operating
activities for the year $ (616) $ 1,379 N/A
Less: change in assets and liabilities (138) 624 N/A
-------- -------- --------
Cash flow from operations before
change in assets and liabilities $ (478) $ 755 N/A
======== ======== ========
</TABLE>
The decrease in cash flow from operating activities 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, the decrease in
cash flow was considerably less. Lower oil and gas revenues and higher cash
interest expense were the primary contributors to the 1998 decrease in cash
flow. Management believes that, even in the face of fluctuating oil and gas
prices, Fortune has adequate capital to fund its capital program during the
short term.
Fortune's internal liquidity and capital resources in the near term will
consist of working capital and its unused borrowing capacity, if any, under its
bank credit facility.
22
<PAGE>
- - 1997 and 1996
Analysis of changes in selected liquidity measures -
<TABLE>
<CAPTION>
Percent
1997 1996 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
Cash balance at year end $ 1,667 $ 2,174 (23)%
Net working capital at year end 1,376 276 399 %
Long-term debt 3,775 680 455 %
Cash flow from operating
activities for the year $ 1,379 $ 607 127 %
Less: change in assets and liabilities 624 216 189 %
-------- -------- --------
Cash flow from operations before
change in assets and liabilities $ 755 $ 391 93 %
======== ======== ========
</TABLE>
Although Fortune's cash balance decreased from 1996 to 1997, working
capital increased significantly. Refinancing Fortune'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.
Changes in accounts receivable and accounts payable were significant
components of the net cash flow amounts in both 1997 and 1996. 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 compared to 1996. The absence of corporate
relocation costs in 1997 and lower interest and production and operating expense
in 1997 contributed to this increase. Fortune's 1996 exploratory discovery at
East Bayou Sorrel, Iberville Parish, Louisiana had no impact on Fortune's
revenues in 1996. Its impact on 1997 production was partially offset by the
items discussed in the 1997 operating results section above.
CAPITAL RESOURCES
CASH USED IN INVESTING ACTIVITIES - CAPITAL EXPENDITURES
- - 1998
Cash expenditures for oil and gas properties in 1998 were $3.7 million as
compared to $4.9 million for the same period in 1997. The 1998 expenditures have
been incurred primarily in Fortune's projects at LaRosa, Espiritu Santo Bay,
East Bayou Sorrel, Whiskey Pass, Sea
Serpent and Southwest Segno.
23
<PAGE>
Fortune has been involved in two significant proprietary 3D seismic
projects along the Texas coast. The La Rosa project, a 24-square mile
proprietary 3D seismic survey over one of Fortune's existing producing fields
has been shot and drilling operations have commenced. Fortune sold one-half of
its interest in the non-producing portion of this field in exchange for the
acquiring parties paying 100% of Fortune's 3D seismic costs. Drilling began in
December 1997. Seven wells had been drilled based upon the 3D seismic. Four
wells were completed as producers and three wells have been plugged and
abandoned. During 1998, Fortune incurred $770,000 of seismic interpretation,
leasing and drilling costs. Fortune holds a 37.5% working interest in the wells
drilled prior to the 3D seismic survey 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. This involves a 135-square mile proprietary 3D seismic
survey in which Fortune owns a 12.5% working interest. This survey was completed
in 1997 and is continually being interpreted. Drilling began in August 1998.
Five wells have been drilled to date. Two have been plugged, two are being
completed and the fifth is a potential discovery which may need to be redrilled
as the result of experiencing an underground blowout. Additional drilling is
planned. During 1998, Fortune incurred $1,068,000 of seismic interpretation,
leasing costs and well operations.
During the second quarter of 1998, Fortune entered into agreements to
participate in the drilling of three wells on prospects in the transition zone
offshore Louisiana. Two of the wells are on the Whiskey Pass prospect and the
third is on the Sea Serpent prospect. The prospects were identified by another
company on a 25-square mile transition zone 3D seismic survey which Fortune also
owns. All three wells were drilled and plugged and abandoned. In 1998, Fortune
incurred approximately $887,000 of seismic, leasehold and drilling costs.
Fortune also incurred $166,000 in 1998 in connection with its dry hole at the
Southwest Segno prospect in Liberty County, Texas.
Fortune continually reviews exploration, development and acquisition
opportunities and expects to participate in additional projects in 1999.
- - 1997 and prior
Capital expenditures funded with cash for the years ended December 31,
1997 and 1996 were $4.9 million and $3.2 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.
In June 1997, Zydeco returned to Fortune $2.2 million of exploration
venture cash under the terms of the venture agreement, as discussed in note 2 to
the December 31, 1998 financial statements. The cash was previously reported on
Fortune's balance sheet as restricted cash in "Other Assets." Fortune 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."
24
<PAGE>
CASH FLOWS FROM FINANCING ACTIVITIES -
- OUTSTANDING DEBT AND DEBT REDUCTION
On March 31, 1998, Fortune paid off all but $10,000 of its bank credit
facility using $540,000 of the proceeds from the sale of East Bayou Sorrel.
Fortune's other debt, all of which is subordinated convertible debt, is not due
until 2007. Since 1994, Fortune has reduced its total debt by $3.9 million and
virtually eliminated its current maturities of long-term debt.
- 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. An aggregate of $3,225,000
principal amount of notes was sold and Fortune received $2,815,000 of net
proceeds after offering expenses and commissions. The notes were sold to a group
of accredited investors under a placement agreement with J. Robbins Securities
L.L.C.
The net proceeds of the private placement were used to refinance existing
debt and for general corporate purposes. On December 5, 1997, using the proceeds
of the notes offering, Fortune redeemed the remaining outstanding balance of
$1,028,000 of Fortune's debentures due December 31, 1997. In addition, $315,000
of net proceeds of the notes offering were used to reduce the borrowings under
Fortune's credit facility with Credit Lyonnais. See note 5 of the December 31,
1998 financial statements for the terms of the notes.
- CREDIT FACILITY
Fortune 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,
Fortune repaid all but $10,000 of the outstanding balance of the credit facility
with a portion of the proceeds from the sale of East Bayou Sorrel. Prior to
Fortune's sale of its interest in the East Bayou Sorrel field, Fortune's
borrowing base was $2 million. The bank has not completed its redetermination of
the borrowing base subsequent to this sale; consequently, Fortune does not know
how much, if any, is currently available for borrowing under this credit
facility. Primarily as a result of the lower revenues in 1998 because of lower
oil and gas prices and the sale of East Bayou Sorrel, Fortune 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 December 31, 1998. Fortune
received a waiver of this covenant from the bank for the period ended December
31, 1998. Fortune will need a wavier of this debt covenant in future periods
until operating cash flow increases significantly. See note 5 of the December
31, 1998 financial statements for the terms of this credit facility.
- DEBENTURES
On February 26, 1997, Fortune closed an exchange offer for the Convertible
Subordinated Debentures due December 31, 1997 which resulted in 40%, or $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.
25
<PAGE>
In connection with the February 1997 exchange of debentures, Fortune
recorded a non-cash debt conversion expense of approximately $316,000 during the
first quarter of 1997. This expense represents the difference between the fair
market value of all of the common stock and warrants issued in 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 their
original terms.
- CASH PROVIDED FROM EQUITY TRANSACTIONS
Fortune's primary source of capital during 1996 was stock offerings and
the exercise of warrants and options. In December 1996, Fortune 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.
OIL AND GAS PRICES AND RESERVES
Fortune's revenues, profitability and future growth are substantially
dependent upon oil and gas prices. These prices can be extremely volatile and in
recent years have been depressed by excess supplies. These fluctuating oil and
gas prices have contributed to impairments to oil and gas properties such as the
$3.7 million impairments recorded in 1997 and the $960,000 impairments recorded
in 1998. As a result of continued fluctuating oil and gas prices, Fortune
expects to incur further impairments in 1999. As of March 4, 1999, Fortune was
receiving an average of approximately $11.00 per Bbl for its oil production and
$1.70 per Mcf for its gas production.
Analysis of selected reserve information at year end:
<TABLE>
<CAPTION>
Percent
1998 1997 Change
-------- -------- --------
(Thousands except where indicated)
<S> <C> <C> <C>
Proved Reserves
Oil - MBbl 106 257 (59)%
Gas - Mmcf 3,082 3,217 (4)%
- MCFE 3,718 4,759 (22)%
Year end Prices
Oil - $/Bbl $ 9.85 $ 16.90 (42)%
Gas - $/Mcf 2.25 2.60 (13)%
Estimated future net revenue
undiscounted $ 4,985 $ 8,410 (41)%
Standardized measure of discounted
future net cash flow $ 3,527 $ 6,503 (46)%
</TABLE>
Fortune's 1998, 1997 and 1996 year end oil and gas reserve reports have
been prepared by Huddleston & Co. Inc., of Houston, Texas, its independent
petroleum engineers. The present value of the reserves decreased in 1998
primarily because of the sale of East Bayou Sorrel and significantly lower oil
and gas prices at year end 1998. The present value discounted at 10% of the East
Bayou Sorrel proved reserves at the time of the sale was approximately $1.9
million. Fortune sold this property for $4.7 million, resulting in a significant
economic gain on this transaction. At December 31, 1997, these net proved
reserve figures included 152,000 barrels of oil and 204,000 Mcf of gas
attributable to Fortune's interest at East Bayou Sorrel. See note 3 to the
December 31, 1998 financial statements regarding this sale.
26
<PAGE>
"YEAR 2000" COMPLIANCE
Fortune 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. Fortune has reviewed its internal and accounting systems and
believes that they are "year 2000 compliant." Fortune currently does not operate
any of its producing properties; accordingly it does not use any operating
systems internally that must be evaluated for compliance. Fortune's concerns
regarding year 2000 compliance rests almost solely with its third party business
associates. Fortune 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 is ongoing. Fortune has begun
making contingency plans in the event that its third parties are unable to
achieve compliance. With respect to oil and gas product purchasers, systems
providers, consultants, its bank, and its stock transfer agent, for example,
Fortune does not have any contracts that extend beyond mid-1999. Accordingly,
Fortune can change to goods and service providers who are year 2000 compliant,
if necessary. With respect to operators of its properties, Fortune 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
operates South Timbalier Block 76 and Fortune is monitoring CNG's compliance
efforts. Fortune does not believe that the direct, out-of-pocket cost of its
year 2000 compliance requirements will be significant. There are, however,
numerous parties who Fortune has no direct contact with but who nonetheless
could have a significant impact on Fortune'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 Fortune has no practical way of assessing
the viability of these companies, Fortune believes that its risks are no greater
in this regard than businesses and the public in general. Fortune will continue
to monitor the status of year 2000 compliance issues to determine the impact, if
any, on its operations.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
133 establishes accounting and reporting standards for derivative instruments,
including derivative instruments embedded in other contracts and for hedging
activities. SFAS 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. As it has not historically utilized derivative
instruments, the impact upon Fortune of SFAS 133 is not expected to have an
effect on the reporting of future operating results.
FORWARD LOOKING STATEMENTS
This annual report contains forward-looking statements. Forward-looking
statements include statements regarding future oil and gas production and
prices, future exploration and development spending, future drilling and
operating plans, reserve and production potential of Fortune's properties and
prospects and Fortune's business strategy. Actual events or results could differ
materially from those discussed in the forward-looking statements as a result of
various risk factors including the factors described below.
27
<PAGE>
RISKS ASSOCIATED WITH FORTUNE
FORTUNE'S RELIANCE ON EXPLORATORY PROJECTS INCREASES THE RISKS INHERENT IN
THE OIL AND GAS INDUSTRY. We base our individual decisions to participate in
particular exploration projects on assumptions and judgements concerning the oil
and gas industry, such as future oil and gas prices, varying levels of
competition for leases, reserves, and equipment, and our management's perceived
risk of success. These assumptions and judgments may be speculative and are
often subjective. Although we can obtain information with respect to potential
oil or gas properties, it is impossible to determine with certainty the ultimate
production potential, if any, of a particular property or well. Moreover, the
successful completion of an oil or gas well does not insure a profit on our
investment, since completion and production expenses must also be considered.
Our current investments are primarily in exploration projects, where the risks
are substantially greater than in the case of wells drilled into already
producing formations. We anticipate that one or more of our next wells will be
designed to test the deeper formations beneath known production in Espiritu
Santo Bay. These formations have not been extensively tested to date, leaving
seismic imaging as one of the few tools available to aid in understanding
subsurface geology. The exploration risks, therefore, are higher on this project
than they might be where a greater number of underground references exist.
Fortune has realized less success than originally anticipated in developing some
of its recent prospects and we expect that a substantial number of our future
projects could experience similar results.
FORTUNE CHANGED ITS BUSINESS STRATEGY IN MID-1994 TO EMPHASIZE EXPLORATORY
PROJECTS INSTEAD OF PROPERTY ACQUISITIONS. In mid-1994, Fortune changed its
strategy from the acquisition of producing oil and gas properties with
anticipated development potential to one which stresses exploratory drilling for
oil and gas. Fortune made substantial changes in management and personnel and,
in 1996, sold all of its California properties. At the time, those properties
accounted for a significant portion of our oil and gas reserve volumes. We
relocated our offices to Houston, developed a new area of interest and new
working relationships, and invested in new prospects. It is too early to fully
assess the operating results of these changes, but current and future results of
operations may not be comparable to historical performance.
FORTUNE HAS INCURRED NET LOSSES FOR EACH OF THE LAST THREE years. Fortune
has incurred substantial net losses in each of the last three years. Although we
are making significant budget cuts in 1999, oil and gas prices remain
historically low. This makes it likely that these losses will continue. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
FORTUNE IS NOT CURRENTLY REPLACING ALL OF ITS EXISTING reserves. Oil and
gas reserves which are being produced are depleting assets. Fortune's future
cash flow and income are highly dependent on our ability to find or acquire
additional reserves to replace those being currently produced. We are not adding
reserves at present at the same pace at which they are being produced.
Therefore, without adding additional reserves in the future, our oil and gas
reserves and production will decline.
OUR REVENUE IS DEPENDENT UPON A LIMITED NUMBER OF PRODUCING WELLS.
Approximately 40% of our oil and gas revenues, cash flow, and proved oil and gas
reserves are currently accounted for by a single well at South Timbalier Block
76. This well was shut-in for repairs for one month in 1997 and for over two
months during 1996 as the result of mechanical failures. See "Business and
Properties Significant Properties and Activities - South Timbalier Block 76
federal waters, offshore Louisiana." A significant curtailment or loss of
production for a prolonged period before we could replace the reserves through
new discoveries or acquisitions would have a material adverse effect on our
projected operating results and financial condition.
28
<PAGE>
OUR NEED FOR WORKING CAPITAL MAY AFFECT OUR LEVEL OF PARTICIPATION IN
VARIOUS PROJECTS. Investment in oil and gas exploration requires the commitment
of substantial amounts of capital over significant periods of time. For the
three-year period ended December 31, 1998, Fortune incurred over $11 million of
capital costs in its oil and gas exploration, development and acquisition
activities. While we believe we have sufficient capital or cash flow to meet our
projected capital needs over the short-term, it is very difficult for small-cap
energy companies to raise additional funds because of the depressed state of the
oil and gas industry. We do not expect this situation to change in the near
term. We may not have sufficient liquid capital resources to participate at our
existing working interest level if the operators of any of our properties
propose an accelerated drilling schedule. If we fail to participate in the
capital expenditures for any project, our interest in that project will be
substantially reduced or lost entirely.
FORTUNE IS DEPENDENT ON OPERATORS, CONSULTANTS AND PARTNERS OVER WHOM IT
HAS LITTLE CONTROL. Since we do not operate our projects, we are dependent on
other oil and gas companies to conduct operations in a prudent, competent, and
timely manner. Although we are actively involved in project evaluations, we
often have little or no control over the manner or timing of such operations. If
the operator proves incompetent, we could be forced to incur additional costs to
conduct remedial procedures and could lose our investment in a property
altogether. Because we employ a variety of technological approaches to our
geologic, geophysical, and engineering evaluation of properties and projects, we
rely heavily on outside consultants for their expertise. Fortune has no
long-term agreements with such consultants, all of whom are available to other
oil and gas companies, including our competitors. In the current environment of
low oil and gas prices, our partners may determine that projects which have
previously been agreed upon are no longer economically feasible. If this were to
occur, projects could be delayed or cancelled completely.
ACCOUNTING RULES MAY RESULT IN ADDITIONAL WRITE-DOWNS OF PROPERTY VALUES.
We report our operations using the full-cost method of accounting for oil and
gas properties. Under these rules, all exploration and development costs are
capitalized. Dispositions of properties are generally accounted for as
adjustments of capitalized costs, with no gain or loss recognized, unless it is
deemed to be significant. See note 1 to the December 31, 1998 financial
statements. Under these rules, the net capitalized costs of properties may not
exceed a "ceiling" limit of the tax-effected present value of estimated future
net revenues from proved reserves, discounted at 10%, plus the lower of cost or
fair market value of unproved properties. This requires calculating future
revenues at the unescalated prices in effect as of the end of each fiscal
quarter. A write-down is required if the net capitalized costs of the properties
exceed the ceiling limit, even if price declines are only temporary. The risk
that we will be required to write down the carrying value of our properties
increases when oil and gas prices are depressed or unusually volatile or when
previously unevaluated properties carried at cost are disposed of below that
cost. For example, we recognized a $3.7 million impairment in 1997 and a
$960,000 impairment for in 1998. As a result of continued low oil and gas
prices, it is likely that we will incur further impairments in 1999.
ALL OUR PROVED PROPERTIES ARE PLEDGED TO SECURE DEBT. All of our proved
properties are pledged to secure our bank credit facility. If we fail to pay the
principal or interest to the bank or breach the financial covenants under our
credit facility, we could lose our principal producing properties. The entire
principal balance of the credit facility is due July 11, 1999. Although the
current balance is only $10,000, we may borrow additional amounts if the bank
approves. If our operating activities are significantly curtailed or our
financial position weakens significantly and we are unable to repay such debt
when it comes due, our properties could be seized through a foreclosure. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
29
<PAGE>
THERE ARE UNINSURED RISKS IN OUR OPERATIONS WHICH COULD CAUSE MATERIAL
LOSSES. The operators of each of the projects in which we are involved are
required to carry insurance against certain risks of oil and gas operations. We
normally pay our proportionate share of the premiums for such insurance and are
named as an additional insured under the policy. In addition to such insurance,
we also carry insurance against operating risks such as pollution control and
blowouts. However, we may not be fully insured against all risks because such
insurance is not available, is not affordable, or losses may exceed policy
limits.
THE MARKET FOR FORTUNE COMMON STOCK IS LIMITED. On February 11, 1999,
Fortune was notified by the American Stock Exchange that its stock would be
delisted from the exchange effective March 1, 1999. Fortune has failed to comply
with the exchange's continued listing guidelines because it has not reported a
profit in any of the last five years. We have appealed the delisting decision,
but our appeal may not be successful. If the appeal is unsuccessful, trades in
Fortune's stock will be reported on the OTC Bulletin Board or regional exchanges
in the near future. Because of the current low volume of trading in Fortune
stock, there may not be a ready market for our stock. Fortune is not now aware
of any broker/dealer who intends to make a market in Fortune stock.
THE NUMBER OF SHARES ELIGIBLE FOR FUTURE SALE WILL POTENTIALLY DILUTE THE
PRICE OF FORTUNE STOCK. At December 31, 1998, 12,134,675 shares of our common
stock were outstanding, of which 11,566,054 shares were freely tradeable and
568,621 shares were "restricted securities" as that term is defined in Rule 144
under the Securities Act. At that date, we also had outstanding options and
private warrants to acquire 6,604,827 shares of common stock. We also had
$3,225,000 of notes convertible into common stock at $3.00 per share, subject to
adjustment. Beginning May 1, 1999, the notes are convertible into Fortune common
stock at a conversion price based on the stock's average closing price from
March 2 through April 30. If the conversion price were based on the closing
price of the stock on March 12, 1999, approximately 9.8 million additional
shares would be issuable upon conversion of the notes. The issuance of
substantial additional shares or sales of substantial amounts of the common
stock in the public market could adversely affect the market price of Fortune's
common stock. We are investigating ways to reduce this potential dilution.
FORTUNE DEPENDS ON A KEY OFFICER. Fortune depends to a large extent on the
abilities and continued participation of its key employee, Tyrone J. Fairbanks,
President and Chief Executive Officer. The loss of Mr. Fairbanks could have a
material adverse effect on Fortune. In an effort to reduce the risk, Fortune has
entered into an employment agreement with Mr. Fairbanks which expires May 31,
2000. See "Management." Fortune also has obtained $500,000 of key man life
insurance on the life of Mr. Fairbanks.
ADDITIONAL FACTORS. Additional factors that apply generally to the oil and
gas industry but that could cause actual events to vary from those discussed in
this annual report include: adverse change in governmental regulation; inability
to obtain critical supplies and equipment, personnel and consultants; and
inability to access capital to pursue our plans.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DISCLOSURE ABOUT MARKET RISK
Fortune is exposed to market risk, including adverse changes in oil and
gas prices and interest rates as discussed below. Fortune does not currently use
derivative financial instruments to mitigate fluctuations in oil and gas prices
or interest rates.
30
<PAGE>
OIL AND GAS PRICE RISK. Fortune's oil and gas revenues can be
significantly affected as oil and gas prices fluctuate widely in response to
changing market forces. These fluctuations can be reduced through the proper use
of oil and gas price hedging tools. We currently do not use oil and gas price
hedges because we do not believe that Fortune has sufficient production volumes
to justify their use. Consequently, our oil and gas revenues will continue to
fluctuate as prices fluctuate.
INTEREST RATE RISK. Fortune's exposure to changes in interest rates
primarily results from its short-term and long-term debt with both fixed and
floating interest rates.
Fortune's debt structure is comprised of:
Stated Balance
Interest Rate December 31, 1998 Matures
------------- ----------------- -------
12% Fixed $3,225,000 2007
Variable at banks
Base rate + 1 1/4% or
LIBOR + 4% $10,000 1999
Changes in interest rates currently will not have a significant impact on
Fortune's operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this item is submitted beginning at page 43.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON AUDITING
AND FINANCIAL DISCLOSURE
None.
31
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
The directors and executive officers of Fortune are:
<TABLE>
<CAPTION>
Director
Executive Officer Age Since Title
-------------------------- --- ------ -----------------------------
<S> <C> <C> <C>
Tyrone J. Fairbanks.......... 42 1991 President, Chief Executive Officer,
and Director
Dean W. Drulias.............. 52 1990 Executive Vice President, General Counsel,
Corporate Secretary and Director
J. Michael Urban............. 45 -- Vice President, Chief Financial Officer
and Assistant Secretary
Graham S. Folsom............. 41 1992 Director
Barry Feiner................. 64 1995 Director
Gary Gelman.................. 33 1995 Director
Daniel R. Shaughnessy........ 48 1997 Director
Dewey A. Stringer, III....... 56 1998 Director
</TABLE>
Tyrone J. Fairbanks serves as President and Chief Executive Officer of
Fortune. Mr. Fairbanks served as Vice President and Chief Financial Officer of
Fortune 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 Fortune, 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 Fortune 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 and serves on the Compensation Committee of
the board.
J. Michael Urban was hired effective March 11, 1996 as Fortune's Vice
President and Chief Financial Officer. Mr. Urban previously served as
Vice-President, Finance with Norcen Explorer, Inc., a Houston based oil and gas
company with operations primarily in the Gulf of Mexico. Norcen was a wholly
owned subsidiary of Norcen Energy Resources Limited, a Canadian public company.
Mr. Urban had been with Norcen since March 1986. Mr. Urban is also a director of
Community Bank, a private commercial bank located in the Houston area. Mr. Urban
received his B.B.A. in Accounting from the University of Texas in 1976 and has
been a Certified Public Accountant in the State of Texas since 1978.
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 board's Audit Committee.
32
<PAGE>
Barry Feiner graduated from Columbia Law School and is a member of the Bar
of the State of New York. He has practiced law in the State of New York since
1965. His practice concentrates on the areas of corporate and securities law.
Prior to beginning private practice, Mr. Feiner served on the staff of the
Securities and Exchange Commission. Mr. Feiner also serves on the board of
directors of Alfin, Inc., a company whose stock is listed on the American Stock
Exchange. He is chairman of the board's Compensation Committee.
Gary Gelman has served as president of GAR-COR Holding Corporation, a real
estate management and brokerage firm, since 1989. Mr. Gelman is a principal of
and serves as a loan consultant for National Bank of New York City and is a
member of the Audit Committee.
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. 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."
Mr. Shaughnessy is a member of the Audit Committee.
Dewey A. Stringer has been the president of Petro-Guard Company, Inc.
since 1982. Petro-Guard specializes in acquiring operated and non-operated oil
and gas properties, exploration utilizing 3D seismic technology and organizing
large exploration projects. Petro-Guard currently operates the Espiritu Santo
Bay project in which Fortune is a participant. Mr. Stringer received his B.S.
degree from the University of Houston in 1966 and serves on the Compensation
Committee.
33
<PAGE>
ITEM 11. EXECUTIVE COMPENSATION
The following table lists the total compensation paid by Fortune to its
chief executive officer during the periods indicated and up to four other
executive officers whose combined 1998 salary and bonus exceeded $100,000:
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
Long Term Compensation
---------------------------------------
Annual Compensation Awards Payouts
--------------------------- ------------------------- --------
Restricted Securities
Stock Underlying LTIP All Other
Name and Principal Salary Bonus Other Awards Options/Warrants Payouts Compensation
Position Year ($) ($) ($) ($) (No.) ($) ($)
- -------------------------- ---- -------- -------- -------- -------- -------------- -------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks....... 1998 164,667 17,500 20,885 - 100,000 - 5,000
President and CEO 1997 155,833 17,500 35,309 - 120,000 - 4,748
1996 150,000 - 20,934 - 80,000 - 3,000
Dean W. Drulias........... 1998 125,000 - - - 150,000 - 5,000
Executive Vice President 1997 125,000 3,000 - - 75,000 - 4,750
1996 26,291 250 - - 56,000 - 1,643
J. Michael Urban.......... 1998 120,000 - - - 150,000 - 5,000
Chief Financial Officer 1997 120,000 5,000 - - 100,000 - 4,750
1996 97,308 - - - 55,000 - 4,750
</TABLE>
"Other" annual compensation includes automobile expenses and loan
forgiveness, but are shown only if such amounts exceed 10% of the total annual
salary and bonus.
The following table lists the outstanding options and warrants held on
December 31, 1998 by Fortune's executive officers under our stock option plans:
AGGREGATE OPTIONS EXERCISES IN 1998 AND YEAR END OPTION VALUES
<TABLE>
<CAPTION>
Number of Value of Unexercised
Unexercised Options/ in the Money Options
Warrants at FY-End at FY-End
Shares Acquired Exercisable/ Exercisable/
Name on Exercise Value Realized ($) Unexercisable Unexercisable
---------------------- ----------- ------------------ -------------- ----------------
<S> <C> <C> <C> <C>
Tyrone J. Fairbanks - - 506,999 / 0 -
Dean W. Drulias1,200 1,200 - 299,800 / 0 -
J. Michael Urban- - - 305,000 / 0 -
</TABLE>
34
<PAGE>
EMPLOYMENT AGREEMENTS
Fortune has 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 cause, death or disability within two
years following a change in control, 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. For purposes of the employment agreement, change in control means a
change in more than one-third of the board of directors following certain
special events. 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 $168,000 and additional compensation, in an
amount not to exceed his annual salary, based upon certain increases in the
value of Fortune'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 Fortune'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."
STOCK OPTIONS
Fortune has two stock option plans that cover its directors, officers and
employees. Awards are made by the board of directors upon recommendations of its
compensation committee. There is no performance formula or measure. Options
granted under each of these plans must be exercised within five years of the
date of grant or they are forfeited.
On January 12, 1995 Fortune reduced the exercise price of all options
granted in 1991, 1993, 1994 and 1995 that were held by employees and directors
on that date. The repricing included options held by one executive officer as
follows:
TEN-YEAR OPTION REPRICINGS
<TABLE>
<CAPTION>
Length of
Securities original
underlying Market price option term
number of of stock at Exercise New remaining
options time of price at time exercise at date of
Name and Position Date repriced repricing of repricing price repricing
- ---------------------- ------- ---------- ------------ ------------ -------- -----------
<S> <C> <C> <C> <C> <C> <C>
President and CEO -
Tyrone J. Fairbanks 1/12/95 10,000 $1.75 $6.00 $2.75 2.1 years
Tyrone J. Fairbanks 1/12/95 22,500 $1.75 $5.00 $2.75 4.1 years
Tyrone J. Fairbanks 1/12/95 78,900 $1.75 $5.48 $2.75 4.1 years
Tyrone J. Fairbanks 1/12/95 105,599 $1.75 $6.03 $2.75 5.0 years
</TABLE>
During the ten year period ended December 31, 1998, no other options held
by executive officers were repriced or amended.
35
<PAGE>
The following table shows the grants of stock options during 1998 to each
of the executives named in the Summary Compensation Table.
<TABLE>
<CAPTION>
OPTION GRANTS IN 1998
Individual Grants
-------------------------------------------------------- Potential Realizable Value At
Number of % of Total Assumed Annual Rates of
Securities Options Stock Price Appreciation
Underlying Granted to Exercise or For Option Term
Options Employee in Base Price Expiration -------------------
Name Granted Fiscal Year ($/Share) Date 5% 10%
- ------------------- ---------- ------------ ----------- ------------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks 100,000 17.9% 1.56 March 4, 2003 $ 43,000 $ 95,000
Dean W. Drulias 150,000 26.8% 1.56 March 4, 2003 $ 65,000 $143,000
J. Michael Urban 150,000 26.8% 1.56 March 4, 2003 $ 65,000 $143,000
</TABLE>
In the event of a change in control of Fortune, the shares of common stock
subject to options granted to all option holders under the 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, Fortune 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 Fortune, subject to IRS limitations, and are
100% vested after two years of service with Fortune. Salary deferrals are 100%
vested at all times. Fortune does not make profit sharing contributions to the
plan. Messrs. Drulias and Urban are the trustees of the plan.
For the 1998 plan year, Fortune's matching contribution obligation was
$24,000, all of which will be paid in shares of common stock. The amounts
contributed to the plan as matching contributions for Fortune's executives are
shown in the Summary Compensation Table set forth above.
DIRECTOR COMPENSATION
Fortune pays outside directors fees of $2,500 per quarter. Inside
directors do not receive any compensation for serving as directors.
36
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table contains information at February 26, 1999, as to all
persons who, to our knowledge, were the beneficial owners of five percent or
more of the outstanding shares of Fortune's common stock, and of all officers
and directors.
<TABLE>
<CAPTION>
Position Amount and Nature Percent
Name and Address with Fortune of Beneficial Ownership of Class
- ------------------------------ ------------------------ ----------------------- --------
<S> <C> <C> <C>
Barry Blank
5353 N. 16th Street
Phoenix, AZ 85016 - 1,132,604 8.6%
William D. Forster
237 Park Avenue
New York, NY - 681,000 5.4%
Tyrone J. Fairbanks
515 W. Greens Road, #720 Director, President
Houston, TX 77067 and CEO 511,021 4.0%
Dean W. Drulias Director, Executive Vice
515 W. Greens Road, #720 President, General Counsel
Houston, TX 77067 and Corporate Secretary 333,641 2.7%
J. Michael Urban
515 W. Greens Road, #720
Houston, TX 77067 Vice President and CFO 323,701 2.6%
Graham S. Folsom
515 W. Greens Road, #720
Houston, TX 77067 Director 168,501 1.4%
Gary Gelman
515 W. Greens Road, #720
Houston, TX 77067 Director 131,583 1.1%
Barry Feiner
515 W. Greens Road, #720
Houston, TX 77067 Director 127,993 1.0%
Daniel R. Shaughnessy
515 W. Greens Road, #720
Houston, TX 77067 Director 77,500 *
Dewey A. Stringer, III
515 W. Greens Road, #720
Houston, TX 77067 Director 15,000 *
All Officers and Directors
as a group of eight persons 1,688,940 12.4%
</TABLE>
* indicates less than 1%.
37
<PAGE>
ADDITIONAL INFORMATION REGARDING THESE HOLDINGS FOLLOWS:
o MR. BLANK'S HOLDING
Mr. Blank's holdings include 137,000 shares of common stock and the
following warrants:
Number of Warrant Common Stock
Warrants Exercise Price Equivalent
-------- -------------- ------------
200,000 $2.40 200,000
17,917 $3.60 17,917
541,000 $3.75 777,687
See "Certain Relationships and Related Transactions" regarding Mr. Blank's
acquisition of certain of the warrants.
o MR. FORSTER'S HOLDING
Mr. Forster's holdings include 515,000 shares of common stock underlying
stock purchase warrants exercisable at $4.75 per share and expiring April 2000.
o OFFICER AND DIRECTOR HOLDINGS
The table includes the following shares of common stock issuable upon the
exercise of stock options granted under Fortune'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:
Common Stock Average Weighted
Issuable Exercise Price
------------ ----------------
Tyrone J. Fairbanks 484,499 $2.63
J. Michael Urban 305,000 2.25
Dean W. Drulias 299,800 2.27
Graham S. Folsom 148,475 2.61
Gary Gelman 111,750 2.56
Barry Feiner 111,750 2.56
Daniel R. Shaughnessy 47,500 1.87
Dewey A. Stringer, III 10,000 1.50
Mr. Folsom's holdings also include 7,187 shares issuable upon exercise of
5,000 stock purchase warrants exercisable at $3.75 per warrant.
Mr. Feiner's holdings also include 1,868 shares of common stock and 14,375
shares issuable upon exercise of 10,000 stock purchase warrants exercisable at
$3.75 per warrant. These shares and warrants are owned by Mr. Feiner's wife,
Janet Portelly. Mr. Feiner disclaims beneficial ownership of all such securities
owned by Mrs. Portelly.
38
<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 private
placement was completed on December 1, 1997. An aggregate of $3,225,000
principal amount of notes was sold, and Fortune received $2,815,000 of net
proceeds after offering expenses and commissions. The notes were sold under an
agreement with J. Robbins Securities, L.L.C. who served as 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
warrant. Barry W. Blank, a beneficial owner of more than five percent of
Fortune's common stock, was a managing director for the placement agent at the
time of the offering 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 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. Mr. Blank's mother also
acquired $50,000 of notes. Mr. Blank disclaims beneficial ownership of the notes
purchased by his mother. Barry Feiner, a director of Fortune, acted as outside
counsel for the placement agent in 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 board of director matters associated with the private
placement.
As part of the relocation of Fortune's headquarters to Houston, Texas,
Fortune 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 Fortune 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 contingent on Mr. Fairbank's continued employment by Fortune.
As of January 31, 1999, the entire amount of this loan had been forgiven. The
$70,000 loan also bears interest at the rate of 6% per annum, payable interest
only for two years with $35,000 principal payments due on the second and third
anniversaries of the loan. Mr. Fairbanks had repaid all but $5,000 of the
$70,000 loan as of December 31, 1998. On December 4, 1998 Fortune granted an
extension of the due date of the remaining balance to July 1, 1999. See
"Management - Employment Agreements.
During 1996, the law firm of which Dean W. Drulias was formerly a
shareholder billed Fortune a total of $152,000 for legal fees and costs. See
"Management - Directors and Executive Officers."
During 1998, 1997 and 1996, Fortune incurred $421,000, $182,000 and
$45,000, respectively, for consulting services provided by Interpretation-3, of
which Daniel R. Shaughnessy is the owner and president. Mr. Shaughnessy was
elected to Fortune's board of directors in January 1997. See "Management -
Directors and Executive Officers."
Petro-Guard Company, Inc., the operator at Espiritu Santo Bay, is owned by
Dewey A. Stringer III. Mr. Stringer has been a director of Fortune since April
1998. As the operator of Espiritu Santo Bay, Petro-Guard bills Fortune and the
other Espiritu Santo Bay partners their share of the monthly expenditures on the
project. As such, Petro-Guard billed Fortune $1,042,000 of Espiritu Santo Bay
exploration expenditures in 1998.
All of the foregoing transactions were, and any future transactions with
related parties will be, on terms no less favorable to Fortune than those which
could be obtained from unaffiliated third parties. In addition, no transaction
will be entered into between Fortune and its management or principal
stockholders unless they are approved by a majority of the directors who are not
members of management or principal stockholders.
39
<PAGE>
LIMITED LIABILITY OF DIRECTORS
In accordance with the Delaware General Corporation Law, Fortune 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 Fortune or its stockholders
for monetary damages, except for any breach of the directors' duty of loyalty to
Fortune or its stockholders, for acts or omissions not in good faith or which
involve intentional misconduct or a knowing violation of law, for unlawful
payment of dividends or unlawful stock purchases or redemptions, or for any
transaction from which any director derived an improper personal benefit.
This provision protects Fortune'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 Fortune and its stockholders and
for the specific matters set forth above, as well as for violations of the
federal securities laws. The provision has no effect on the availability of
equitable remedies such as injunction or rescission. Additionally, these
provisions do not protect a director from activities undertaken in any capacity
other than that of director.
INDEMNIFICATION OF OFFICERS AND DIRECTORS
Fortune'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 Fortune or its affiliates.
Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers or persons controlling Fortune
pursuant to the foregoing provisions, Fortune has been informed that in the
opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Securities 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 LLP................. 44
Balance Sheets--December 31, 1998 and 1997............. 45
Statements of Operations for the years ended
December 31, 1998, 1997 and 1996.................... 46
Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996.................... 47
Statements of Cash Flows for the years ended
December 31,1998, 1997 and 1996..................... 48
Notes to Financial Statements.......................... 49
(2) Financial Statement Schedules
None
40
<PAGE>
(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)
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)
41
<PAGE>
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 (filed as Exhibit 10.8 to
Registrant's Form 10-K for the year ended December 31, 1997
and incorporated herein by reference)
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 LLP
23.2* Consent of Huddleston & Co., Inc.
27.1* Financial Data Schedule
(b) Reports on Form 8-K
Form 8-K filed March 12, 1999 to report Fortune's press release of its
year end and fourth quarter 1998 financial results.
* Filed herewith
42
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
----
Independent Auditors' Report - KPMG LLP......................... 44
Balance Sheets - December 31, 1998 and 1997..................... 45
Statements of Operations for the years ended
December 31, 1998, 1997 and 1996............................. 46
Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996.............................. 47
Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.............................. 48
Notes to Financial Statements................................... 49
43
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Fortune Natural Resources Corporation:
We have audited the accompanying balance sheets of Fortune Natural
Resources Corporation as of December 31, 1998 and 1997, and the related
statements of operations, stockholders' equity and cash flows for each of the
years in the three-year period ended December 31, 1998. 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, 1998 and 1997, and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 1998, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
- ---------------------
Houston, Texas
March 5, 1999
44
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
December 31,
-----------------------------
1998 1997
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ............................. $ 1,452,000 $ 1,667,000
Accounts receivable ................................... 361,000 507,000
Prepaid expenses ...................................... 74,000 --
------------ ------------
Total Current Assets .................................. 1,887,000 2,174,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method .......................... 26,800,000 27,822,000
Office and other ...................................... 384,000 383,000
------------ ------------
27,184,000 28,205,000
Less--accumulated depletion, depreciation
and amortization .................................... (20,728,000) (18,403,000)
------------ ------------
6,456,000 9,802,000
------------ ------------
OTHER ASSETS:
Deposits and other .................................... 51,000 124,000
Debt issuance costs (net of accumulated amortization of
$346,000 and $93,000 at December 31, 1998
and 1997, respectively) ............................. 98,000 526,000
------------ ------------
149,000 650,000
------------ ------------
TOTAL ASSETS .............................................. $ 8,492,000 $ 12,626,000
============ ============
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt ..................... $ 10,000 $ --
Accounts payable ...................................... 93,000 279,000
Accrued expenses ...................................... 351,000 407,000
Royalties payable ..................................... 12,000 36,000
Accrued interest ...................................... 97,000 76,000
------------ ------------
Total Current Liabilities ............................. 563,000 798,000
------------ ------------
LONG-TERM DEBT, net of current portion .................... 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--12,134,675 and 12,118,982 shares
shares at December 31, 1998 and 1997, respectively. 121,000
121,000
Capital in excess of par value ........................ 30,171,000 30,283,000
Treasury stock, at cost (9,769 shares at
December 31, 1997) -- (38,000)
Accumulated deficit ................................... (25,588,000) (22,313,000)
------------ ------------
NET STOCKHOLDERS' EQUITY .................................. 4,704,000 8,053,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................ $ 8,492,000 $ 12,626,000
============ ============
</TABLE>
See accompanying notes to financial statements.
45
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES
Sales of oil and gas, net of royalties ............. $ 1,881,000 $ 3,851,000 3,825,000
Other income ....................................... 142,000 154,000 215,000
------------ ------------ ------------
2,023,000 4,005,000 4,040,000
------------ ------------ ------------
EXPENSES
Production and operating ........................... 595,000 1,094,000 1,172,000
Provision for depletion, depreciation
and amortization ................................. 1,365,000 2,219,000 1,623,000
General and administrative ......................... 1,547,000 1,965,000 1,924,000
Corporate relocation ............................... -- -- 216,000
Debt conversion expense ............................ -- 316,000 --
Stock offering cost ................................ -- 323,000 --
Interest ........................................... 831,000 396,000 435,000
Impairments to oil and gas properties .............. 960,000 3,650,000 --
------------ ------------ ------------
5,298,000 9,963,000 5,370,000
------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES ................. (3,275,000) (5,958,000) (1,330,000)
PROVISION FOR INCOME TAXES ............................. -- -- --
------------ ------------ ------------
NET LOSS ............................................... $ (3,275,000) $ (5,958,000) (1,330,000)
============ ============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING ............................ 12,132,362 12,086,219 11,351,211
============ ============ ============
NET LOSS PER COMMON SHARE
(BASIC AND DILUTED) .................................. $ (0.27) $ (0.49) $ (0.12)
============ ============ ============
</TABLE>
See accompanying notes to financial statements.
46
<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, 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
401(k) Plan...................... 4,835 - 14,000 - - 14,000
Common stock repurchased in
odd-lot buyback.................. (9,769) - - (38,000) - (38,000)
Common stock returned to treasury (5) - - - - -
Net loss........................... - - - - (5,958,000) (5,958,000)
---------- -------- ----------- --------- ------------ -----------
BALANCE, December 31, 1997 12,118,982 $121,000 $30,283,000 $ (38,000) $(22,313,000) $ 8,053,000
========== ======== =========== ========= ============ ===========
Common stock issued for
exercise of stock options........ 5,512 - 13,000 - - 13,000
Common stock contributed to
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.. (4) - - - - -
Net loss........................... - - - - (3,275,000) (3,275,000)
---------- -------- ----------- --------- ------------ -----------
BALANCE, December 31, 1998......... 12,134,675 $121,000 $30,171,000 $ - $(25,588,000) $ 4,704,000
========== ======== =========== ========= ============ ===========
</TABLE>
See accompanying notes to financial statements.
47
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ............................................... $ (3,275,000) $ (5,958,000) $ (1,330,000)
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
Common stock issued for directors' fees,............... -- -- 4,000
Depletion, depreciation and amortization .............. 1,365,000 2,219,000 1,623,000
Amortization of deferred financing cost ............... 428,000 147,000 74,000
Debt conversion expense ............................... -- 316,000 --
Stock offering cost ................................... -- 323,000 --
Impairments to oil and gas properties ................. 960,000 3,650,000 --
Non-cash compensation expense ......................... 44,000 58,000 20,000
Changes in assets and liabilities:
Accounts receivable ................................... 146,000 188,000 340,000
Prepaids and oil inventory ............................ (74,000) 25,000 102,000
Accounts payable and accrued expenses ................. (145,000) 525,000 (215,000)
Royalties and working interest payable ................ (24,000) (67,000) 9,000
Accrued interest ...................................... (76,000) (25,000) (18,000)
Deposits and other .................................... 35,000 (22,000) (2,000)
------------ ------------ ------------
Net cash provided by (used in) operating activities .... (616,000) 1,379,000 607,000
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties ................ (3,673,000) (4,946,000) (3,232,000)
(Increase) decrease in restricted cash ................. -- 2,293,000 937,000
Proceeds from sale of properties and equipment ......... 4,695,000 203,000 2,197,000
Net change in other property and equipment ............. 17,000 (27,000) (297,000)
------------ ------------ ------------
Net cash provided by (used in) investing activities .... 1,039,000 (2,477,000) (395,000)
------------ ------------ ------------
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 ............................ (540,000) (1,793,000) (1,979,000)
Gross proceeds from issuance of common stock ........... 13,000 103,000 2,168,000
Debt and equity offering costs ......................... (59,000) (971,000) (115,000)
Common stock and warrant repurchase .................... (52,000) (38,000) --
------------ ------------ ------------
Net cash provided by (used in) financing activities .... (638,000) 591,000 74,000
------------ ------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ...... (215,000) (507,000) 286,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR .............. 1,667,000 2,174,000 1,888,000
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, END OF YEAR .................... $ 1,452,000 $ 1,667,000 $ 2,174,000
============ ============ ============
Supplemental information:
Interest paid in cash ................................... $ 403,000 $ 249,000 $ 361,000
Common stock issued or issuable as directors' fees ...... -- -- 4,000
Common stock issued for conversion of debt .............. -- 975,000 --
Common stock issued for 401(k) Plan contribution ........ 24,000 14,000 --
</TABLE>
See accompanying notes to financial statements.
48
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
(1) GENERAL AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Fortune Natural Resources Corporation, formerly Fortune Petroleum
Corporation, is an independent energy company engaged in the acquisition,
production and exploration of oil and gas, primarily onshore and offshore
Louisiana and Texas. Fortune considers its business to be a single operating
segment.
USE OF ESTIMATES
In order to prepare financial statements in conformity with generally
accepted accounting principles, management must make estimates, judgments and
assumptions that affect the reported amounts. Actual results could differ from
those estimates.
CASH EQUIVALENTS
Fortune considers all highly liquid instruments with original maturities
of three months or less to be cash equivalents.
PROPERTY AND EQUIPMENT
Fortune 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, 1998.
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 Fortune's properties
are located in the United States. Estimated future development and abandonment
costs are included in the amortization base. Oil and gas property depreciation,
depletion and amortization expense per equivalent Mcf was $1.54, $1.62 and $1.14
for the years ended December 31, 1998, 1997, and 1996, respectively. Capitalized
costs and estimated future development costs associated with unevaluated
properties are excluded from amortization until the quantity of proved reserves
attributable to the property has been determined or impairment has occurred.
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.
49
<PAGE>
The cost of oil and gas properties net of amortization and 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
Fortune'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 1998 and 1997, Fortune
recorded $1.0 million and $3.7 million of impairments to oil and gas properties,
respectively. See note 2 regarding the 1997 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
Fortune utilizes the asset and liability method for recognizing deferred
tax assets and liabilities. Deferred taxes are recognized for future tax
consequences attributable to (1) differences between financial statement basis
of assets and liabilities and their respective tax bases and (2) tax net
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
The cost of issuing Fortune's convertible debt is being amortized over the
period that such debt is not convertible, which ends April 30, 1999.
STOCK OPTION PLANS
Prior to January 1, 1996, Fortune 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. 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, Fortune adopted SFAS
No. 123, ACCOUNTING FOR STOCK-BASED COMPENSATION. SFAS No. 123 permits entities
to either: 1) recognize as expense over the vesting period the fair value of all
stock-based awards on the date of grant or 2) continue to apply the provisions
of APB Opinion No. 25. Entities who continue to apply APB Opinion No. 25 must
provide pro forma net income and pro forma earnings per share disclosures to
employee stock option grants made after 1994 as if the fair-value-based method
defined in SFAS No. 123 had been applied. Fortune 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
Basic net loss per common share is computed by dividing net loss by the
weighted average number of common shares outstanding. Since the issuance or
conversion of additional securities would have an anti-dilutive effect, diluted
loss per share is the same as basic loss per share.
(2) RESTRICTED CASH AND ZYDECO VENTURE
Under the terms of Fortune's exploration venture agreement with Zydeco
Exploration, Inc., 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's area of
operations. Prior to June 1997, the remaining unspent contribution had been
50
<PAGE>
recorded as restricted cash on Fortune's balance sheet. On June 4, 1997, Fortune
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, Fortune's
50% working interest in each project which has not already been farmed out is
subject to a proportionate reduction if Zydeco expends additional funds on such
project.
In connection with requesting the return of unspent venture funds, Fortune
reviewed for impairment its $4.3 million remaining unevaluated investment in the
Zydeco exploration venture properties. The $4.3 million investment included 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
impairment review, Fortune transferred all of its investment in the Zydeco
exploration venture projects to the evaluated property account during 1997.
Consequently, Fortune recorded impairments to oil and gas properties during 1997
of $3.7 million.
(3) SALE OF EAST BAYOU SORREL
On March 31, 1998, Fortune 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 Fortune's interest in
the Schwing #1 and #2 wells and all of the associated leases, facilities and
interests.
Fortune's interest in the two productive wells at East Bayou Sorrel were
pledged to secure the 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, Fortune paid down all but $10,000 of the
outstanding balance of the credit facility.
The Schwing #1 and #2 wells began producing 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 Fortune'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. During 1997 and 1998, Fortune incurred approximately $1 million
to drill and attempt completion of this well as a result of difficult drilling
conditions and mechanical problems. Selected unaudited financial information
attributable to Fortune's interest in the East Bayou Sorrel field as reported in
its 1997 and 1998 financial results is as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1998 1997
---------- ----------
<S> <C> <C>
Production Oil (Bbls) 12,000 55,000
Gas (Mcf) 18,000 78,000
Oil and gas revenues $ 231,000 $1,241,000
Production and operating expense 60,000 205,000
Provision for depletion, depreciation
and amortization 54,000 430,000
</TABLE>
<TABLE>
<CAPTION>
As of December 31, 1997
------------------------
<S> <C>
Estimated net reserve quantities
of total proved reserves
Oil (Bbls) 152,000
Gas (Mcf) 204,000
</TABLE>
51
<PAGE>
This represents 32% and 30% of Fortune's 1997 oil and gas revenues and
production and 23% of proved reserves as of December 31, 1997. Consequently,
Fortune's revenues and cash flow from operations have decreased significantly
since the sale.
Under the full cost method of accounting, 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% of the reserve quantities in a given cost center. Because the sale of
East Bayou Sorrel represents less than 25% of Fortune'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, Fortune recorded impairments to oil and gas
properties. Consequently, if Fortune had reported a gain on the sale of this
property, it would have been completely offset by additional impairments to oil
and gas properties.
(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, 1998, 1997
and 1996 were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
----------- ------------ ------------
<S> <C> <C> <C>
Capitalized costs of oil and gas properties $26,800,000 $ 27,822,000 $ 23,079,000
Less accumulated depletion,
depreciation and amortization (20,422,000) (18,137,000) (12,308,000)
----------- ------------ ------------
$ 6,378,000 $ 9,685,000 $ 10,771,000
=========== ============ ============
</TABLE>
The unproved properties portion of capitalized costs was $2.6 million,
$3.2 million, and $4.9 million in 1998, 1997 and 1996, respectively.
Costs incurred in oil and gas producing activities were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Property acquisition
Unproved............................ $ 437,000 $ 333,000 $ 77,000
Proved.............................. - 368,000 -
Exploration........................... 2,558,000 2,285,000 2,317,000
Development........................... 678,000 1,960,000 838,000
---------- ---------- ----------
$3,673,000 $4,946,000 $3,232,000
========== ========== ==========
</TABLE>
52
<PAGE>
The results of operations from oil and gas producing activities for the
years ended December 31, 1998, 1997 and 1996, are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Revenues from oil and gas producing activities:
Sales to unaffiliated parties...................... $ 1,881,000 $ 3,851,000 $ 3,825,000
------------ ------------ ------------
Expenses -
Production and operating.............................. 595,000 1,094,000 1,172,000
Depreciation, depletion and amortization.............. 1,325,000 2,179,000 1,576,000
Impairments to oil and gas properties................. 960,000 3,650,000 -
------------ ------------ ------------
Total expenses........................................ 2,880,000 6,923,000 2,748,000
------------ ------------ ------------
Pretax income (loss) from producing activities........ (999,000) (3,072,000) 1,077,000
Income tax expense.................................... - - -
------------ ------------ ------------
Results of oil and gas producing activities
(excluding corporate overhead and interest costs)... $ (999,000) $ (3,072,000) $ 1,077,000
</TABLE>
(5) LONG-TERM DEBT
A summary of long-term debt follows:
<TABLE>
<CAPTION>
December 31,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Convertible Subordinated Notes due December 31, 2007....... $ 3,225,000 $ 3,225,000
Credit Lyonnais credit facility due July 11, 1999,
including interest at 1.25% over the bank's base rate..... 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
============ ============
</TABLE>
During November and December of 1997, Fortune closed a private placement
of 12% Convertible Subordinated Notes due December 31, 2007. An aggregate of
$3,225,000 principal amount of notes was sold, and Fortune received $2,815,000
of proceeds, net of offering expenses and commissions.
The notes are convertible into Fortune'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 Fortune
sells shares of its common stock at a price below the conversion price. The
notes are redeemable by Fortune 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 Fortune'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
Fortune's common stock price averages less than the conversion price for a
certain period prior to May 1, 1999. If the conversion price were based on the
closing price of the stock on March 12, 1999, approximately 9.8 million
additional shares would be issuable upon conversion of the notes. At the time
the notes were issued, Fortune determined the value of the potential adjustments
to the conversion price to be immaterial. The notes are subordinate to all of
Fortune'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%.
53
<PAGE>
A portion of the net proceeds of the notes placement was used to refinance
existing debt. On December 5, 1997, Fortune redeemed the remaining outstanding
balance of $1,028,000 of Fortune's debentures due December 31, 1997. In
addition, $315,000 of net proceeds was used to reduce the borrowings under
Fortune's credit facility with Credit Lyonnais.
As discussed in the proceeding paragraph, the remaining balance on the 10
1/2% Convertible Subordinated Debentures was repaid on December 5, 1997. The
debentures bore an effective interest rate of 12.13% and were convertible into
shares of Fortune's common stock at a conversion price of $6.32 per share. On
February 26, 1997, Fortune closed an exchange offer for these debentures which
resulted in $697,000, or $680,000 net of discount, principal amount of
debentures being converted to 218,858 shares of common stock. Fortune also
issued 174,250 common stock warrants to the debentureholders who exchanged their
debentures. 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,
Fortune recorded a non-cash debt conversion expense of $316,000 during the first
quarter of 1997. The $316,000 non-cash expense is 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 under
their original terms. For purposes of calculating the non-cash debt conversion
expense, Fortune valued the 218,858 shares of common stock issued in connection
with the exchange offer at $547,502. This value is based on the closing price of
the common stock on the American Stock Exchange on February 26, 1997 of $2.625
per share. Fortune estimated the value of the common stock warrants issued to
the debentureholders at $8,713, or $0.05 per warrant.
On July 11, 1997, Fortune refinanced its bank debt by entering into a $20
million credit facility with Credit Lyonnais New York Branch. The credit
facility is due July 11, 1999, extendable for one year upon mutual consent. On
March 31, 1998, Fortune repaid all but $10,000 of the outstanding balance of the
credit facility with a portion of the proceeds from the sale of East Bayou
Sorrel. Prior to Fortune's sale of the East Bayou Sorrel field, Fortune's
borrowing base was $2 million. The bank has not completed its redetermination of
the borrowing base subsequent to this sale; consequently, Fortune does not know
how much, if any, is currently available for borrowing under this credit
facility. Under the credit facility, once the borrowing base is redetermined,
Fortune may borrow up to a pre-determined borrowing base, for acquisitions and
development projects approved by Credit Lyonnais at either 1.25% above Credit
Lyonnais' base rate or 4% above LIBOR. The credit facility is secured by a
mortgage on all of Fortune's proved oil and gas properties. Fortune is also
required to pay a commitment fee of 0.5% on the unused portion of the borrowing
base. At December 31, 1998, the interest rate on this credit facility was 9%.
Primarily as a result of the lower revenues in 1998 because of lower oil
and gas prices and the sale of East Bayou Sorrel, Fortune 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 December 31, 1998. Fortune
received a waiver of this covenant from the bank for the period ended December
31, 1998. Fortune will need waivers of this debt covenant in future periods
until operating cash flow increases significantly.
The $10,000 balance on this credit facility matures in 1999.
54
<PAGE>
(6) INCOME TAXES
No provision for income taxes was required for the years ended December
31, 1998, 1997 and 1996. Deferred taxes consist of the following:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................. $4,539,000 $4,990,000
Difference in basis of oil and gas properties.... 3,267,000 1,517,000
---------- ----------
7,806,000 6,507,000
Less valuation allowance (100%).................. 7,806,000 6,507,000
---------- ----------
Net deferred taxes............................... $ - $ -
========== ==========
</TABLE>
At December 31, 1998, Fortune estimates it had cumulative net operating
loss carryforwards for federal income tax purposes of approximately $13.3
million which, subject to significant restrictions under I.R.C. 382, is
available to offset future federal taxable income, if any. The net operating
losses expire from 2002 through 2013. Fortune also has available IRC Section 29
Tax Credits that may be used to reduce or eliminate federal income tax through
the year 2001. Fortune is uncertain as to the recoverability of the above
deferred tax assets and has therefore applied a 100% valuation allowance.
(7) STOCK OFFERINGS
In December 1996, Fortune 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, Fortune issued to the acquiring shareholders one
common stock warrant for every two common stock shares acquired. The 206,000
warrants were exercisable for a period of two years at a price of $3.50 per
share. 137,500 of these warrants expired in December 1998 and the remaining
68,500 were extended for one year at an exercise price of $3.625 per warrant.
(8) COMMITMENTS AND CONTINGENCIES
Fortune has an employment agreement with its President and Chief Executive
Officer that provides for an annual salary of $168,000 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 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 Fortune's common stock.
55
<PAGE>
Fortune leases office space under a non-cancelable operating lease. Rental
expense under the office lease for the years ended December 31, 1998, 1997 and
1996 was $89,000, $86,000 and $75,000, respectively.
Minimum future lease payments under the non-cancelable operating leases
are as follows:
Year ending December 31,
1999...................... $ 95,000
2000...................... 95,000
2001...................... 40,000
--------
$230,000
========
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 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 Fortune 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 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 Fortune 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 vigorously
defend plaintiffs' actions and prosecute its own counterclaims. Discovery has
been stayed pending a ruling by the court on a motion filed by one of these
third-party defendants.
(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 Fortune's
common stock, was managing director for the placement agent at the time of the
offering 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 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. Mr. Blank's mother also acquired
$50,000 of notes. Mr. Blank disclaims beneficial ownership of the notes
purchased by his mother. Barry Feiner, a director of Fortune, 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 board of director matters
associated with the private placement.
56
<PAGE>
As part of the relocation of its headquarters to Houston, Texas, Fortune
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 Fortune 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. As of January 31, 1999, the entire amount of the loan has
been forgiven. The $70,000 loan also bears interest at the rate of 6% per annum,
payable interest only for two years, with $35,000 principal payments due on the
second and third anniversaries of the loan. Mr. Fairbanks had repaid all but
$5,000 of the $70,000 loan as of December 31, 1998. On December 4, 1998, Fortune
granted an extension of the due date of the remaining loan balance to July 1,
1999.
Until his employment by Fortune 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 Fortune since its incorporation in May 1987. Mr. Drulias has served
as a director since 1990 and as Secretary since July 1994. During 1996, his firm
billed Fortune a total of $152,000 for legal fees and costs.
On January 22, 1997, Fortune's board of directors appointed Daniel R.
Shaughnessy as a director of Fortune. 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 Fortune. During 1998, 1997 and 1996, Mr.
Shaughnessy's firm billed Fortune a total of $421,000, $182,000 and $45,000,
respectively, for geological and geophysical consulting.
Petro-Guard Company, Inc., the operator at Espiritu Santo Bay, is owned by
Dewey A. Stringer III. Mr. Stringer has been a director of Fortune since April
1998. As the operator of Espiritu Santo Bay, Petro-Guard bills Fortune and the
other Espiritu Santo Bay partners their share of the monthly expenditures on the
project. As such, Petro-Guard billed Fortune $1,042,000 of Espiritu Santo Bay
exploration expenditures in 1998.
As compensation to outside directors, Fortune pays directors' fees of
$2,500 per quarter. Inside directors do not receive such compensation.
(10) STOCKHOLDERS' EQUITY
On September 30, 1997 Fortune completed an odd-lot shareholder stock buy
back wherein Fortune offered to buy for $3.00 per share the common stock owned
by shareholders who held fewer than 100 shares of Fortune's common stock.
Fortune initiated the odd-lot buy back to reduce the cost of administering
odd-lot shareholders. As a result, 9,769 shares of Fortune's common stock were
acquired as treasury stock. The treasury stock was cancelled in 1998.
Fortune has two stock option plans only one of which, the 1998 plan, has
options available for grant. The plans cover all officers, directors and
employees of Fortune. The board of directors grants awards upon recommendations
of its compensation committee. There is no performance formula or measure.
Options granted under the plans must be exercised within five years of the date
of grant or they are forfeited.
Fortune follows the intrinsic value method for stock option grants. In
October 1995, the FASB issued Statement of Financial Accounting Standard No.
123, "Accounting for Stock-Based Compensation." Fortune 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 Fortune's stock option
plans been determined based upon the methodology prescribed under FAS 123, the
impact on Fortune's reported net loss and loss per share would have been:
57
<PAGE>
Year ended December 31,
-----------------------
1998 1997 1996
----- ----- -----
Impact on net loss:
Increase in net loss (millions) $ 0.5 $ 0.6 $ 0.5
Increase in net loss per share $0.04 $0.05 $0.05
The fair value on the date of grant of the options granted during 1998 is
estimated as $0.68 per common stock option using the Black-Scholes
option-pricing model. Fortune used the following assumptions 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,
-----------------------
1998 1997 1996
----- ----- -----
Assumptions:
Dividend yield 0% 0% 0%
Volatility 65% 65% 65%
Risk-free interest rate 5.7% 6.3% 6.14%
Forfeiture rate 5% 5% 5%
Expected life (years) 2.5 2.5 2.5
Common stock option transactions were:
<TABLE>
<CAPTION>
Weighted Average
Number of Exercise Price
Options Exercisable of Options
------------------- ----------------
<S> <C> <C>
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 2.80
Exercised........................ (6,400) 2.75
Forfeited........................ (20,411) 2.74
--------- -----
Balance, December 31, 1997....... 1,502,898 2.96
Granted.......................... 757,500 1.57
Exercised........................ (1,200) 1.56
Forfeited........................ (115,975) 2.96
--------- -----
Balance, December 31, 1998....... 2,143,223 $2.47
========= =====
</TABLE>
The above table includes 80,000 common stock warrants which were issued to
employees in 1995 and 1996 in lieu of common stock options.
58
<PAGE>
All options are immediately exercisable upon grant. At December 31, 1998,
Fortune had 1,213,467 common stock options available for grant during 1999 under
the 1998 Stock Option Plan.
The following table summarizes information concerning currently
outstanding and exercisable options and warrants issued in lieu of options:
<TABLE>
<CAPTION>
Options Outstanding and Exercisable
----------------------------------------
Weighted
Average Weighted
Range of Remaining Average
Exercise Number Contractual Exercise
Price Outstanding Life Price
-------------- ----------- ----------- ---------
<S> <C> <C> <C>
$1.50 to $3.25 2,143,223 2.6 years $2.47
</TABLE>
At December 31, 1998 Fortune's outstanding common stock purchase warrants
consisted of (b):
<TABLE>
<CAPTION>
Number of Warrants Exercise Price Expiration Date
------------------ -------------- ---------------
<S> <C> <C>
100,000 $ 3.50 3/31/99
50,000 $ 4.00 5/19/99
75,000 $ 2.82 8/29/99
1,779,713 (a) $ 2.61 9/28/99
87,125 $ 4.00 12/2/99
87,125 $ 5.00 12/2/99
31,000 $ 3.63 12/3/99
37,500 $ 3.63 12/5/99
35,000 $ 2.75 1/06/00
27,600 $ 3.19 2/25/00
685,000 $ 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
80,000 $ 1.03 8/21/01
20,000 $ 2.44 8/29/01
10,000 $ 2.44 9/06/01
17,917 $ 3.60 11/30/02
---------
3,682,980
=========
</TABLE>
- -------------
(a) Warrants permit the holders to purchase 2,558,337 total shares of common
stock.
(b) Table excludes warrants that have been issued to employees in lieu of
stock options.
On April 15, 1998, Fortune closed a voluntary offer to exchange its
1,917,000 publicly traded common stock warrants and 63,000 private warrants for
new private warrants. These old warrants would have expired September 28, 1998.
1,779,713 old warrants were tendered and accepted by Fortune, representing 93%
of the outstanding public warrants. An additional 3,000 public warrants were
exercised by warrantholders during the exchange offer period. The new private
warrants which expire September 28, 1999 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 are similar to the old
warrants. Fortune did not receive any proceeds as a result of this exchange
offer, but incurred $59,000 of offering expense that was charged to
stockholders' equity in 1998. The old warrants that were not exchanged expired
on September 28, 1998.
59
<PAGE>
In May 1998, Fortune repurchased 515,000 of its then outstanding private
common stock warrants for $0.10 per warrant. The warrants were exercisable at
$4.75 per share and would have expired April 2000. The purchase price was
charged to stockholders' equity.
(11) MAJOR CUSTOMERS AND PRODUCTION CONCENTRATION
Fortune routinely sells over 10% of its oil and gas revenues to single
customers. The following table shows the percentage of oil and gas revenues to
each customer who exceeded 10% of total such revenues during 1998, 1997 and
1996:
1998 1997 1996
---- ---- ----
Largest customer 29% 27% 34%
Next largest customer 14% 25% 16%
Next largest customer 11% 11% 14%
Next largest customer 10% 12%
---- ---- ----
Total sold to all customers who exceed 10% 64% 63% 76%
==== ==== ====
Approximately 40% of Fortune's oil and gas revenues, cash flow, and proved
oil and gas reserves are currently accounted for by a single well at South
Timbalier Block 76. This well was shut-in for repairs for one month in 1997 and
for over two months during 1996 as the result of mechanical failures. A
significant curtailment or loss of production for a prolonged period before we
could replace the reserves through new discoveries or acquisitions would have a
material adverse effect on our projected operating results and financial
condition.
(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, Fortune 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 limitations. Salary deferrals
will be matched 50% by Fortune, subject to IRS limitations, and are 100% vested
after two years of service with the company. Salary deferrals are 100% vested at
all times. Fortune makes its matching contribution in shares of Fortune common
stock. Fortune does not make profit sharing contributions to the plan. For the
1998, 1997 and 1996 plan years, Fortune's matching contribution liability was
$24,000, $24,000 and $14,000, respectively.
(14) UNAUDITED OIL AND GAS PRODUCINGACTIVITIES AND OIL AND GAS COST INFORMATION
All of Fortune'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.
60
<PAGE>
For the years ended December 31, 1998, 1997 and 1996, the oil and gas
reserve estimates were determined by Huddleston & Co., Inc., 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 proved reserves and in the
projection of future production, prices and costs. 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. They should not be construed to be the current market values of
Fortune's oil and gas reserves or the costs that would be incurred to obtain
equivalent reserves.
CHANGES IN ESTIMATED RESERVE QUANTITIES
Fortune's net interests in estimated quantities of proved developed and
undeveloped reserves of oil and gas at December 31, 1998, 1997, and 1996, and
changes in such quantities during the years then ended were as follows:
<TABLE>
<CAPTION>
Oil (MBbls)
--------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
BEGINNING OF PERIOD................. 257 249 347
Revisions of previous estimates... 16 (1) 6
Extensions and discoveries........ 15 88 106
Production........................ (42) (87) (57)
Purchase of minerals in place..... - 13 -
Sales of minerals in place........ (140) (5) (153)
------ ------ ------
END OF PERIOD....................... 106 257 249
====== ====== ======
Proved developed reserves
Beginning of period.............. 198 160 324
====== ====== ======
End of period.................... 47 198 160
====== ====== ======
</TABLE>
<TABLE>
<CAPTION>
Gas (Mmcf)
--------------------------
1998 1997 1996
------ ------ ------
<S> <C> <C> <C>
BEGINNING OF PERIOD................. 3,217 3,481 5,938
Revisions of previous estimates... 306 431 (753)
Extensions and discoveries........ 354 187 85
Production........................ (609) (821) (1,038)
Purchase of minerals in place..... - 11 -
Sales of minerals in place........ (186) (72) (751)
------ ------ ------
END OF PERIOD....................... 3,082 3,217 3,481
====== ====== ======
Proved developed reserves
Beginning of period............. 1,548 1,749 4,686
====== ====== ======
End of period .................. 1,413 1,548 1,749
====== ====== ======
</TABLE>
61
<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" and based on oil and gas reserve and
production volumes determined by Fortune's reserve engineers. It may be useful
for certain comparative purposes, but should not be solely relied upon in
evaluating Fortune 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 Fortune.
Fortune believes that the following factors should be taken into account
in reviewing this information:
o future costs and selling prices will probably differ from those required
to be used in these calculations;
o due to future market conditions and governmental regulations, actual rates
of production in future years may vary significantly from the rate of
production assumed in the calculations;
o 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
o 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. SFAS
No. 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>
1998 1997 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Future cash inflows..................... $ 8,709 $ 12,717 $ 19,751
Future costs:
Production........................... (2,807) (3,346) (4,026)
Development.......................... (917) (961) (1,613)
-------- -------- --------
Future net inflows before income taxes.. 4,985 8,410 14,112
Future income taxes..................... - - -
-------- -------- --------
Future net cash flows................... 4,985 8,410 14,112
10% discount factor..................... (1,458) (1,907) (3,292)
-------- -------- --------
Standardized measure of
discounted net cash flows............. $ 3,527 $ 6,503 $ 10,820
======== ======== ========
</TABLE>
62
<PAGE>
The average prices received by Fortune at year end 1998, 1997 and 1996 and
used in determining year end proved reserves were as follows:
1998 1997 1996
------ ------ ------
Oil - $/Bbl $ 9.85 $16.90 $22.79
Gas - $/Mcf $ 2.25 $ 2.60 $ 4.04
As of March 4, 1999, Fortune was receiving an average of approximately
$1.70 per Mcf for its gas production and $11.00 per Bbl for its oil production.
The current gas prices represent a decline from December 1998 prices.
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>
1998 1997 1996
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Standardized Measure:
Beginning of period.................................. $ 6,503 $ 10,820 $ 8,942
Increases (decreases):
Sales and transfers, net of production costs......... (1,286) (2,757) (2,653)
Extensions and discoveries........................... 541 1,571 1,532
Net change in sales and transfer prices,
net of production costs............................ (964) (4,643) 5,233
Changes in estimated future development costs........ - 245 (332)
Development costs incurred during the period......... - 400 -
Revisions of quantity estimates...................... 418 630 (1,473)
Accretion of discount................................ 650 1,082 894
Purchases of reserves in place....................... - 191 -
Sales of reserves in place........................... (1,870) (199) (1,612)
Changes in timing of production and other........... (465) (837) 289
-------- -------- --------
Standardized Measure:
End of period........................................ $ 3,527 $ 6,503 $ 10,820
======== ======== ========
</TABLE>
63
<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 12,
1999.
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
- ------------------------------ President, Chief Executive
Tyrone J. Fairbanks Officer and Director March 12, 1999
/s/ Dean W. Drulias Executive Vice President,
- ------------------------------ General Counsel, Corporate
Dean W. Drulias Secretary and Director March 12, 1999
/s/ Graham S. Folsom
- ------------------------------
Graham S. Folsom Director March 12, 1999
/s/ Barry Feiner
- ------------------------------
Barry Feiner Director March 12, 1999
/s/ Gary Gelman
- ------------------------------
Gary Gelman Director March 12, 1999
/s/ D. R. Shaughnessy
- ------------------------------
D. R. Shaughnessy Director March 12, 1999
/s/ Dewey A. Stringer, III
- ------------------------------
Dewey A. Stringer, III Director March 12, 1999
64
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Fortune Natural Resources Corporation:
We consent to incorporation by reference of our report dated March 5, 1999,
relating to the balance sheets of Fortune Natural Resources Corporation as of
December 31, 1998, and 1997, and the related statements of operations,
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1998, which report appears in the December 31, 1998,
annual report on Form 10-K of Fortune Natural Resources Corporation in the
following registration statements of Fortune Natural Resources Corporation: (i)
No. 333-35417 on Form S-8 dated September 11, 1997 and (ii) No.
333-60557 on Form S-8 dated August 4, 1998.
/s/ KPMG LLP
Houston, Texas
March 12, 1999
HUDDLESTON & CO., INC.
PETROLEUM AND GEOLOGICAL ENGINEERS
1111 FANNIN-SUITE 1700
HOUSTON, TEXAS 77002
-----
PHONE (713) 209-1100 - FAX (713) 752-0828
CONSENT OF INDEPENDENT PETROLEUM ENGINEER
March 12, 1999
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 12, 1999, 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, 1996, December 31,
1997 and December 31, 1998.
HUDDLESTON & CO., INC.
/s/ Gregory S. Floyd, P.E.
-----------------------------
Gregory S. Floyd, P.E.
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 1,452
<SECURITIES> 0
<RECEIVABLES> 361
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 1,887
<PP&E> 27,184
<DEPRECIATION> 20,728
<TOTAL-ASSETS> 8,492
<CURRENT-LIABILITIES> 563
<BONDS> 0
0
0
<COMMON> 121
<OTHER-SE> 4,583
<TOTAL-LIABILITY-AND-EQUITY> 8,492
<SALES> 1,881
<TOTAL-REVENUES> 2,023
<CGS> 0
<TOTAL-COSTS> 595
<OTHER-EXPENSES> 1,365
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 831
<INCOME-PRETAX> (3,275)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,275)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (3,275)
<EPS-PRIMARY> (0.27)
<EPS-DILUTED> (0.27)
</TABLE>
