SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
JUNE 30, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD
FROM _________ TO _________
COMMISSION FILE NO. 1-12334
FORTUNE NATURAL RESOURCES CORPORATION
(Exact Name of Registrant as specified in its charter)
Delaware 95-4114732
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Commerce Green, 515 W. Greens Rd.,
Suite 720, Houston, Texas 77067
(Address of Principal Executive Offices) (Zip Code)
281-872-1170
-------------------------
Issuer's telephone number
N/A
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No ___
Applicable only to corporate issuers:
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
12,236,811 as of July 31, 1999
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ................................ $ 637,000 $ 1,452,000
Accounts receivable ...................................... 283,000 361,000
Prepaid expenses ......................................... 47,000 74,000
------------ ------------
Total Current Assets .................................. 967,000 1,887,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method ............................. 27,109,000 26,800,000
Office and other ......................................... 384,000 384,000
------------ ------------
27,493,000 27,184,000
Less--accumulated depletion, depreciation
and amortization........................................ (21,168,000) (20,728,000)
------------ ------------
6,325,000 6,456,000
------------ ------------
OTHER ASSETS:
Deposits and other ....................................... 51,000 51,000
Debt issuance costs (net of accumulated amortization of
$347,000 at December 31, 1998) ......................... - 98,000
------------ ------------
51,000 149,000
------------ ------------
TOTAL ASSETS ................................................ $ 7,343,000 $ 8,492,000
============ ============
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
1999 1998
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt ........................ $ 10,000 $ 10,000
Accounts payable ......................................... 61,000 93,000
Accrued expenses ......................................... 87,000 351,000
Royalties and working interests payable .................. - 12,000
Accrued interest ......................................... 97,000 97,000
------------ ------------
Total Current Liabilities ............................. 255,000 563,000
------------ ------------
LONG-TERM DEBT .............................................. 3,225,000 3,225,000
------------ ------------
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 12,196,811 and 12,134,675 at
June 30, 1999 and December 31, 1998, respectively ..... 122,000 121,000
Capital in excess of par value ........................... 30,273,000 30,171,000
Accumulated deficit ...................................... (26,532,000) (25,588,000)
------------ ------------
NET STOCKHOLDERS' EQUITY .................................... 3,863,000 4,704,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................. $ 7,343,000 $ 8,492,000
============ ============
</TABLE>
See accompanying notes to financial statements
2
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Six Months Ended
---------------------------
June 30, June 30,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties ............... $ 676,000 $ 1,123,000
Other income ......................................... 24,000 76,000
------------ ------------
700,000 1,199,000
------------ ------------
COSTS AND EXPENSES
Production and operating ............................. 202,000 359,000
Provision for depletion, depreciation
and amortization..................................... 440,000 830,000
Impairment to oil and gas properties ................. - 260,000
General and administrative ........................... 648,000 813,000
Note restructuring cost .............................. 61,000 -
Interest paid in cash ................................ 194,000 209,000
Interest - amortization of deferred financing cost ... 99,000 192,000
------------ ------------
1,644,000 2,663,000
------------ ------------
LOSS BEFORE INCOME TAXES ................................ (944,000) (1,464,000)
PROVISION FOR INCOME TAXES .............................. - -
------------ ------------
NET LOSS ................................................ $ (944,000) $ (1,464,000)
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING ............. 12,165,835 12,127,877
============ ============
NET LOSS PER COMMON SHARE (BASIC AND DILUTED) ........... $ (0.08) $ (0.12)
============ ============
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Three Months Ended
---------------------------
June 30, June 30,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties................ $ 421,000 $ 417,000
Other income.......................................... 9,000 59,000
------------ ------------
430,000 476,000
------------ ------------
COSTS AND EXPENSES
Production and operating.............................. 113,000 132,000
Provision for depletion, depreciation and amortization 230,000 260,000
Impairment to oil and gas properties.................. - 260,000
General and administrative............................ 357,000 354,000
Interest paid in cash................................. 97,000 99,000
Interest - amortization of deferred financing cost.... 26,000 96,000
------------ ------------
823,000 1,201,000
------------ ------------
LOSS BEFORE INCOME TAXES................................. (393,000) (725,000)
PROVISION FOR INCOME TAXES............................... - -
------------ ------------
NET LOSS................................................. $ (393,000) $ (725,000)
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING.............. 12,193,734 12,133,479
============ ============
NET LOSS PER COMMON SHARE (BASIC AND DILUTED)............ $ (0.03) $ (0.06)
============ ============
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1998
AND THE SIX MONTHS ENDED JUNE 30, 1999
<TABLE>
<CAPTION>
Common Stock Capital in Stock-
---------------------- Excess of Treasury Accumulated holders'
Shares Amount Par Value Stock Deficit Equity
---------- --------- ----------- -------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1997 ......... 12,118,982 $ 121,000 $30,283,000 $(38,000) $(22,313,000) $ 8,053,000
Common stock issued for
exercise of warrants ............ 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
========== ========= =========== ======== ============ ===========
Common stock contributed to
401(k) Plan ..................... 22,137 - 29,000 - - 29,000
Warrants issued for
note restructuring .............. - - 61,000 - - 61,000
Common stock issued for
directors' fees ................. 40,000 1,000 12,000 - - 13,000
Common stock returned to treasury... (1) - - - - -
Net loss............................ - - - - (944,000) (944,000)
---------- --------- ----------- -------- ------------ -----------
BALANCE, June 30, 1999
(Unaudited) ..................... 12,196,811 $ 122,000 $30,273,000 $ - $(26,532,000) $ 3,863,000
========== ========= =========== ======== ============ ===========
</TABLE>
See accompanying notes to financial statements.
5
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Six Months Ended
-------------------------
June 30, June 30,
1999 1998
----------- -----------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ..................................................... $ (944,000) $(1,464,000)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depletion, depreciation and amortization .................. 440,000 830,000
Non-cash compensation expense ............................. 20,000 20,000
Common stock issued for directors' fees ................... 13,000 -
Amortization of deferred financing cost ................... 99,000 192,000
Impairment of oil and gas assets .......................... - 260,000
Note restructuring cost ................................... 61,000 -
Changes in assets and liabilities:
Accounts receivable ....................................... 78,000 72,000
Prepaids .................................................. 27,000 (99,000)
Accounts payable and accrued expenses ..................... (296,000) (231,000)
Royalties and working interest payable .................... (12,000) (25,000)
Accrued interest .......................................... - (76,000)
Other ..................................................... 8,000 23,000
----------- -----------
Net cash used in operating activities ........................ (506,000) (498,000)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties ...................... (309,000) (1,711,000)
Proceeds from sale of properties and equipment ............... - 4,695,000
Expenditures for other property and equipment and other assets - 17,000
----------- -----------
Net cash provided by (used in) investing activities .......... (309,000) 3,001,000
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long term debt .................................. - (540,000)
Proceeds from issuance of common stock ....................... - 11,000
Expenditures for debenture exchange and other offerings....... - (59,000)
Repurchase of private warrants ............................... - (52,000)
----------- -----------
Net cash used in financing activities ........................ - (640,000)
----------- -----------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS .......................................... (815,000) 1,863,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .................. 1,452,000 1,667,000
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ........................ $ 637,000 $ 3,530,000
=========== ===========
Supplemental information:
Interest paid in cash ........................................ $ 194,000 $ 209,000
Non-cash transactions
Common stock issued for 401(k) Plan contribution ............. 29,000 24,000
Common stock issued for directors' fees ...................... 13,000 -
</TABLE>
See accompanying notes to financial statements
6
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
June 30, 1999
(1) LINE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
AND PROCEDURES
The condensed financial statements at June 30, 1999, and for the periods
then ended included herein have been prepared by Fortune Natural Resources
Corporation, without audit, pursuant to the rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
rules and regulations. However, Fortune believes that the disclosures are
adequate to make the information presented not misleading. These condensed
financial statements should be read in conjunction with the financial statements
and the notes thereto included in Fortune's latest annual report on Form 10-K.
Certain reclassifications have been made to prior period amounts to conform to
presentation in the current period. In Fortune's opinion, the financial
statements reflect all adjustments, consisting only of normal recurring
adjustments, necessary to present fairly its financial position for the dates
presented and the results of its operations and its cash flows for the periods
presented. The results of the operations for these interim periods are not
necessarily indicative of the results for the full year.
(2) LONG-TERM DEBT
At June 30, 1999, a summary of long-term debt is as follows:
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------- -----------
<S> <C> <C>
Convertible Subordinated Notes due December 31, 2007...... $ 3,225,000 $ 3,225,000
Credit Lyonnais credit facility due December 31, 1999..... 10,000 10,000
----------- -----------
Total long-term debt...................................... 3,235,000 3,235,000
Less current installments................................. (10,000) (10,000)
----------- -----------
Long-term debt, excluding current installments............ $ 3,225,000 $ 3,225,000
=========== ===========
</TABLE>
In March 1999, noteholders representing $2,295,000 principle amount of the
Convertible Subordinated Notes agreed to amend the conversion price of their
notes. As a result, the amended notes are convertible into Fortune's common
stock at a conversion price of $0.75 per share, subject to adjustment for
certain recapitalizations or dividends of Fortune. The remaining $930,000
principal amount of notes are convertible into Fortune's common stock at a
conversion price of approximately $0.33 per share, subject to adjustment for
certain recapitalizations or dividends of Fortune. As of May 1, 1999, all notes
are convertible by the holders and/or redeemable by Fortune. The notes are
redeemable by Fortune at a premium that reduces monthly from 10% to zero from
May 1999 to November 2000. Any such premium on redemption is waived if Fortune's
common stock price averages at least $4.50 per share for 30 consecutive trading
days. 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 cost incurred to issue the original notes has
been amortized as additional interest expense over the 18-month period ended May
1, 1999, the first date that the notes were convertible. As a
7
<PAGE>
result of this amortization of issuance costs, the effective interest rate of
the notes over this 18-month period was 21.2%. If the notes are held to
maturity, the effective interest rate to maturity will be 13.4%.
For agreeing to amend their conversion price, the amending noteholders
received one three-year warrant, exercisable at $1 each, for each share into
which each of their notes is now convertible. Fortune valued this warrant at
$0.02 per warrant and expensed the value of all such warrants during the first
quarter of 1999 as note restructuring cost.
Fortune's $20 million credit facility with Credit Lyonnais New York Branch
was to expire July 11, 1999; however, it has been extended to December 31, 1999.
Upon mutual consent, it is extendable through July 11, 2000. 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. (See note 6).
Prior to its sale of the East Bayou Sorrel field, Fortune's borrowing base was
$2 million. The bank has not redetermined 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. Once the borrowing base is
redetermined, Fortune may borrow up to that amount 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 existing proved oil and gas properties. Fortune is
also required to pay a commitment fee of 0.5% on the unused portion, if any, of
the borrowing base.
Primarily as a result of the lower revenues after 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-months
period ended June 30, 1999. Fortune has requested a waiver of this covenant from
the bank for the period ended June 30, 1999.
The $10,000 balance on the credit facility matures December 31, 1999.
(3) INCOME TAX EXPENSE
No provision for income taxes was required for the six months ended June
30, 1999.
At June 30, 1999, Fortune estimates it had cumulative net operating loss
carryforwards for federal income tax purposes of approximately $14 million which
are significantly restricted under IRC Section 382. These carryforwards are
available to offset future federal taxable income, if any, with various
expirations through 2014. Fortune also has net operating loss carryforwards in
certain states, including California, New Mexico and Texas, with various
expiration dates and restrictions. Fortune is uncertain as to the recoverability
of these deferred tax assets and has therefore applied a 100% valuation
allowance.
Fortune has available IRC Section 29 Tax Credits that may be used to
reduce or eliminate any corporate taxable income in future years. It is
uncertain at this time to what extent Fortune will be able to utilize these
federal tax credits, as their utilization is dependent upon the amount, if any,
of future federal income tax incurred, after application of the company's net
operating loss carryforwards.
(4) LEGAL PROCEEDINGS
There are no material pending legal proceedings involving any of Fortune's
properties or which involve a claim for damages which exceed 10% of the
company's current assets.
8
<PAGE>
On April 16, 1996, Fortune was served with two lawsuits which had been
filed in the Federal District Court in New York by purchasers of Fortune common
stock in an offering in December 1995 under Regulation S. Under the terms of the
subscription agreement pursuant to which the plaintiffs acquired their shares,
each was entitled to receive additional shares of Fortune common stock if the
market price fell below a stated level during a specified period following the
40-day holding period prescribed by Regulation S. Fortune responded to the
suits, admitting that the stock price declined but alleged that suspicious
trading activity in Fortune stock occurred immediately prior to and during the
time period in which the additional-share allocation was computed. Fortune
believes that it has discovered evidence of active market manipulation in the
common stock by these plaintiffs; accordingly, it has commenced a countersuit
for damages suffered by Fortune and its shareholders as a result of these acts
and has also added certain third-party defendants whose actions furthered this
market manipulation. Fortune intends to continue to vigorously defend
plaintiffs' actions and prosecute its own counterclaims. Discovery is proceeding
on this matter.
(5) COMPUTATION OF LOSS PER SHARE
Basic net loss per common share is computed by dividing net loss by the
weighted average number of common shares outstanding. Diluted earnings per
common share are not presented, since the issuance or conversion of additional
securities would have an antidilutive effect.
(6) 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 associated leases, facilities and interests.
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 through that date. Selected
unaudited financial information attributable to Fortune's interest in the East
Bayou Sorrel field as reported in its 1998 financial results is as follows:
Six Months Ended
June 30, 1998
----------------
(unaudited)
Production
Oil (Bbls) 12,000
Gas (Mcf) 18,000
Oil and gas revenues $231,000
Production and operating expense 60,000
Provision for depletion, depreciation
and amortization 54,000
This represented 32% and 30% of Fortune's oil and gas revenues and
production for the first half of 1998. Consequently, Fortune's revenues and cash
flow from operations have decreased significantly since the sale.
Because the sale of East Bayou Sorrel represented 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.
9
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
COMPARISON OF 1999 OPERATING RESULTS TO 1998
QUARTER ENDED JUNE 30, 1999 AND 1998
Fortune's oil and gas revenues are now being improved by higher oil and
gas prices and successful drilling results. New production from two successful
year-end 1998 drilling projects, at South Timbalier Block 86 and Espiritu Santo
Bay, began contributing revenues during the quarter ended June 30, 1999.
Increases in oil and gas prices and natural gas production offset lower oil
production. Consequently, Fortune's revenues from sales of oil and gas for the
second quarter ended June 30, 1999 ($421,000) were higher than both the second
quarter ended June 30, 1998 ($417,000) and the first quarter ended March 31,
1999 ($255,000). As a result, Fortune's net loss improved to $393,000 during the
second quarter of 1999 compared to a net loss of $725,000 for the same 1998
period. The lower 1999 loss is due to a combination of the higher oil and gas
prices, increased natural gas production volumes and a reduction in most costs
as a result of our cost reduction plan implemented in January 1999.
Gas production increased 1% during the second quarter of 1999 versus 1998.
New production from primarily gas discoveries offset depletion on existing
properties. Fortune's oil production decreased 38% during the second quarter of
1999 versus 1998. Depletion was the primary contributor to the oil decrease.
Gas prices on Fortune's production averaged $2.28 per Mcf for the second
quarter of 1999 as compared to $2.22 per Mcf for the same 1998 period (a 3%
increase). Oil prices averaged $17.75 per barrel for the second quarter of 1999
compared to $12.32 per barrel for the same 1998 period (a 44% increase).
Production and operating expense decreased by $19,000 (14)% for the second
quarter of 1999 versus 1998 because of the lower production discussed above and
the absence of workovers and operating problems during 1999.
Non-cash amortization of debt financing costs has declined because all
such costs were fully amortized by the end of April 1999.
Fortune's provision for depletion, depreciation and amortization (DD&A)
decreased by $30,000 (12%) in the second quarter of 1999 as compared to 1998
primarily because of lower production and past ceiling test impairments. Fortune
recorded an impairment to oil and gas properties of $260,000 during the second
quarter of 1998. Primarily as a result of higher oil and gas prices and the
effect of past impairments, no impairment was recorded in the second quarter of
1999.
10
<PAGE>
SIX MONTHS ENDED JUNE 30, 1999 VS. 1998
During the first six months of 1999, Fortune's net loss improved to
$944,000 compared to a net loss of $1,464,000 for the same 1998 period. Lower
expenses in almost all categories in 1999 more than offset a decline in
revenues. Significantly lower gas prices and lower oil and gas production
resulted in net oil and gas revenues decreasing by $447,000 (40%) in the first
six months of 1999, compared to the same 1998 period. The East Bayou Sorrel
field, which accounted for 32% and 30% of first six months 1998 revenues and
production, respectively, was sold on March 31, 1998 for $4.7 million. See note
6 to the financial statements for a discussion of this sale and the impact on
the company's operating results.
Fortune's oil production decreased 73% during the first six months of 1999
versus 1998. Gas production decreased 14% during the first six months of 1999
versus 1998. The sale of East Bayou Sorrel and depletion were the primary
contributors to these decreases.
Gas prices on Fortune's production averaged $2.07 per Mcf for the first
six months of 1999 as compared to $2.30 per Mcf for the same 1998 period (a 10%
decrease). Oil prices averaged $14.30 per barrel for the first six months of
1999 compared to $13.82 per barrel for the same 1998 period (a 4% increase).
Production and operating expense decreased by $157,000 (44)% for the first
six months of 1999 versus 1998 because of the lower production discussed above
and the absence of workovers and operating problems during 1999.
General and administrative expense decreased by $165,000 (20%) primarily
because of reductions which have been made in response to lower oil and gas
prices. In connection with Fortune's efforts to reduce cash outlays, the board
of directors voted, effective January 1, 1999, to begin paying the $2,500 per
quarter outside director fees in Fortune common stock instead of cash.
Interest expense paid in cash decreased by $15,000 (7%) for the first six
months of 1999 over 1998 due to a lower debt balance. The lower debt balance
resulted from Fortune paying off substantially all of its credit facility at
March 31, 1998 with a portion of the proceeds of the sale of East Bayou Sorrel.
Non-cash amortization of debt financing costs has declined because all such
costs were fully amortized at the end of April 1999.
Fortune's provision for depletion, depreciation and amortization (DD&A)
decreased by $390,000 (47%) in the first six months of 1999 as compared to 1998
primarily because of lower production, a lower property balance as a result of
the sale of the East Bayou Sorrel property and past ceiling test impairments.
LIQUIDITY AND CAPITAL RESOURCES
CASH BALANCE, WORKING CAPITAL AND CASH FLOWS FROM OPERATING ACTIVITIES
Fortune used approximately the same amount of cash in its operating
activities during the first six months of 1999 compared to the same 1998 period.
Before considering the effect of changes in non-cash working capital accounts,
operating cash flow used was $(311,000) for 1999 compared to $(162,000) for
1998. Lower gas prices and lower oil and gas production, as discussed above,
accounts for this decrease in cash flow. Working capital at June 30, 1999
decreased from December 31,1998 because of the negative cash flow from operating
activities and the capital expenditures discussed below. Cash flow increased in
the second quarter of 1999 compared to the prior quarter ended March 31, 1999 as
the production from two recently completed wells at Espiritu Santo Bay, the
recently completed farmout wells at South Timbalier 86 and Bay Marchand Block 5
and a well being completed in Mississippi commenced production. These wells are
discussed below. Also, oil and gas prices have increased since March 31, 1999.
11
<PAGE>
CASH USED IN INVESTING ACTIVITIES - CAPITAL EXPENDITURES
Expenditures for oil and gas properties for the first six months of 1999
were $309,000 compared to $1,711,000 for 1998. The 1999 expenditures include
primarily:
- additional leases at Espiritu Santo Bay;
- seismic interpretation at Espiritu Santo Bay and LaRosa;
- completion expenditures for two wells at Espiritu Santo Bay, ST216 #16
and ST 210 #5;
- completion expenditures for the Bacon prospect well drilled in
Mississippi; and
- expenditures for the Espiritu Santo Bay ST 164 #4 well which was
plugged and abandoned in May 1999
The ST 164 #4 well which was plugged this quarter experienced an
underground blowout during September and October 1998 after logging potential
pay. The well was temporarily abandoned until May 1999 when it was plugged.
Fortune has been reimbursed by its insurance underwriter for a portion of its
control of well expenditures and we believe that a substantial portion of
Fortune's cost to redrill the well will also be reimbursable by our underwriter.
However, redrill operations have been delayed because the operator and other
well owners are involved in a dispute with their underwriters over their control
of well and redrill claim.
Fortune did not incur any expenditures on the South Timbalier 86 and Bay
Marchand Block 5 wells because Fortune farmed out these properties retaining
overrides of 3.17% and .5%, respectively. The South Timbalier 86 override
converts to 4% after payout. The Bay Marchand Block 5 farmout acreage was
unitized with acreage containing another producing well. This unitization
resulted in Fortune's revenue interest decreasing to .24% over the
newly-combined acreage block.
The 1998 expenditures include primarily:
- drilling and completion expenditures for the third well at East
Bayou Sorrel, which was plugged on March 5, 1998;
- drilling and completion operations at LaRosa;
- drilling costs for a dry hole at the S.W. Segno prospect; and
- land, seismic and well costs for the dry holes at Whiskey Pass
and Sea Serpent.
Fortune believes that it has sufficient capital to drill its deep Frio
target at Espiritu Santo Bay. However, if this well is unsuccessful or it
encounters significant drilling problems or delays, Fortune may need to make
additional significant reductions in overhead or raise additional capital to
pursue its business strategy.
OIL AND GAS PRICES
Conditions outside of our control influence the prices we receive for oil
and gas. As of August 9, 1999, Fortune was receiving an average of approximately
$18.00 per barrel for its oil production and $2.70 per Mcf for its gas
production.
12
<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 rest 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 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 they do not
achieve compliance. These indirect third parties include oil and gas refiners,
gas and oil transmission companies, third party banking institutions, suppliers
of suppliers, 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, as amended, is effective for all fiscal quarters beginning
after June 15, 2000. Fortune has not historically utilized derivative
instruments; accordingly, 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 Form 10-Q 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, Fortune's business strategy, "Year 2000" compliance expectations and
management's plans and expectations. 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.
13
<PAGE>
FORTUNE'S RELIANCE ON EXPLORATORY PROJECTS INCREASES THE RISKS INHERENT IN
THE OIL AND GAS INDUSTRY. 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 drilling some of its recent prospects and we expect that a substantial number
of our future projects could experience similar results.
FORTUNE HAS INCURRED NET LOSSES FOR EACH OF THE LAST SEVERAL YEARS.
Fortune has incurred substantial net losses for several years. Although we are
making significant budget cuts in 1999, oil and gas prices continue to fluctuate
significantly. 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. 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. A significant
curtailment or loss of production for a prolonged period before we could replace
the reserves would have a material adverse effect on our projected operating
results and financial condition.
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. We may not
have sufficient liquid capital resources to participate at our existing working
interest level if the operators of any of our properties accelerate the drilling
and development schedule or if we incur unexpected significant expenditures or
reduced production. If we do not 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.
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, the net capitalized costs of properties may
not exceed a "ceiling" limit of the tax-effected, discounted present value of
estimated future net revenues from proved reserves, plus the lower of cost or
fair market value of unproved properties. 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 are determined to be worth less than their cost. Fortune has
recognized significant impairments in past periods. As a result of continued
fluctuating oil and gas prices, it is likely that we will incur further
impairments in future periods.
14
<PAGE>
ITEM 3. 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.
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 offset the risks inherent in 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 June 30, 1999 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 will not currently have a significant impact on
Fortune's interest expense.
15
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See note 4 of the footnotes to the financial statements in Part I herein
for a description of legal proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit No. Description
----------- -----------
27.1* Financial Data Schedule.
(b) REPORTS ON FORM 8-K / 8K-A
A report on Form 8-K was filed with the Securities and Exchange Common on
July 28, 1999 to report Fortune's press release announcing the delisting of
Fortune's common stock by the American Stock Exchange.
A report on Form 8-K was filed with the Securities and Exchange Commission
on August 9, 1999 to report Fortune's press release announcing its start of
trading on the NASD OTC Bulletin Board.
A report on Form 8-K was filed with the Securities and Exchange Commission
on August 12, 1999 to report Fortune's press releases of its second quarter 1999
financial results.
*Filed herewith.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FORTUNE NATURAL RESOURCES CORPORATION
By: /s/ TYRONE J. FAIRBANKS
-------------------------------------
Tyrone J. Fairbanks
President and Chief Executive Officer
By: /s/ J. MICHAEL URBAN
-------------------------------------
J. Michael Urban
Vice President and Chief Financial
and Accounting Officer
Date: August 13, 1999
17
<PAGE>
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