AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON APRIL 6, 1999
REGISTRATION STATEMENT NO. 333-
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------
FORM S-2
REGISTRATION STATEMENT
Under
THE SECURITIES ACT OF 1933
------------------------------
FORTUNE NATURAL RESOURCES CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 1311 95-4114732
(State of other jurisdiction (Primary Standard (I.R.S. Employer
of incorporation or Industrial Classification Identification No.)
or organization) Code Number)
515 WEST GREENS ROAD, SUITE 720
HOUSTON, TEXAS 77067
(281) 872-1170
(Address, including zip code, and telephone number,
including area code, of registrant's principal executive offices)
DEAN W. DRULIAS, ESQ.
FORTUNE NATURAL RESOURCES CORPORATION
515 WEST GREENS ROAD, SUITE 720
HOUSTON, TEXAS 77067
(281) 872-1170
(Name, address, including zip code, and telephone number,
including area code, of agent for service)
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
As soon as practicable after this Registration Statement becomes effective.
------------------------------
If any of the securities being registered on this Form are to be offered
on a delayed or continuous basis pursuant to Rule 415 under the Securities Act
of 1933, check the following box. [X]
If the registrant elects to deliver its latest annual report to security
holders, or a complete and legible facsimile thereof, pursuant to Item 11(a)(1)
of this Form, check the following box. [ ]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]
If delivery of the prospectus is expected to be made pursuant to
Rule 434, please check the following box. [ ]
------------------------------
<PAGE>
<TABLE>
<CAPTION>
CALCULATION OF REGISTRATION FEE
=============================================================================================================
Proposed Maximum
Title of Each Class of Amount to Proposed Maximum Aggregate Amount of
Securities to be Registered be Registered Offering Price (1) Offering Price (1) Registration Fee
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
12% Convertible Subordinated Notes
due 2007......................... $2,295,000 100% $2,295,000 $638
Common Stock, $.01 par value....... 3,060,000 $0.75 $2,295,000 None (2)
Common Stock, $.01 par value....... 3,060,000 $1.00 $3,060,000 $851
==============================================================================================================
</TABLE>
(1) Estimated solely for purposes of calculating the registration fee.
(2) No additional consideration will be received for the Common Stock and
therefore no registration fee is required pursuant to Rule 457(i).
------------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO
SECTION 8(A), MAY DETERMINE.
<PAGE>
INFORMATION IN THIS PROSPECTUS IS NOT COMPLETE AND MAY BE CHANGED. WE MAY NOT
SELL THESE SECURITIES UNTIL THE REGISTRATION STATEMENT FILED WITH THE SECURITIES
AND EXCHANGE COMMISSION IS EFFECTIVE. THIS PROSPECTUS IS NOT AN OFFER TO SELL
THESE SECURITIES AND IT IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN
ANY STATE WHERE THE OFFER OR SALE IS NOT PERMITTED.
SUBJECT TO COMPLETION, DATED APRIL ___, 1999
[FORTUNE LOGO]
FORTUNE NATURAL RESOURCES CORPORATION
$2,295,000
12% CONVERTIBLE SUBORDINATED PROMISSORY NOTES DUE DECEMBER 31, 2007
Holders of these notes may offer them for sale by this prospectus. The
common stock of Fortune into which the notes may be converted and underlying the
warrants issued to the placement agent of the notes may also be offered for sale
by use of this prospectus. See "Description of the Notes" on page 42 of this
prospectus for a full description of the terms of the notes and "Description of
Securities" on page 47 for a full description of the underlying shares.
Fortune will not receive any of the proceeds from the sale of the notes or
the underlying shares by the selling holders, who may sell the notes or the
underlying shares from time to time through underwriters in negotiated
transactions at prevailing market prices. The notes will not be listed for
trading on a national securities exchange, and a market for the notes may not
develop. The underlying shares will be listed for trading on the American Stock
Exchange under the symbol FPX, so long as Fortune's common stock continues to be
listed on that exchange. See "Risk Factors - The market for Fortune common stock
is limited" on page 6 for a discussion of current delisting proceedings. On
March 31, 1999, the closing price of the common stock, as reported on the AMEX,
was $0.31 per share.
THESE SECURITIES INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 5.
------------------------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
THE DATE OF THIS PROSPECTUS IS APRIL ___, 1999
<PAGE>
PROSPECTUS SUMMARY
THE FOLLOWING SUMMARY IS QUALIFIED IN ITS ENTIRETY BY THE MORE DETAILED
INFORMATION AND FINANCIAL STATEMENTS AND NOTES THERETO APPEARING ELSEWHERE IN
THIS PROSPECTUS. CAPITALIZED TERMS NOT OTHERWISE DEFINED ARE USED AS DEFINED IN
THE GLOSSARY INCLUDED ELSEWHERE IN THIS PROSPECTUS.
FORTUNE
Fortune Natural Resources Corporation is an independent oil and gas
company whose primary focus is exploration for and development of domestic oil
and gas. Fortune is active principally in areas onshore and offshore Louisiana
and Texas, including the relatively shallow transition zone. It uses modern
geophysical technology and advanced interpretation techniques in these areas in
an attempt to make new discoveries in areas of proven historical production.
Fortune participates generally as a non-operator of relatively small
interests in a variety of exploration and development projects. We use
state-of-the-art technologies, including three dimensional seismic and
computer-aided exploration technology, wherever possible because we believe that
these techniques have undergone important technological advances in recent years
and that their use can provide us with a more accurate and complete prospect
evaluation. This is intended to increase the likelihood of finding commercial
quantities of oil and gas at lower average reserve finding costs.
Our strategy is to invest in a diversified portfolio of oil and gas
exploration and development properties within our areas of interest, since doing
so mitigates the risks of exploration drilling. In furtherance of this strategy,
Fortune has developed working relationships with other independent resource
companies operating in its areas of interest and has acquired interests in
exploration projects, which are currently in various stages of evaluation,
acquisition and preparation for drilling. See "Business and Properties -
Exploration Activities."
Prior to mid-1994, 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 shifted its
emphasis from the acquisition of producing properties to exploration for oil and
natural gas reserves, although it continues to examine attractive acquisition
opportunities. This decision was prompted by increasing price competition for
attractive producing properties as well as recent important advances in
exploration technology. To help facilitate this exploration strategy and focus
its efforts, Fortune sold all of its California producing properties and
prospects in early 1996 and relocated its headquarters from Los Angeles to
Houston in February 1996.
All of our current and proposed exploration activities involve a high
degree of risk, including the risk that we will make substantial investments in
properties and wells without achieving commercial production. While Fortune
attempts to manage exploration risk through careful evaluation of potential
investments and diversification, the company's efforts may not result in
successful development of oil or gas wells.
Fortune's principal executive offices are located at 515 West Greens Road,
Suite 720, Houston, Texas 77067. Our telephone number is (281) 872-1170. In 1997
Fortune changed its name from Fortune Petroleum Corporation to "Fortune Natural
Resources Corporation," the name under which we previously operated in Louisiana
and Texas.
2
<PAGE>
RISK FACTORS
The securities offered hereby involve a high degree of risk and investors
should carefully consider the information set forth under "Risk Factors," as
well as the other information and data in this prospectus.
THE OFFERING
SECURITIES OFFERED .................. $2,295,000 principal amount of
12% Convertible Subordinated Notes due
December 31, 2007.
PAYMENT OF INTEREST.................. The first day of January, April,
July and October.
CONVERSION........................... Convertible into common stock of
Fortune at the option of the
holder at any time after May 1,
1999 and before maturity, unless
previously prepaid, at $0.75,
subject to adjustment in certain
events.
ALTERNATE CONVERSION................. Convertible in whole on one
occasion prior to May 1, 1999 if
Fortune issues common stock,
except in certain limited
circumstances, at less than the
conversion price in effect on
that date.
SUBORDINATION........................ Subordinated to all present and
future senior debt of Fortune.
As of December 31, 1998, the
aggregate amount of senior debt
was $10,000. The notes do not
restrict Fortune's ability to
incur additional indebtedness.
PREPAYMENT BY FORTUNE................ After May 1, 1999, Fortune may
elect to prepay the notes at a
premium, plus accrued interest,
or, if Fortune's common stock
trades at $4.50 or more per share
for 30 consecutive trading days,
without premium.
ACCELERATION OF PAYMENT BY HOLDERS... If an event of default
occurs, the holders of at least
51% in principal amount of the
notes may accelerate maturity and
demand payment in full of all
unpaid amounts, plus expenses.
No assurance can be given that
Fortune will be able to pay the
amounts due under the notes if an
event of default occurs.
USE OF PROCEEDS...................... Fortune will not receive any of
the proceeds of the sale by the
selling holders of the notes or
the underlying shares.
LISTING FOR TRADING.................. The notes will not be listed for
trading. The shares underlying
the conversion of the notes and
accompanying warrants will be
listed for trading on the
American Stock Exchange under the
symbol FPX, so long as Fortune's
common stock continues to be
listed on that exchange. See
"Risk Factors - The market for
Fortune common stock is limited"
for a discussion of current
delisting proceedings.
3
<PAGE>
SUMMARY FINANCIAL AND OPERATING DATA
The following Summary Condensed Financial Data for each of the years in
the three-year period ended December 31, 1998 are derived from, and qualified by
reference to, Fortune's financial statements appearing elsewhere herein. The
Summary Condensed Financial Data should be read in conjunction with the
financial statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing elsewhere herein.
The ratio of earnings to fixed charges is expressed as the ratio of: (1)
fixed charges plus income from operations, to (2) fixed charges. Fixed charges
consist of interest expense and amortization of deferred financing fees.
Earnings were insufficient to cover fixed charges for the years ended December
31, 1998, 1997 and 1996 by the amount of $2,444, $5,562, and $895, respectively.
SUMMARY CONDENSED FINANCIAL DATA
(dollars and shares in thousands, except per share, Bbl and Mcf data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues........................... $ 2,023 $ 4,005 $ 4,040
Impairment to oil and gas properties..... $ 960 $ 3,650 $ -
Net loss................................. $ (3,275) $ (5,958) $ (1,330)
Net loss per share (basic and diluted)... $ (0.27) $ (0.49) $ (0.12)
Net weighted average shares outstanding.. 12,132 12,086 11,351
OPERATING DATA:
Net Production:..........................
Oil (Bbl)............................. 42,000 87,000 57,000
Gas (Mcf)............................. 609,000 821,000 1,038,000
Gas equivalent (MCFE)................. 859,000 1,343,000 1,383,000
Average Sales Price:.....................
Oil ($ per Bbl)....................... $ 13.08 $ 19.04 $ 20.24
Gas ($ per Mcf)....................... $ 2.19 $ 2.66 $ 2.56
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Total assets............................. $ 8,492 $ 12,626 $ 16,335
Total debt............................... $ 3,235 $ 3,775 $ 2,933
Net stockholders' equity................ $ 4,704 $ 8,053 $ 13,037
</TABLE>
Estimates of oil and gas reserves in future years are based in part on the
sales price at December 31 of the respective year. To the extent that the cost
of producing the oil and gas, plus applicable taxes, from any particular
property exceeds the sales price, the quantity of proved reserves is reduced.
See "Business and Properties - Significant Properties and Activities - Oil and
Gas Reserves."
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
RESERVES:
Estimated Net Proved Reserves:
Oil (MBbls).......................... 106 257 249
Gas (Bcf)............................ 3.1 3.2 3.5
Estimated future net revenues
before income taxes................... $ 4,985 $ 8,410 $ 14,112
Standardized measure of future..........
net cash flow......................... $ 3,527 $ 6,503 $ 10,820
</TABLE>
4
<PAGE>
RISK FACTORS
This prospectus 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 factors including the risk factors described below. An investment in the
notes or common stock involves a high degree of risk. You should not acquire
them unless you can afford the loss of your entire investment. As a prospective
investor you should carefully consider all of the information contained in this
prospectus, including the following risk factors:
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.
5
<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 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."
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. Fortune has appealed the delisting and has
been advised that its stock will remain listed until its appeal is heard and
decided. The appeal is currently set for May 13, 1999. Because of the current
low volume of trading in Fortune stock, there may not be a ready market for the
shares underlying the notes. Fortune is not now aware of any broker/dealer who
intends to make a market in Fortune stock.
6
<PAGE>
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.
RISKS ASSOCIATED WITH THE OIL AND GAS INDUSTRY
OIL AND GAS PRICES ARE VOLATILE AND HAVE BEEN DEPRESSED RECENTLY. Our
revenues, profitability and future rate of growth depend on prevailing market
prices for oil and gas, which can be extremely volatile. In addition to market
factors, actions of state and local agencies, the United States and foreign
governments, and international cartels affect oil and gas prices. All of these
factors are beyond our control. These external factors and the volatile nature
of the energy markets make it difficult to estimate future prices of oil and
gas. Current price levels, especially for oil, are at historically low levels
and may fall even further. We may not be able to produce oil or gas on an
economic basis in light of prevailing market prices. Any additional substantial
or extended decline in the price of oil and/or gas would have a material adverse
effect on our financial condition and results of operations, including reduced
cash flow and borrowing capacity, and could reduce both the value and the amount
of Fortune's oil and gas reserves. See "Business and Properties - Prices and
Production Costs."
FORTUNE'S PRODUCTION MAY DIFFER MARKEDLY FROM ESTIMATES OF PROVED RESERVES
AND FUTURE NET REVENUES. Estimating quantities of proved reserves and projecting
future rates of production and timing of development expenditures involve many
uncertainties and factors beyond our control. The reserve data set forth in this
prospectus represent only estimates. Estimating quantities of proved reserves is
inherently imprecise. Such estimates are based upon assumptions about future
production levels, future oil and gas prices and future operating costs which
use currently available geologic, engineering, and economic data. These
assumptions may prove to be incorrect over time. As a result of changes in these
assumptions, and based upon further production history, results of future
exploration and development, future oil and gas prices and other factors, the
quantity of proved reserves may be subject to downward or upward adjustment. In
addition, estimates of the economically recoverable oil and gas reserves
attributable to any particular group of properties, classifications of such
reserves based on risk of recovery, and estimates of future net cash flows
expected, prepared by different engineers or by the same engineers at different
times, may vary substantially. The rate of production from oil and gas
properties declines as reserves are depleted. If we do not acquire additional
properties containing proved reserves, conduct successful exploration and
development activities, or identify additional behind-pipe zones or secondary
recovery reserves, our proved reserves will decline as oil and gas are produced.
Future oil and gas production is, therefore, highly dependent upon our level of
success in acquiring or finding additional reserves. See "Business and
Properties - Oil and Gas Operations - Oil and Gas Reserves."
OIL AND GAS LEASES MAY BE SUBJECT TO DIFFERING AND ADVERSE
INTERPRETATIONS. Our right to explore and produce oil and gas from our
properties is based upon leases with the owners of properties. There are many
versions of oil and gas leases in use. The properties in which we have an
interest were, in most cases, acquired from other companies who first entered
into leases with the landowners. These leases generally call for annual rental
payments and the payment of a percentage royalty on the oil and gas produced.
Courts in many states have interpreted oil and gas leases to include various
implied covenants, including an implied obligation to develop the lease
diligently, to prevent drainage of oil and gas by wells on adjacent land, to
seek markets for production, and to operate prudently according to industry
standards. Leases with similar language may be interpreted quite differently
depending on the state in which the property is located. We believe we and our
operators have followed industry standards in interpreting our leases in the
states where we operate, but those leases may still be the subject of litigation
concerning the meaning of their terms. Adverse decisions could result in
material costs or the loss of one or more leases.
These leases typically have a primary term of three to ten years. If a
productive well is drilled, the lease is extended for the life of the
production. All of the non-producing leases covering our exploration projects
will expire over the next two to five years. If productive wells are not drilled
on these projects before that time, the leases will terminate and we will lose
our entire investment in the leases. We may not be able to drill or farm out all
of our existing exploration projects prior to expiration of the leases in those
prospects.
7
<PAGE>
WEATHER, UNEXPECTED SUBSURFACE CONDITIONS, AND OTHER UNFORESEEN OPERATING
HAZARDS MAY ADVERSELY IMPACT OUR SHORT-TERM ABILITY TO CONDUCT BUSINESS. A
variety of factors, including unexpected drilling conditions, equipment failures
or accidents and adverse weather conditions may curtail, delay, or cancel our
operations. We may encounter unexpected downhole formations or pressures,
corrosive or hazardous substances, mechanical equipment failure, blowouts,
cratering, or fires, any of which could result in damage to formations,
producing facilities or other property, or could result in personal injuries,
loss of life or environmental pollution. Any such event could result in
substantial loss which could have a material adverse effect on our financial
condition. In 1996 and 1997, we experienced mechanical failures of downhole
equipment at Fortune's South Timbalier Block 76 well. As a result of these
equipment failures, the well was shut in for approximately two months in 1996
and one month in 1997, and we incurred significant repair costs. See "Business
and Properties - Significant Properties and Activities - South Timbalier Block
76 - federal waters, offshore Louisiana." Although such operational risks and
hazards may to some extent be minimized, no combination of experience, knowledge
and scientific evaluation can eliminate the risk of investment or assure a
profit to any company engaged in oil and gas operations.
COMPLIANCE WITH ENVIRONMENTAL AND OTHER GOVERNMENT REGULATIONS COULD BE
COSTLY AND NEGATIVELY IMPACT PRODUCTION. We have never experienced a significant
environmental mishap, but releases of oil or natural gas could occur which could
create material liability to Fortune for clean-up expenses. Our business is
regulated by numerous federal, state and local laws and regulations. Compliance
with these laws and regulations is expensive and may result in a decrease in the
amount of production we obtain. For example, 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 us to produce
certain wells at less than their maximum flow rate. State law also governs the
apportionment of production among property owners and producers where numerous
wells may be producing from a single reservoir. Rulings in these proceedings may
allocate production in a particular reservoir in a manner that decreases our
share of production. Other regulations prevent us from freely conducting
operations at all times during the year, such as those which protect the
whooping crane habitat which occupies a portion of our Espiritu Santo Bay area
of interest. See "Business and Properties - Governmental Regulation."
OUR RELATIVELY SMALL SIZE MAY MAKE US LESS ABLE TO COMPETE IN THIS
ECONOMIC ENVIRONMENT. The oil and gas exploration, production and acquisition
business is highly competitive. A large number of companies and individuals
engage in acquiring properties or drilling for oil and gas, and there is a high
degree of competition for desirable oil and gas prospects and properties. There
is also competition between the oil and gas industry and other industries in
supplying the energy and fuel requirements of industrial, commercial,
residential and other consumers. Many of our competitors have greater financial
and other resources than do we. These financial resources are even more
important during times when commodity prices are low, since low prices mean that
we are less able to cover our fixed costs. In order to better continue our
operations, we would like to acquire additional producing reserves in order to
increase our cash flow. Because of our limited cash reserves and low stock
price, however, our flexibility in this environment is limited.
SHORTAGES OF SUPPLIES AND EQUIPMENT MAY INTERRUPT PRODUCTION. Our ability
to conduct operations in a timely and cost effective manner is subject to the
availability of oil and gas operations equipment, supplies, and service crews.
The industry has recently experienced a shortage of certain types of drilling
rigs and work boats in the Gulf of Mexico. This shortage has and may continue to
result in delays in Fortune's operations as well as higher operating and capital
costs. Low commodity prices have reduced the number of wells being drilled.
This, in turn, has forced service companies to mothball or drydock significant
numbers of rigs and other equipment, making shortages worse. These shortages
could continue to occur from time to time, further hindering our ability to
conduct operations as planned.
RISKS ASSOCIATED WITH THIS OFFERING
THE NOTES ARE SUBORDINATED TO SENIOR DEBT. All current and future senior
debt of Fortune is entitled to be paid before the notes. Senior debt includes
all indebtedness under our credit agreement with our bank and most indebtedness
secured by our assets. As of December 31, 1998, we had $10,000 outstanding under
the credit agreement and no other senior debt. We are not prohibited from
incurring additional senior debt. In the event of any insolvency, bankruptcy,
liquidation, reorganization, dissolution or winding up, our assets will be
available to pay the amounts due on the notes only after all senior debt has
been paid in full.
8
<PAGE>
IF FORTUNE DEFAULTS, THE NOTES MAY BE ACCELERATED AND FUNDS MAY BE
INSUFFICIENT FOR THEIR PAYMENT. If Fortune fails to make a timely payment of
principal or interest on the notes, fails to issue the common stock upon
conversion of the notes, or fails in certain other respects to comply with the
technical provisions of the notes, the holders may declare all unpaid
obligations immediately due and payable. The notes also become immediately due
and payable if we file an action for bankruptcy, liquidation, reorganization,
dissolution or winding up. Our ability to pay the amount due under the notes if
they are accelerated may be limited by the terms of the senior debt and will
depend on the availability of sufficient funds. Senior debt must be paid in full
before any payments can be made on the notes. Because of this, no assurance can
be given that we will be able to pay the notes upon the occurrence of an event
of default.
THERE IS A LIMITED MARKET FOR THE NOTES. The notes will not be listed for
trading. A market for the notes may not develop or be sustained. Future trading
prices of the notes will depend on many factors, including, prevailing interest
rates, Fortune's operating results, the price of the common stock and the market
for similar securities. The notes will not be rated by any rating agency.
THE NUMBER OF SHARES ELIGIBLE FOR FUTURE SALE WILL POTENTIALLY DILUTE THE
PRICE OF FORTUNE STOCK. 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 the common stock. See "Description of Securities." At
February 28, 1999, 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 6,566,226 shares of common stock. 3,060,000 additional warrants to
acquire a like number of shares of common stock were also issued in connection
with the amendment of the conversion price of the notes.
Beginning May 1, 1999, the amended notes are convertible into Fortune
common stock at a conversion price of $0.75. If all amended notes were to be
converted, 3,060,000 additional shares would be issued In addition, $930,000 of
promissory notes remain outstanding which contain a provision entitling the
holders to convert them into shares of common stock pursuant to a formula based
upon the daily average closing price of the stock between March 2 and April 30,
1999. If the conversin price of the remaining $930,000 of notes were based on
the average closing stock price through March 31, approximately 3.1 million
shares would be issuable for conversion of those notes.
Two purchasers of common stock pursuant to a 1995 offering under
Regulation S of the Securities Act have filed suit to require the issuance to
them of additional shares of common stock. These claims have arisen under
"reset" provisions which required us to issue additional shares if the market
price of the common stock declined during a recalculation period. See "Business
and Properties - Legal Proceedings." While we believe that we are not obligated
to issue any additional shares, any such issuance would be dilutive to our other
shareholders. If successful, the plaintiffs would be entitled to the issuance of
approximately 580,000 additional shares of common stock or, in the alternative
and if proven to the satisfaction of the court, to the market value of those
shares at the time of the breach.
FORTUNE'S INTEREST COSTS HAVE INCREASED AS A RESULT OF THE ISSUANCE OF THE
NOTES. We used $1,343,000 of the net proceeds from the sale of the notes to
repay indebtedness which had interest rates below the rate being paid by Fortune
on the notes. Prior to issuing the notes, our interest bearing debt was
comprised of bank debt and convertible subordinated debentures due December 31,
1997 which bore interest at 10.5%. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Capital Resources." Those
debentures were repaid with a portion of the proceeds from the offering of the
notes. Our bank debt bears interest at 1.25% over the bank's base rate; the
interest rate is currently 9.50%. Fortune repaid $315,000 of this debt with a
portion of the proceeds of the notes, replacing debt which bore a fluctuating
rate of interest with fixed rate debt.
FORTUNE HAS BEEN UNABLE TO COVER ITS FIXED CHARGES. Since 1993, Fortune's
earnings have been insufficient to cover its fixed charges. See "Selected
Financial Data." As a result of the sale of the notes, Fortune's total debt and
fixed charges have increased significantly. Fortune's earnings may not ever
increase sufficiently to cover its fixed charges.
A DEFAULT ON THE NOTES MAY NOT BE IMMEDIATELY KNOWN. Default on any senior
debt does not itself constitute a default under the notes. A default with
respect to the notes occurs only if we fail to make a required payment or if
other specific events occur. Since payments under the notes are due only
quarterly, we could experience financial difficulties between dates interest
payments are due on the notes, and a default with respect to the notes would not
occur until the next payment due date passed without payment being made. See
"Description of the Notes."
9
<PAGE>
A NOTEHOLDER MAY LOSE ACCRUED INTEREST IF THE NOTE IS converted. If a note
is surrendered for conversion after an interest payment date, the holder will
not receive the accrued but unpaid interest on the note. This forfeiture of
interest does not apply if we call the note for redemption.
NOTEHOLDERS MAY BE TREATED AS RECEIVING A TAXABLE DIVIDEND. If we were to
make a distribution of property to our stockholders which would be taxable to
them as a dividend, and the conversion price of the notes were to be decreased
because of the anti-dilution provisions of the notes, that decrease could be
deemed to be payment of a taxable dividend to noteholders.
CAPITALIZATION
The capitalization of Fortune will not change as a result of a sale of the
notes or the underlying shares by the selling holders.
DIVIDEND POLICY
Fortune has not paid dividends on its common stock and does not intend to
pay such dividends in the foreseeable future. Under Fortune's line of credit,
the company may not pay dividends on its capital stock without the prior written
consent of its lending bank.
USE OF PROCEEDS
Fortune will not receive any proceeds from the sale of the notes or the
underlying shares by the selling holders, but will receive the exercise price if
the warrants are exercised.
10
<PAGE>
PRICE RANGE OF SECURITIES
The following table sets forth the high and the low closing prices of the
common stock of Fortune on the AMEX for the periods indicated. The AMEX has
notified Fortune that the stock would be delisted beginning March 1, 1999
because of noncompliance with listing guidelines. Fortune has appealed this
decision, and delisting action has been stayed pending a hearing on the appeal,
currently set for May 13, 1999. If Fortune stock is delisted, trades in the
company's common stock will be reported on the OTC Bulletin Board.
Common Stock
--------------------
High Low
-------- --------
1996
First Quarter................. 5 2
Second Quarter................ 4 2 5/8
Third Quarter................. 3 11/16 2 1/4
Fourth Quarter................ 3 1/2 2 1/4
1997
First Quarter................. 3 1/4 2 1/4
Second Quarter................ 2 7/16 1 5/8
Third Quarter................. 2 1/2 1 9/16
Fourth Quarter................ 3 3/16 2 3/8
1998
First Quarter................. 2 5/8 1 1/2
Second Quarter................ 1 11/16 1 3/16
Third Quarter................. 1 7/16 11/16
Fourth Quarter................ 1 5/8 3/8
1999
First Quarter................. 1/2 3/16
At March 31, 1999, the closing price of the common stock was $0.31 per
share. At February 28, 1999, there were 12,134,675 shares of common stock
outstanding held of record by approximately 3,000 stockholders.
11
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following Summary Condensed Financial Data for each of the years in
the five-year period ended December 31, 1998 are derived from, and qualified by
reference to, Fortune's audited financial statements, appearing elsewhere
herein. The Summary Selected Financial Data should be read in conjunction with
the financial statements and "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing elsewhere herein.
The ratio of earnings to fixed charges is expressed as the ratio of: (1)
fixed charges plus income from operations, to (2) fixed charges. Fixed charges
consist of interest expense and amortization of deferred financing fees.
Earnings were insufficient to cover fixed charges for the years ended December
31, 1998, 1997, 1996, 1995 and 1994 by the amount of $2,444, $5,562, $895,
$5,006, and $3,993 respectively.
(dollars and shares in thousands, except per share, Bbl and Mcf 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>
<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 in future years are based in part on the
sales price at December 31 of the respective year. To the extent that the cost
of producing the oil and gas, plus applicable taxes, from any particular
property exceeds the sales price, the quantity of proved reserves is reduced.
See "Business and Properties - Oil and Gas Operations - Oil and Gas Reserves."
<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>
12
<PAGE>
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.
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
13
<PAGE>
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.
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>
14
<PAGE>
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
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>
15
<PAGE>
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.
<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.
16
<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.
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 have been
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.
17
<PAGE>
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."
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.
Beginning May 1, 1999, the notes are convertible into Fortune common stock
at the lower of $3.00 per share or 105% of the stock's average closing price
from March 2 through April 30. The stock price from March 2 through March 31,
the date hereof, has averaged substantially less than $3.00 per share. In March
1999, 21 of the 26 holders of these notes agreed to set a fixed conversion price
on the notes of $0.75 per share in lieu of the average price through April 30.
The 21 noteholders represent $2,295,000 of the $3,225,000 principal amount of
the notes outstanding.
The $2,295,000 of amended notes are now convertible into a total of
3,060,000 shares of common stock. If the conversion price of these amended notes
were instead based on the closing price of the stock from March 2 through March
31, approximately 7.7 million additional shares would have been issuable upon
their conversion. If the conversion price of the remaining $930,000 of notes
were based on the average closing stock price through March 31, approximately
3.1 million shares would be issuable for conversion of those notes.
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<PAGE>
Each holder who agreed to this amendment also received one three-year
warrant to purchase a share of Fortune common stock at $1.00 for each share into
which the holder's note is now convertible. The issuance of these warrants was
not included in the original terms of the note agreement; accordingly, Fortune
will recognize a non-cash expense in the first quarter of 1999 for the value of
the warrants. The expense will be approximately $153,000, or $0.05 per warrant.
- 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.
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 31, 1999, Fortune was
receiving an average of approximately $15.00 per Bbl for its oil production and
$1.70 per Mcf for its gas production.
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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.
"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.
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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 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.
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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.
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.
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<PAGE>
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.
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 have been 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.
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<PAGE>
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. Another well has been
proposed to be drilled during the second quarter of 1999.
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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<PAGE>
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 second 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.
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
25
<PAGE>
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.
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.
26
<PAGE>
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 $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.
27
<PAGE>
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 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.
28
<PAGE>
<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>
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>
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
29
<PAGE>
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>
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.
30
<PAGE>
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.
OFFICE FACILITIES
Fortune relocated its headquarters to Houston, Texas in February 1996.
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 31, 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.
31
<PAGE>
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.
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.
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 added certain third-party defendants whose actions
allegedly furthered this market manipulation. Fortune intends to continue to
vigorously defend plaintiffs' actions and prosecute its own counterclaims.
Discovery is proceeding following a court-ordered stay.
32
<PAGE>
ADDITIONAL INFORMATION
Fortune is subject to the informational requirements of the Exchange Act
and, in accordance therewith, files reports and other information with the
Commission. Reports, proxy and information statements filed by Fortune with the
Commission pursuant to the informational requirements of the Exchange Act may be
inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, Judiciary Plaza Building, 450 Fifth Street, N.W.
Washington, D.C. 20549, and the Regional offices of the Commission: Seven World
Trade Center, Suite 1300, New York, New York 10048, and Citicorp Center, 500 W.
Madison Street, Suite 1400, Chicago, Illinois 60661. Copies of such material may
be obtained at prescribed rates from the Public Reference Section of the
Commission at Room 1025, Judiciary Plaza Building, 450 Fifth St., N.W.,
Washington, D.C. 20549. Information on the operation of the Public Reference
Room may be obtained by calling 800-SEC-0330. In addition, reports and other
information concerning Fortune can be inspected at the offices of the American
Stock Exchange, Inc., 86 Trinity Place, New York, New York 10006-1881, on which
the common stock will be listed until at least March 1, 1999. The SEC maintains
an Internet site which contains reports, proxy and information statements, and
other information regarding issuers which file electronically with the SEC, as
does Fortune. The address of that site is http://www.sec.gov. Fortune does not
currently have an Internet address.
All documents filed by Fortune with the Commission pursuant to Section
13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of this
prospectus and prior to the termination of the offering of the notes and the
underlying shares shall be deemed to be incorporated by reference in this
prospectus and to be a part hereof from the date of the filing of such
documents. Any statement contained in a document incorporated or deemed to be
incorporated herein by reference shall be deemed to be modified or superseded
for purposes of this prospectus to the extent that a statement contained herein
or in any other subsequently filed document which also is incorporated or deemed
to be incorporated by reference herein modifies or supersedes such statement.
Any such statement so modified or superseded shall not be deemed, except as so
modified or superseded, to constitute a part of this prospectus.
Fortune will provide without charge to each person to whom this prospectus
is delivered, upon oral or written request, a copy of any or all of the
documents incorporated by reference (other than exhibits to such documents,
unless such exhibits are specifically incorporated by reference in such
documents). Written or telephone requests should be directed to Fortune Natural
Resources Corporation, 515 West Greens Road, Suite 720, Houston, Texas 77067.
Attention: Dean W. Drulias, General Counsel (telephone (281) 872-1170).
33
<PAGE>
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of 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.
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.
34
<PAGE>
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.
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>
35
<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 $2.75 5.0 years
</TABLE>
During the ten year period ended December 31, 1998, no other options held
by executive officers were repriced or amended.
The following table shows the grants of stock options during 1998 to each of
the executives named in the Summary Compensation Table.
<TABLE>
<CAPTION>
OPTION GRANTS IN 1998
Individual Grants
-------------------------------------------------------- Potential Realizable Value At
Number of % of Total Assumed Annual Rates of
Securities Options Stock Price Appreciation
Underlying Granted to Exercise or For Option Term
Options Employee in Base Price Expiration -------------------
Name Granted Fiscal Year ($/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>
36
<PAGE>
On March 25, 1999, Messrs. Fairbanks, Drulias, and Urban were each granted
120,000 options to purchase common stock. The exercise price of these options
was $1.56.
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
Outside directors earn fees of $2,500 per quarter, paid in common stock
valued as of the last trading day of each quarter. Inside directors do not
receive any compensation for serving as directors.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
On October 14, 1997, Fortune commenced a private placement of up to $4.5
million of 12% Convertible Subordinated Notes due December 31, 2007. The 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."
37
<PAGE>
During 1998, 1997 and 1996, Fortune incurred $421,000, $182,000 and
$45,000, respectively, for consulting services provided by Interpretation3, 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.
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.
38
<PAGE>
PRINCIPAL STOCKHOLDERS
The following table contains information at March 31, 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 - 2,465,938 17.3%
John E. McConnaughy, Jr.
1011 Highridge Road
Stanford, CT 06905 - 1,366,667 10.1%
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 557,946 4.4%
Dean W. Drulias Director, Executive
515 W. Greens Road, #720 Vice President,
Houston, TX 77067 General Counsel and
Corporate Secretary 457,466 3.6%
J. Michael Urban
515 W. Greens Road, #720
Houston, TX 77067 Vice President and CFO 447,526 3.6%
Barry Feiner
515 W. Greens Road, #720
Houston, TX 77067 Director 297,327 2.4%
Graham S. Folsom
515 W. Greens Road, #720
Houston, TX 77067 Director 197,926 1.6%
Gary Gelman
515 W. Greens Road, #720
Houston, TX 77067 Director 167,583 1.4%
Daniel R. Shaughnessy
515 W. Greens Road, #720
Houston, TX 77067 Director 113,500 *
Dewey A. Stringer, III
515 W. Greens Road, #720
Houston, TX 77067 Director 51,000 *
All Officers and Directors
as a group of eight persons 2,290,274 16.1%
</TABLE>
* indicates less than 1%.
39
<PAGE>
ADDITIONAL INFORMATION REGARDING THESE HOLDINGS FOLLOWS:
o MR. BLANK'S HOLDING
In addition to the shares into which the notes are convertible, Mr.
Blank's holdings include 137,000 shares of common stock and the following
warrants:
Number of Warrant Common Stock
Warrants Exercise Price Equivalent
--------- -------------- ------------
666,666 $1.00 666,666
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. MCCONNAUGHY'S HOLDING
In addition to the shares into which the notes are convertible, Mr.
McConnaughy's holdings include warrants to purchase 666,666 shares of common
stock exercisable at $1.00 each and 33,333 warrants to purchase common stock
exercisable at $4.75 each.
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 525,599 $2.37
J. Michael Urban 425,000 2.06
Dean W. Drulias 419,800 2.07
Graham S. Folsom 174,150 2.38
Gary Gelman 147,750 2.32
Barry Feiner 147,750 2.32
Daniel R. Shaughnessy 83,500 1.73
Dewey A. Stringer, III 46,000 1.55
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, 14,375
shares issuable upon exercise of 10,000 stock purchase warrants exercisable at
$3.75 per warrant, 66,666 shares issuable upon exercise of a like number of
stock purchase warrants exercisable at $1.00 per warrant, and the shares into
which the notes are convertible. These shares, warrants, and notes are owned by
Mr. Feiner's wife, Janet Portelly. Mr. Feiner disclaims beneficial ownership of
all such securities owned by Ms. Portelly.
40
<PAGE>
THE SELLING HOLDERS
Fortune issued and sold the notes to the selling holders in a private sale
exempt from the registration requirements of the Securities Act, and agreed to
register the sale of the notes and the underlying shares with the Securities and
Exchange Commission on one occasion after December 31, 1997 upon the request of
holders of a majority of the underlying shares. Fortune has agreed to indemnify
the selling holders against certain liabilities, including liabilities under the
Securities Act, and to bear the expenses of the registration of which this
prospectus is a part.
Except as otherwise indicated, the following table is as of December 31,
1998. The term "selling holders" includes the beneficial owners of the notes and
the underlying shares listed below and their respective transferees, pledgees,
donees or other successors. Shares shown are the number of whole shares into
which the selling holder's notes are convertible at the initial conversion price
of $0.75. Except as noted in "Certain Relationships and Related Transactions",
no selling holder has had any material relationship with Fortune or any of its
affiliates within the past three years.
<TABLE>
<CAPTION>
Number of Shares
Aggregate Principal Amount of Common Stock Owned
Name of Selling Holder of Notes Owned and Offered Hereby and Offered Hereby
- ------------------------- --------------------------------- ---------------------
<S> <C> <C>
Sherrill M. Baird $150,000 200,000
Violet M. Blank Trust 50,000 66,666
William N. Jones 50,000 66,667
Robert A. Mignatti 50,000 66,667
Janet M. Portelly 50,000 66,666
Richard J. Cranmer 50,000 66,667
Joseph Roselle 150,000 200,000
Dwight and Judith Haight 100,000 133,333
Tenaire Profit Sharing Trust 20,000 26,667
Suzanne Bader 50,000 66,667
Richard Maser 50,000 66,667
JoAnn Timbanard Trust 50,000 66,667
George P. Haight 100,000 133,333
J. E. McConnaughy, Jr. 500,000 666,666
Barry A. Friedman 50,000 66,667
Kenneth W. Moore IRA 50,000 66,667
Sam A. and Barbara C. Phillips 50,000 66,667
John L. and Sharon L. Kiser 50,000 66,667
Willard J. Kiser Living Trust 100,000 133,333
Alec G. Land 75,000 100,000
Barry W. Blank 500,000 666,666
---------- ---------
Total $2,295,000 3,060,000
========== =========
</TABLE>
The table above reflects information furnished to Fortune by or on behalf
of the selling holders. Changes in that information and information respecting
additional selling holders will be included in supplements hereto when
necessary.
41
<PAGE>
DESCRIPTION OF THE NOTES
The following summary of certain provisions of the notes does not purport
to be complete and is subject to and is qualified in its entirety by reference
to the notes, a copy of which is filed as an exhibit to the registration
statement of which this prospectus is a part and is incorporated herein by this
reference.
GENERAL
The notes are unsecured obligations of Fortune, are limited to $2,295,000
in aggregate principal amount and mature on December 31, 2007. The notes bear
simple interest at the annual rate of 12%, payable quarterly in arrears, on the
first day of each January, April, July and October commencing on January 1,
1998, until paid in full. Interest on the notes will be paid on the basis of a
360-day year of twelve 30-day months.
Payment of principal and interest on the notes may be made by Fortune's
check. Interest payments are mailed to the holder's address as furnished to
Fortune, and principal payments will be made upon surrender of the note to
Fortune.
CONVERSION RIGHTS
Subject to the alternate conversion right described below, the notes are
convertible into common stock, at the option of the holder, at any time
commencing on May 1, 1999 until the close of business on the business day
preceding the day the notes are paid in full, if not earlier prepaid by Fortune.
The notes may be converted in part so long as each portion is $50,000 or a whole
multiple thereof. The conversion price, subject to adjustment as described
below, is $0.75.
Holders of the notes will have an alternate conversion right if, prior to
May 1, 1999, Fortune issues any shares of common stock for purposes other than
for one of the adjustment events described below or in satisfaction of any
exercise of stock options or stock purchase warrants, for less than the
conversion price then in effect. If that happens, Fortune shall, within ten
business days after such issuance, give notice of it to each holder. The holders
then have the one time right for 20 business days thereafter to convert all, but
not less than all, of the notes. In that event, the conversion price shall be
reduced to adjust for the issuance. The conversion price will be reduced by an
amount equal to the number obtained by the following calculation:
Number of shares issued Existing conversion price
- ---------------------------- multiplied by
Total shares outstanding
after issuance Less: Price of stock issued
Shares issued for cash are considered to be sold for the gross cash proceeds
received; issuances for other than cash are considered to be for the value of
the consideration placed by the parties to the transaction. If that value is not
stated, then the value shall be determined by the board of directors of Fortune
acting in good faith and with respect to all aspects of the transaction. No
fractional shares shall be issued on conversion.
The conversion price is subject to adjustment on the occurrence of any of
the following events by Fortune, each of which is called an adjustment event:
- the declaration of a dividend on its outstanding common
stock in shares of its capital stock,
- the subdivision of its outstanding common stock,
- the combination of its outstanding common stock into a
smaller number of shares,
- the issuance of any shares of its capital stock by
reclassification of its common stock, including any such
reclassification in a consolidation or merger in which
Fortune is the continuing corporation, unless in connection
with a merger, consolidation or similar transaction, the
notes are converted into the equivalent kind and amount of
securities, cash or other assets, and with equivalent
adjustments, as would have been owned if the note had been
converted immediately prior to the transaction,
- the issuance to all its existing stockholders of rights, options, or
warrants for common stock at a price per share less than the average
of the daily closing prices for the 30 consecutive trading days
commencing 45 trading days before the record date for the
determination of stockholders entitled to receive such rights, or
- the distribution to its stockholders of evidences of its
indebtedness or assets.
42
<PAGE>
No adjustment need be made, however, if
- in each case the holder is permitted to participate in the
transaction on a basis no less favorable than any other party and at
a level which would preserve holder's percentage equity participation
in the common stock upon conversion of the note,
- the sales of common stock are pursuant to a company plan for
reinvestment of dividends or interest, the granting or exercise of
options under existing stock option plans, the exercise of any other
outstanding options or authorized warrants, or
- the note becomes convertible solely into cash.
In the case of each adjustment event, the conversion price shall be
adjusted to reflect the dilutive effect of the adjustment event on the
conversion price. Adjustments are made successively whenever an adjustment event
occurs, and are effective immediately after the record date in the case of a
dividend or distribution and immediately after the effective date in the case of
a subdivision, combination or reclassification. Any adjustment of less than 1%
of the conversion price will not be made, but will be carried forward and taken
into account in any subsequent adjustment. Fortune will promptly mail a notice
of adjustment to all holders, stating the facts requiring the adjustment, the
adjusted conversion price, the manner of computing it and the effective date of
the adjustment. As of the date of this prospectus, no alternate conversion right
has arisen and no adjustment event has occurred.
Fortune may reduce the conversion price for any period of time of at least
20 days by any amount, and shall mail a notice of the reduction to all holders
at least 15 days before the effective date of the reduction. A reduction of the
conversion price will not, however, change or adjust the conversion price
otherwise in effect beyond the period specified in the notice.
If conversion occurs prior to an interest payment date, the accrued
interest on the notes so converted will be forfeited. Upon a partial conversion
of the principal amount of a note, shares of common stock will be issued in
accordance with the conversion price for that portion of the principal amount of
the note so converted, and a new note will be issued for the balance of the
principal amount.
SUBORDINATION
The payment of the principal, any premium and interest on the notes and
the obligation of Fortune to repurchase the notes, are subordinated in right of
payment to the prior payment in full of all senior debt, whether outstanding on
the date of the issuance of the notes or thereafter incurred. There are two
components of senior debt. The first is all indebtedness, and any deferrals,
renewals, increases or extensions thereof, borrowed under Fortune's credit
agreement with Credit Lyonnais. The second component is all indebtedness secured
by assets of Fortune having a value of more than 50% of the outstanding
principal amount of such indebtedness or $100,000, whichever is less,
- for borrowed money,
- for money borrowed by others and guaranteed by Fortune, or
- constituting purchase money indebtedness for the payment of
which Fortune is liable,
whether existing on or created after the date the notes are issued, that is not
made subordinate to or pari passu with the notes by the instrument creating the
indebtedness. Purchase money indebtedness means indebtedness evidenced by a
note, debenture, bond or other similar instrument issued to or assumed for a
vendor as all or part of the purchase price of such asset acquired by Fortune.
Each note shall be paid on a pari passu basis with all other notes. All senior
debt evidenced by the credit agreement and the documents related thereto, and
all modifications and amendments thereto and substitutions thereof, are referred
to in this prospectus as the senior bank debt.
If there is a payment or distribution of assets to creditors on any
liquidation, dissolution, winding up, receivership, reorganization, assignment
for the benefit of creditors, marshaling of assets and liabilities or any
bankruptcy, insolvency or similar case or proceeding of Fortune, the holders of
all senior bank debt will be entitled to receive payment in full of all
obligations under the senior debt before the holders of the notes will be
entitled to receive any payment in respect of the principal or interest on the
notes. In addition, Fortune may not make any payment on any of its obligations
under the notes if a default or potential default, as defined in the credit
agreement, occurs and until it is remedied by payment in full of all senior bank
debt or waived in writing by all affected holders of the senior bank debt. So
long as any senior bank debt is outstanding, holders of the notes may not
43
<PAGE>
- take any enforcement action to accelerate the debt
evidenced by the notes,
- exercise any remedies against Fortune to collect any of its
obligations thereunder, or
- join in or initiate any action in bankruptcy, insolvency,
liquidation, reorganization, receivership, dissolution or
similar law,
if a default or potential default under the credit agreement has occurred and
has not been remedied or waived so that the full amount of the senior bank debt
is declared due and payable. In addition, holders of the notes may not institute
any proceedings against Fortune or the holder of the senior bank debt which
would interfere with or delay the exercise of the rights of such holders in
respect of any property of Fortune constituting collateral security for the
senior bank debt or under the credit agreement. Any distribution received by the
holders of the notes, other than the underlying shares received in conversion of
the notes, in contravention of any of the terms of the note before all senior
bank debt has been paid in full shall be deemed to be held in trust for the
benefit of the holders of the senior bank debt.
Fortune is not prohibited or limited in the incurrence of additional
senior debt. As of December 31, 1998, $10,000 was outstanding under the credit
agreement. Fortune has no other senior debt. Fortune expects to incur senior
debt from time to time in the future. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations".
PREPAYMENT
Fortune may not repay the notes or any portion thereof prior to May 1,
1999. Thereafter, Fortune may prepay the notes or any portion thereof, together
with accrued interest to the date fixed for repayment, at any time after notice
to the holders. Notice of such repayment shall be given to the holders not more
than 30 nor less than 60 days before the date fixed for repayment. Beginning May
1, 1999, Fortune may prepay the notes without any premium or penalty on 30 days
notice to the holders if the closing price of the common stock on the principal
national securities exchange on which it is listed for 30 consecutive trading
days immediately preceding the day on which the repayment notice is sent equals
or exceeds $4.50 per share. Alternatively, if such trading price is not reached,
Fortune may prepay the notes at the percent of principal amount of the notes as
indicated below for the dates shown:
Percent of Percent of
Date Principal Date Principal
----------------- ---------- ------------------- ---------
May 1, 1999 110.00 February 1, 2000 104.96
June 1, 1999 109.44 March 1, 2000 104.40
July 1, 1999 108.88 April 1, 2000 103.84
August 1, 1999 108.32 May 1, 2000 103.28
September 1, 1999 107.76 June 1, 2000 102.72
October 1, 1999 107.20 July 1, 2000 102.16
November 1, 1999 106.64 August 1, 2000 101.60
December 1, 1999 106.08 September 1, 2000 101.04
January 1, 2000 105.52 October 1, 2000 100.48
Repayment after October 1, 2000 shall be at 100% of principal. No sinking
fund is provided for the notes. Notes called for repayment will be convertible
until the close of business on the day before the repayment date, but
noteholders will forfeit the accrued interest for the then-current period on any
notes surrendered for conversion.
RIGHTS UPON AN EVENT OF DEFAULT
An "event of default" consists of:
1. the failure by Fortune to make a timely payment of principal or
interest on the note when due and payable, which failure remains
uncured for a period of 15 days after notice has been given by a
holder to Fortune,
2. Fortune's failure to be in material compliance with its covenant to
issue the common stock upon a holder's conversion of the notes in
accordance with their terms,
44
<PAGE>
3. Fortune's failure to be in material compliance with its
covenant to keep its corporate existence and rights in full
force and effect, continue conducting its business, keep
adequate books and records of account of its business
activities, maintain appropriate levels and types of
insurance with reputable carriers, and comply in all
material respects with all governmental laws and
regulations applicable to it which, if breached, would have
a material adverse effect on its business or financial
condition,
4. Fortune's failure to be in material compliance with or neglect to
perform any of the provisions of the note, which failure remains
uncured for 30 days after notice has been given by the holder or the
agent under the credit agreement to Fortune,
5. any representation or warranty made by Fortune in the note is untrue
or incorrect in any material respect as of the date made,
6. the commencement of any bankruptcy, receivership, winding up or
liquidation of the affairs of Fortune or any of its subsidiaries,
which remains undismissed for a period of 90 consecutive days, or
7. the institution of bankruptcy, custodianship, receivership
or similar action by or with the consent of Fortune or one
of its subsidiaries.
The occurrence of an event of default described in 6 or 7 above shall
result in all obligations due under the notes becoming immediately due and
payable without notice. If an event of default described in 1 through 5 above
shall occur, the holders of at least 51% in principal amount of the notes may at
their option by notice to Fortune declare all unpaid obligations immediately due
and payable. In addition to the obligations remaining unpaid under the notes,
all reasonable costs and expenses of collection and enforcement of the note
shall be payable by Fortune.
Fortune's ability to pay the obligations due under the notes upon the
acceleration of their maturity may be limited by the terms of the senior debt
and will depend on the availability of sufficient funds. Accordingly, Fortune
may not be able to meet its obligations under the notes upon the occurrence of
an event of default.
FORM, DENOMINATION AND TRANSFER
The notes were issued in registered form, without coupons, in
denominations of $10,000 or integral multiples thereof, and in such principal
amounts as were determined by Fortune. No transfer shall be valid unless
effected on Fortune's books by the registered holder in person or by an attorney
duly authorized in writing, and similarly noted on the note. Fortune may charge
a holder a reasonable fee for any re-registration, transfer or exchange of the
notes.
REGISTRATION RIGHTS
This prospectus is part of a registration statement filed pursuant to the
registration rights extended to the selling holders under the notes. Fortune has
registered the sale of the notes and the underlying shares under the Securities
Act for resale by the selling holders who have provided information to Fortune
in this prospectus. Fortune has also agreed to use its best efforts to keep the
registration statement effective until the earliest of two years after the date
of this prospectus, the date all the securities registered hereunder have been
sold or until the notes and the underlying shares may be sold publicly without
registration. That date is November 4, 1999 for holders that have not then been
affiliates of Fortune for at least three months. Fortune will also use its best
efforts to qualify the securities under the securities laws of the states in
which holders reside, provided that Fortune is not required to consent to
service or to qualify to do business in any state as a result of such
qualification. Fortune cannot assure it will be able to maintain an effective,
current registration statement under the Securities Act as required, and any
failure to do so might adversely affect the marketability and sale price of the
notes and the underlying shares. Each of the notes and the underlying shares
will remain restricted in its transfer until sold in accordance with this
registration under the Securities Act or distributed to the public pursuant to
Rule 144 or any similar provision then in force.
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Holders also have the right to include the notes and the underlying shares
in any registration statement filed by Fortune with respect to any of Fortune's
securities, except one relating to stock option or employee benefit plans, in a
piggy-back registration. Those securities may, however, be cut back or down by
any underwriter of Fortune's offering. The piggy-back registration rights cannot
be exercised though if the notes and the underlying shares can be sold pursuant
to the exemption from registration provided by Rule 144(k) promulgated under the
Securities Act. That date is November 4, 1999 for holders that have not then
been affiliates of Fortune for at least three months.
The holders electing to include the notes and the underlying shares in any
registration filed by Fortune must provide the company with such information and
execute such documents, including appropriate cross-indemnification, as are
reasonably required to prepare and process Fortune's registration statement.
Fortune has agreed to bear all expenses, except any underwriting discounts and
commissions and any legal fees and expenses of counsel to holders, necessary and
incidental to either registration.
LIMITED MARKET FOR THE NOTES
On their original issuance, the notes were issued in a private placement
to accredited investors and were severely restricted in their transfer. The
notes have not been and will not be listed for trading on any recognized market.
A market for the notes may not develop, and if it does it may not be liquid or
sustainable. Future trading prices of the notes will depend on many factors,
including prevailing interest rates, Fortune's operating results, the price of
the common stock and the market for similar securities.
GOVERNING LAW; MODIFICATION
The notes are construed in accordance with, and the rights of the parties
thereto shall be governed by, the laws of the State of Texas applicable to
contracts made and to be performed entirely within such state. The notes may be
modified only by a writing signed by the holder and Fortune, and then only to
the extent set forth in such writing and only in the specific instance for which
it is given. No forbearance, delay or failure to exercise any right or remedy by
a holder of a note will operate as a waiver of or acquiescence in any default.
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DESCRIPTION OF SECURITIES
COMMON AND PREFERRED STOCK
The following description is qualified in all respects by reference to
Fortune's Certificate of Incorporation and all amendments thereto and Fortune's
Bylaws, copies of which are filed as exhibits to the registration statement of
which this prospectus is a part.
Fortune's Certificate of Incorporation, as amended, currently authorizes
40,000,000 shares of common stock, $.01 par value and 2,000,000 shares of
preferred stock, $1.00 par value. Of this total, 12,134,675 shares of common
stock were issued and outstanding as of February 28, 1999. An additional
6,566,226 shares of common stock were issuable upon exercise of options and
private warrants outstanding as of that date, and 3,060,000 warrants to purchase
a like number of shares of common stock were issued in connection with these
notes on March 19, 1999. No preferred stock is currently outstanding.
Fortune also has outstanding $930,000 in promissory notes due December 31,
2007 which are convertible into common stock at the election of the holders. The
conversion is based upon a formula which utilizes the average closing price of
the common stock during the period March 2 through April 30, 1999. If the
conversion were based on the period March 2 through March 31, approximately 3.1
million shares would be issuable if all these notes were converted.
COMMON STOCK
Holders of shares of common stock are entitled to dividends when and as
declared by the Board of Directors from funds legally available therefor and
upon liquidation are entitled to share ratably in any distribution to
stockholders. All holders of common stock are entitled to one vote per share on
any matter coming before the stockholders for a vote, including the election of
directors. In keeping with stockholder democracy rights, Fortune's Certificate
of Incorporation permits the stockholders to remove any director or the entire
board of directors, with or without cause, upon a vote of a majority of the
outstanding shares.
All issued and outstanding shares of common stock are validly issued,
fully paid and non-assessable. Holders of the common stock do not have
pre-emptive rights or other rights to subscribe for unissued or treasury shares
or securities convertible into shares.
Additionally, under Section 145 of the Delaware General Corporation Law,
Fortune has availed itself of the provisions permitting the limitation of
liability through the indemnification of officers, directors, employees and
agents of Delaware corporations. See "Certain Relationships and Related
Transactions - Limited Liability of Directors" and " - Indemnification of
Officers and Directors."
PREFERRED STOCK
The Certificate of Incorporation authorizes the board of directors to
establish and designate the classes, series, voting powers, designations,
preferences and relative, participating, optional or other rights, and such
qualifications, limitations and restrictions of the preferred stock as the
board, in its sole discretion, may determine without further vote or action by
the stockholders.
The rights, preferences, privileges and restrictions or qualifications of
different series of preferred stock may differ with respect to dividend rates,
amounts payable on liquidation, voting rights, conversion rights, redemption
provisions, sinking fund provisions and other matters. The issuance of preferred
stock could decrease the amount of earnings and assets available for
distribution to holders of common stock, or could adversely affect the rights
and powers, including voting rights, of holders of common stock.
The existence of the preferred stock, and the power of the board of
directors of Fortune to set its terms and issue a series of preferred stock at
any time without stockholder approval, could have certain anti-takeover effects.
These effects include that of making Fortune a less attractive target for a
"hostile" takeover bid or rendering more difficult or discouraging the making of
a merger proposal, assumption of control through the acquisition of a large
block of common stock or removal of incumbent management, even if such actions
could be beneficial to the stockholders of Fortune.
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WARRANTS
Fortune has issued various common stock private purchase warrants from
time to time.
TRANSFER AGENT AND REGISTRAR
The principal transfer agent and registrar for the common stock is U.S.
Stock Transfer Corporation, Glendale, California. The co-transfer agent and
co-registrar for such securities is Registrar and Transfer Company, Cranford,
New Jersey.
CERTAIN ANTI-TAKEOVER DEVICES
Section 203 of the Delaware General Corporation Law applies to Delaware
corporations with a class of voting stock listed on a national securities
exchange, authorized for quotation on an inter-dealer quotation system or held
of record by 2,000 or more persons. Section 203 applies to an "interested
stockholder," defined generally as any person owning, or who is an affiliate or
associate of the corporation and has owned in the preceding three years, 15% or
more of a corporation's outstanding voting stock and affiliates and associates
of such person. Section 203 prevents an interested stockholder from engaging in
a "business combination" with a Delaware corporation for three years following
the date such person became an interested stockholder unless
1. before such person became an interested stockholder, the board of
directors of the corporation approved either the business combination or
the transaction that resulted in the stockholder becoming an interested
stockholder;
2. the interested stockholder owned at least 85% of the voting stock of the
corporation outstanding at the time the transaction commenced, excluding
stock held by directors who are also officers of the corporation and by
employee stock plans that do not provide employees with the rights to
determine confidentially whether shares held subject to the plan will be
tendered in a tender or exchange offer; or
3. on or subsequent to the date such person became an interested
stockholder, the business combination is approved by the board of
directors of the corporation and authorized at a meeting of stockholders
by the affirmative vote of the holders of two-thirds of the outstanding
voting stock of the corporation not owned by the interested stockholder.
Under Section 203, the restrictions described above also do not apply to
certain business combinations proposed by an interested stockholder following
the announcement or notification of one of certain extraordinary transactions
involving the corporation and a person who had not been an interested
stockholder during the previous three years or who became an interested
stockholder with the approval of a majority of the corporation's directors.
These provisions could have the effect of delaying, deferring or
preventing a change of control of Fortune.
The Commission has indicated that the use of authorized unissued shares of
voting stock could have an anti-takeover effect. In such case, various specific
disclosures to the stockholders are required. Any business combination, as that
term is used in Section 203, would be reviewed by Fortune's board of directors
solely for its impact on Fortune.
Fortune has in place a shareholder rights plan which is designed to
distribute preferred stock purchase rights to holders of common stock in the
event a person acquires beneficial ownership of fifteen percent or more of
Fortune's stock or commences a tender offer which would result in ownership of
fifteen percent or more of such common stock. The plan, which expires February
28, 2007, provides for the issuance of a fraction of a share of a new series of
junior preferred stock of Fortune for each outstanding share of Fortune's stock.
Depending on the circumstances, such new preferred stock will enable the holders
to either buy additional shares of Fortune at a discount or buy an interest in
any acquiring entity.
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CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
The following discussion has been prepared by Fortune to present the
material federal income tax considerations under generally applicable current
law of the acquisition, ownership, conversion and disposition of the notes and
the acquisition, ownership and disposition of any common stock which is received
on the conversion of a note or the warrants, for persons who acquire the notes
and hold those notes and any such common stock as capital assets. It does not,
however, discuss the effect of (1) special rules, such as those which apply to
tax-exempt organizations, insurance companies, financial institutions, persons
who hold the notes or common stock in connection with a straddle or dealers or
(2) any foreign, state or local tax law. Accordingly, each prospective purchaser
of notes is advised to consult its own tax advisor regarding the matters
discussed herein in light of its particular circumstances, the application of
state, local and foreign tax laws, and the fact that such laws change from time
to time.
The following statements are based upon the Internal Revenue Code of 1986,
as amended, existing regulations thereunder and the current judicial and
administrative interpretations thereof.
OWNERSHIP BY U.S. PERSONS
The following applies to a person who is a citizen or resident of the
United States, a corporation or partnership created or organized in the United
States or any state thereof or an estate or trust the income of which is
includible in income for United States federal income tax purposes regardless of
its source.
INTEREST ON NOTES
The stated interest on a note will be taxable as ordinary income at the
time interest is paid or accrued in accordance with the holder's method of
accounting for United States federal income tax purposes. The notes were not
issued with original issue discount.
MARKET DISCOUNT
If a note is acquired at a "market discount," gain realized on a taxable
disposition and certain nontaxable dispositions thereof will be treated as
interest income to the extent of the theretofore unrecognized accrued market
discount. Subject to a DE MINIMIS exception, "market discount" with respect to a
Note is equal to the excess of (1) the stated redemption price at maturity of
the note over (2) the holder's initial basis in the note. Any market discount
accrues on a ratable basis or, at the election of the holder, on the basis of a
constant interest rate, and a holder of a market discount note may elect to
include the market discount in its income as that market discount accrues. If a
holder converts a market discount note into common stock, the theretofore
unrecognized accrued market discount on that note will not, in general, be
recognized, but will be treated as ordinary income on the later disposition of
that common stock to the extent of any gain recognized at that time on the
disposition of that common stock.
CONVERSION OF NOTES
A holder generally will not recognize gain or loss on the conversion of a
note into common stock except that it will recognize a capital gain or loss as a
result of the receipt of cash in lieu of a fractional share equal to the amount
of cash reduced by the basis of the portion of the note in respect of which that
cash was paid. The basis of the common stock that is received on the conversion
will be the adjusted basis of the note which was converted at the time of
conversion increased by any gain that is recognized, decreased by any loss that
is recognized and decreased by any cash that is received. The holding period of
that common stock will include the holding period of the converted note.
CONSTRUCTIVE DIVIDEND
A distribution to holders of common stock may cause a deemed distribution,
which will be a dividend to the extent of Fortune's current or accumulated
earnings and profits, to the noteholders if the conversion price or conversion
ratio of the notes is adjusted to reflect that distribution.
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SALE OR EXCHANGE OF NOTES OR COMMON STOCK
Gain or loss will be recognized on the sale or exchange of the notes or of
common stock in an amount equal to the difference between
(1) the amount of cash and the fair market value of any other property
received by the holder, excluding, in the case of the notes, any amount
representing accrued interest, which will be taxable as such, and
(2) the holder's adjusted basis in the property sold or exchanged.
Any such gain, other than gain characterized as interest under the market
discount rules, or loss with respect to a note or common stock will be a capital
gain or loss.
DIVIDENDS ON COMMON STOCK
Distributions on the common stock will be dividends to the extent of the
current or accumulated earnings and profits of Fortune, then a nontaxable return
of capital reducing the holder's adjusted basis in the common stock until such
adjusted basis is reduced to zero and finally an amount received in exchange for
the common stock. Dividends paid to domestic corporations may qualify for the
dividends received deduction subject to the limiting provisions that apply
thereto.
OWNERSHIP BY NON-U.S. HOLDERS
The following applies to a person who is not a U.S. holder and to the
income received thereby, such as interest, dividends and gain or loss on
disposition, with respect to notes and common stock which is not effectively
connected with the conduct by the non-U.S. holder of a trade or business within
the United States. Any such effectively connected items of income will be
subject to the United States federal income tax that applies to U.S. holders
generally, and, in the case of such a non-U.S. holder that is a foreign
corporation, those items also will be subject to the branch profits tax.
INTEREST ON NOTES
Interest paid on notes to a non-U.S. holder will not be subject to United
States federal income tax or to withholding in respect thereof if:
(1) the beneficial owner, or if certain requirements are satisfied, a member
of a class of financial institutions, certifies, under penalties of
perjury, that the beneficial owner is not a U.S. holder and provides the
beneficial owner's name and address,
(2) the non-U.S. Holder does not actually or constructively own 10% or more
of the total voting power of all classes of stock of Fortune entitled to
vote, common stock into which a note can be converted is constructively
owned for these purposes,
(3) the non-U.S. holder is not a controlled foreign corporation with respect
to which Fortune is a "related person" within the meaning of Section
864(d)(4) of the Code, and
(4) the non-U.S. holder is not a bank holding the notes as a result
of an extension of credit made pursuant to a loan agreement
entered into in the ordinary course of its trade or business.
Accrued market discount on a note is not treated for these
purposes as interest income. If the foregoing conditions are
not satisfied, then the interest will generally be subject to
United States federal income tax withholding at a rate of 30%
or any lower rate that is provided by any applicable treaty.
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SALE OR EXCHANGE OF NOTES OR COMMON STOCK; CONVERSION OF NOTES
A non-U.S. holder generally will not be subject to United States federal
income tax on gain recognized on the sale or exchange of notes or common stock
or on the conversion of a note unless
(1) the holder is an individual who is present in the United States for 183
or more days in the taxable year and certain other conditions are
satisfied or
(2) Fortune is a "United States real property holding corporation," as
defined in Section 897 of the code, and certain exceptions do not apply.
DIVIDENDS ON COMMON STOCK
Any distribution on common stock to a non-U.S. holder will be subject to
United States federal income tax withholding at a rate of 30% or any lower rate
which is provided by any applicable treaty.
ESTATE TAX
An individual non-U.S. holder of a note will not be required to include
the value of such note in his gross estate for United States federal estate tax
purposes, provided that such holder did not at the time of death actually or
constructively own 10% or more of the combined voting power of all classes of
stock of Fortune and, at the time of such holder's death, payments of interest
on such note would not have been effectively connected with the conduct by such
holder of a trade or business in the United States. An individual non-U.S.
holder who is treated as the owner, or has made certain lifetime transfers, of
an interest in the common stock will be required to include the value thereof in
his gross estate for United States federal estate tax purposes and may be
subject to United States federal estate tax with respect thereto, unless
otherwise provided by an applicable estate tax treaty.
BACKUP WITHHOLDING; INFORMATION REPORTING
A noncorporate U.S. holder holding notes or common stock and any non-U.S.
holder failing to provide a certificate that it is not a U.S. holder will be
subject to backup withholding at the rate of 31% with respect to interest paid
on the notes, dividends paid on common stock and the proceeds of any sale,
exchange or redemption thereof if the payee fails to furnish a taxpayer
identification number and in certain other circumstances. Any amounts so
withheld will be allowed as a refund or a credit against the holder's United
States federal income tax liability, provided that certain information is
furnished to the Internal Revenue Service. Information reporting will be
required with respect to a payment of proceeds from the sale or exchange of
notes or common stock through a foreign office of a broker that is a United
States person or of certain foreign brokers unless the broker has documentary
evidence in its files that the owner is a non-U.S. holder and the broker has no
actual knowledge to the contrary.
PLAN OF DISTRIBUTION
The selling holders may offer and sell the notes and the underlying shares
from time to time and will act independently of Fortune in deciding the timing,
manner and size of any sale. Fortune expects that sales generally will be made
at then prevailing market prices, but prices in negotiated transactions may
differ considerably. Fortune cannot predict the extent, if any, to which selling
holders may sell the notes.
Selling holders may sell the notes and the underlying shares in the
over-the-counter market or otherwise at prices that represent or relate to then
prevailing market prices or are negotiated, by purchase by a broker-dealer as
principal and resale by such broker or dealer for its account pursuant to this
prospectus. Sales may also be made in ordinary brokerage transactions and
transactions in which a broker solicits purchasers, and block trades in which a
broker-dealer so engaged will attempt to sell the securities as agent but may
take a position and resell a portion of the block as principal to facilitate the
transaction. In addition, any securities covered by this prospectus which
qualify for sale pursuant to Rule 144 of the Securities Act may be sold under
Rule 144 rather than pursuant to this prospectus.
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No selling holder has advised Fortune, as of the date hereof, that it has
arranged for the offering or sale of any of the notes with any broker.
Underwriters, brokers, dealers or agents may participate in these transactions
as agents and, in that capacity, may
(1) be deemed underwriters for purposes of the Securities Act and
(2) receive brokerage commissions from selling holders or their purchasers
which, together with any profits received by the selling holders, may
be deemed underwriting discounts and commissions under the Securities
Act.
The selling holders have disclaimed the status of Securities Act "underwriters."
To comply with the securities laws of certain jurisdictions, the notes and
the underlying shares will be offered or sold in those jurisdictions only
through registered or licensed brokers or dealers. In addition, in certain
jurisdictions, the securities may not be offered or sold unless they have been
registered or qualified for sale in those jurisdictions or unless an exemption
from that registration or qualification is available and is complied with.
Under applicable rules and regulations under the Exchange Act, any person
engaged in a distribution of the notes and the underlying shares may be limited
in its ability to engage in market activities respecting the securities. In
addition and without limiting the foregoing, each selling holder is subject to
applicable provisions of the Exchange Act and the rules and regulations
thereunder, including, Rule 10b-2 and Regulation M, which provisions may limit
the timing of purchases and sales of any of the securities by the selling
holders. All the foregoing may affect the marketability of the notes and the
underlying shares.
Fortune may suspend the use of this prospectus and any supplements hereto
in certain circumstances because of pending corporate developments or a need to
file a post-effective amendment. In any such event, Fortune will use its
reasonable efforts to ensure that the use of the prospectus may be resumed as
soon as practicable.
Fortune has agreed to pay substantially all the expenses incident to the
registration, offering and sale of the notes and the underlying securities by
the selling holders to the public other than any brokers' commission, agency fee
or underwriter's discount or commission, which will be borne by the relevant
selling holder.
LEGAL MATTERS
The legality of the notes and the underlying shares will be passed upon
for Fortune by Dean W. Drulias, Esq., General Counsel for Fortune.
EXPERTS
The financial statements of Fortune as of December 31, 1998 and 1997 and
for each of the years in the three year period ended December 31, 1998, have
been included herein and in the registration statement in reliance upon the
report of KPMG LLP, independent certified public accountants, appearing
elsewhere herein, and upon the authority of said firm as experts in accounting
and auditing.
The information appearing herein with respect to net proved oil and gas
reserves of Fortune at December 31, 1998, 1997 and 1996, was estimated by
Huddleston & Co., Inc., independent petroleum engineers, and is included herein
on the authority of such engineers as experts in petroleum engineering.
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AVAILABLE INFORMATION
Fortune has filed with the Securities and Exchange Commission a
registration statement on Form S-2 under the Securities Act with respect to the
common stock offered hereby. This prospectus, filed as part of the registration
statement, does not contain all the information set forth in the registration
statement and the exhibits and schedules thereto, certain portions of which have
been omitted in accordance with the rules and regulations of the Commission. For
further information with respect to Fortune and the notes and common stock
offered hereby, reference is made to the registration statement and to the
exhibits and schedules thereto, which may be inspected at the Commission's
offices without charge or copies of which may be obtained from the Commission
upon payment of the prescribed fees. Statements made in the prospectus as to the
contents of any contract, agreement or document referred to are not necessarily
complete, and in each instance, reference is made to the copy of such contract
or other document filed as an exhibit to the registration statement.
The following documents filed by Fortune with the Commission pursuant
to the Exchange Act, File No. 1-12334, are incorporated in this prospectus by
reference and are made a part hereof:
1. Annual Report on Form 10-K for the year ended December 31, 1998, filed on
March 12, 1999.
2. Current report on Form 8-K filed on March 22, 1999.
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GLOSSARY OF OIL AND GAS TERMS
AMI. "AMI" means Area of Mutual Interest.
Bbl. "Bbl" means barrel. "MBbl" means thousand
barrels. "MMBbl" means million barrels.
Bcf. "Bcf" means billion cubic feet.
BOPD. "BOPD" means barrels of oil or condensate per
day of production.
Farmout. "Farmout" means an agreement pursuant to
which an owner of a working interest sells a
portion of its working interest in an
exploration well or prospect in exchange for
either a payment of previously incurred costs
or an agreement to pay a disproportionate
share of future exploration costs. If the
exploration project is unsuccessful, the
working interest farmed out in this manner
commonly reverts to the seller.
Gross Acres or Wells. "Gross Acres or Wells" are the total acres or
wells, as the case may be, in which an entity
has an interest, either directly or through
an affiliate.
Mcf. "Mcf" means thousand cubic feet. "Mmcf"
means million cubic feet. Natural gas volumes
are stated at the legal pressure base of the
state or area in which the reserves are
located at 60 degrees Fahrenheit.
MCFD. "MCFD" means Mcf of gas per day of gas
production.
MCFE. "MCFE" means thousand cubic feet of gas
equivalent, which is determined using the
ratio of one Bbl of crude oil, condensate or
natural gas liquids to six Mcf of natural gas
so that one Bbl of oil is referred to as six
Mcf equivalent or "MCFE." "MMCFE" means
Million cubic feet of gas equivalent. "BCFE"
means billion cubic feet of gas equivalent.
Net Acres or Wells. A party's "Net Acres" or "Net
Wells" are calculated by multiplying the number
of gross acres or gross wells in which that
party has an interest by the fractional interest
of the party in each such acre or well.
Net Revenue Interest. "Net Revenue Interest" reflects the
percentage of net revenues generated by
operating activities on a property, exclusive
of any royalty or overriding royalty
interests which may burden that property.
Overriding Royalty Interest. "Overriding Royalty Interest" is the right to
share in the gross revenues generated by a
producing property, free of any costs of
exploration, acquisition, development, or
operation, and free of all risks in
connection therewith.
Payout. "Payout" refers to the point in time when
initial working interest owners recover a
defined portion of acquisition, exploration,
development, and lease operating expenses
from the revenues generated by a property or
well.
Producing Properties "Producing Reserves" are Proved Developed
or Reserves. Reserves expected to be produced from existing
completion intervals now open for production in
existing wells. A "Producing Property" is a
property to which Producing Reserves have been
assigned by an independent petroleum engineer.
Proved Developed Non- "Proved Developed Non-Producing Reserves" are
Producing Reserves. Proved Developed Reserves that are recoverable
from zones behind cemented casing in existing
wells which will require additional completion
work or a future recompletion prior to the start
of production. The cost of making such reserves
available for production is insignificant
relative to the volume of reserves expected to
be recovered from the planned recompletion
programs. The PDNP reserves are supported by
actual production performance from wells
completed in the same reservoir elsewhere in the
local area.
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Proved Developed "Proved Developed Producing Reserves" are Proved
Producing Reserves. Developed Reserves that are recoverable from
completion intervals in existing wells that are
currently open and delivering commercial volumes
of hydrocarbons to market.
Proved Developed Reserves. "Proved Developed Reserves" are Proved
Reserves which can be expected to be
recovered through existing wells with
existing equipment and operating methods.
Proved Reserves. "Proved Reserves" are the estimated
quantities of crude oil, natural gas and
natural gas liquids which geological and
engineering data demonstrate with reasonable
certainty to be recoverable in future years
from known oil and gas reservoirs under
existing economic and operating conditions,
that is, on the basis of prices and costs as
of the date the estimate is made and any
price changes provided for by existing
conditions.
Proved Undeveloped Reserves. "Proved Undeveloped Reserves" are Proved
Reserves which can be expected to be
recovered from new wells on undrilled
acreage, or from existing wells where a
relatively major expenditure is required for
recompletion. The offset units containing the
proved-undeveloped reserves are reasonably
certain of commercial production when drilled.
Reserves. "Reserves" means crude oil and natural gas,
condensate and natural gas liquids, which are
net of leasehold burdens, are stated on a net
revenue interest basis, and are found to be
commercially recoverable.
Royalty Interest. A "Royalty Interest" is an interest in an oil
and gas property entitling the owner to a
share of oil and gas production, or the
proceeds of the sale thereof, free of the
costs of production.
SEC Method. The "SEC Method" is a method of determining
the present value of proved reserves. Under
the SEC method, the future net revenues from
proved reserves are estimated assuming that
oil and gas prices and production costs
remain constant. The resulting stream of
revenues is then discounted at the rate of
10% per year to obtain a present value.
Shut in. "Shut in" refers to a well or wells which
are capable of producing oil and/or gas, but
which are not currently operational due to
required repairs or prevailing economic
conditions.
Transition Zone. "Transition Zone" is generally the area which
may extend up to five miles on either side of
a shallow water coastline.
Undeveloped Acreage. "Undeveloped Acreage" is oil and gas acreage,
including, in applicable instances, rights in
one or more horizons which may be penetrated
by existing well bores, but which have not
been tested, to which Proved Reserves have
not been assigned by independent petroleum
engineers.
Working Interest. A "Working Interest" is the operating
interest under an Oil and Gas Lease which
gives the owner the right to drill, produce
and conduct operating activities on the
property and a share of production, subject
to all royalties, overriding royalties and
other burdens and to all costs of
exploration, development and operations and
all risks in connection therewith. If a party
owns a "back-in" working interest, it has the
right to acquire a portion of the working
interest owned by another party upon the
occurrence of a specified event, such as
payout of the costs incurred by the other
party in drilling a well or undertaking
another operation on the property.
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INDEX TO FINANCIAL STATEMENTS
Page
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Independent Auditors' Report - KPMG LLP......................... F-2
Balance Sheets - December 31, 1998 and 1997..................... F-3
Statements of Operations for the years ended
December 31, 1998, 1997 and 1996............................. F-4
Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996.............................. F-5
Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.............................. F-6
Notes to Financial Statements................................... F-7
F-1
<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
F-2
<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.
F-3
<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.
F-4
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Capital in Stock-
Common Stock Excess of Treasury Accumulated holders'
Shares Amount Par Value Stock Deficit Equity
---------- -------- ----------- --------- ------------ -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 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.
F-5
<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.
F-6
<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.
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.
F-7
<PAGE>
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
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.
F-8
<PAGE>
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>
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>
F-9
<PAGE>
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>
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,
F-10
<PAGE>
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%.
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.
F-11
<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.
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
========
F-12
<PAGE>
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.
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
F-13
<PAGE>
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:
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
F-14
<PAGE>
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.
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>
F-15
<PAGE>
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.
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%
==== ==== ====
F-16
<PAGE>
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.
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.
F-17
<PAGE>
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>
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.
F-18
<PAGE>
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>
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.
F-19
<PAGE>
CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS
FROM PROVEN RESERVE QUANTITIES
A summary of the changes in the standardized measure of discounted future
net cash flows applicable to proved oil and gas reserves is as follows:
<TABLE>
<CAPTION>
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>
F-20
<PAGE>
====================================== ======================================
UNTIL _________, 1999, ALL DEALERS THAT
EFFECT TRANSACTIONS IN THESE SECURITIES,
WHETHER OR NOT PARTICIPATING IN THIS
OFFERING, MAY BE REQUIRED TO DELIVER A
PROSPECTUS. THIS IS IN ADDITION TO THE
DEALERS' OBLIGATION TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS $2,295,000
AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENT OR SUBSCRIPTIONS.
-----------------------------------
12% CONVERTIBLE
SUBORDINATED NOTES
TABLE OF CONTENTS DUE
Page DECEMBER 31, 2007
Prospectus Summary 2
Risk Factors 5
Dividend Policy 10
Use of Proceeds 10
Price Range of Securities 11
Selected Financial and
Operating Data 12
Management's Discussion and
Analysis of Financial Condition FORTUNE NATURAL
And Results of Operations 13 RESOURCES CORPORATION
Business and Properties 22
Management 34
Certain Relationships and Related --------------
Transactions 37
Principal Stockholders 39 PROSPECTUS
The Selling Holders 41
Description of the Notes 42 --------------
Description of Securities 47
Certain Federal Income
Tax Considerations 49
Plan of Distribution 51
Legal Matters 52
Experts 52 ____________, 1999
Available Information 53
Glossary of Oil and Gas Terms 54
Index to Financial Statements F-1
-----------------------------------
====================================== ======================================
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The Registrant estimates that expenses in connection with the offering
described in the Registration Statement will be as follows:
Securities and Exchange Commission Registration Fee $ 638
Accountants' Fees and Expenses $ 5,000
Legal Fees and Expenses $ 300
American Stock Exchange fees $17,500
Printing and Engraving Expenses $ -
Miscellaneous $ 562
-------
$24,000
=======
ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS
Section 145 of the Delaware General Corporation Law permits the
indemnification of officers, directors, employees and agents of Delaware
corporations. The Certificate of Incorporation and Bylaws of the Company provide
that the corporation shall, to the fullest extent permitted by Section 145 of
the General Corporation Law of the State of Delaware as it may be amended from
time to time, indemnify and hold harmless each person who was or is a party or
is threatened to be made a party to or is involved in any action, suit or
proceeding, whether civil, criminal, administrative or investigative
(hereinafter a "proceeding"), by reason of the fact that he or she, or a person
whom he or she is a legal representative, is or was a director or officer of the
Company or is or was serving at the request of the Company as director, officer,
employee or agent of another corporation or of a partnership, joint venture,
trust or other enterprise, including service with respect to employee benefit
plans, whether the basis of such proceeding is alleged action or inaction in an
official capacity or in any other capacity while serving as a director, officer,
employee or agent, against all costs, charges, expenses, liabilities and losses
(including attorney's fees, judgments, fines, ERISA excise taxes or penalties
and amounts paid or to be paid in settlement) reasonably incurred or suffered by
such person in connection therewith, and such indemnification shall continue as
to persons who have ceased to be a director, officer, employee or agent and
shall inure to the benefit of his or her heirs, executors and administrators.
ITEM 16. EXHIBITS
Number Description
- -------- ----------------------------------------------------------------------
4.1 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 Subordinated
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)
4.10** Form of Amended Note between Registrant and holders of amended
Convertible Subordinated Notes due December 31, 2007
4.11** Form of Warrant exercisable at $1.00 per share between Registrant and
holders of amended Convertible Subordinated Notes due December 31, 2007
II-1
<PAGE>
5.1** Opinion of Mr. Dean W. Drulias, General Counsel of the Registrant,
regarding legality of securities.
10.1 Amendment dated November 3, 1997 to Credit Agreement between Registrant
and Credit Lyonnais New York Branch and Certain Lenders (filed as
Exhibit 10.1 to Registrant's Form 10-Q for the quarter ended September
30, 1997 and incorporated herein by reference)
10.2 Participation Agreement by and between Registrant and Smith Management
Company, Inc. et al. to acquire a 12.5% working interest in Espiritu
Santo Bay (filed as Exhibit 10.1 to Registrant's Registration Statement
on Form S-2 (333-22599) and incorporated herein by reference)
10.3 Credit Agreement between Registrant and Credit Lyonnais New York Branch
and Certain Lenders dated July 11, 1997 (filed as Exhibit 10.1 to
Registrant's Form 10-Q for the quarter ended June 30, 1997 and
incorporated herein by reference)
10.4 Employment Agreement dated June 1, 1997 by and between Registrant and
Tyrone J. Fairbanks (filed as Exhibit 10.2 to Registrant's Form 10-Q
for the quarter ended June 30, 1997 and incorporated herein by
reference)
10.5 Employment Agreement dated August 1, 1996 by and between Registrant and
Dean W. Drulias (filed as Exhibit 10.2 to Registrant's Registration
Statement on Form S-2 (333-22599) and incorporated herein by reference)
10.6 1993 Stock Option Plan (filed as an Exhibit to Registrant's
Registration Statement on Form SB-2 (33-64600) and incorporated herein
by reference)
10.7 1988 Stock Option Plan (filed as Exhibit 10.8 to Registrant's
Pre-Effective Amendment No. 1 to the Registration Statement on Form S-1
(33-49190) and incorporated herein by reference)
10.8 1998 Stock Option Plan (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.
23.4** Consent of Mr. Dean W. Drulias (included in Exhibit 5.1).
25.1 Power of Attorney (included on signature page).
** Filed herewith.
II-2
<PAGE>
ITEM 17. UNDERTAKINGS
The undersigned registrant hereby undertakes:
(1) To file during any period in which offers or sales are being made, a
post effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3)
of the Securities Act;
(ii) To reflect in the prospectus any facts or events arising
after the effective date of the registration statement (or the most
recent post effective amendment thereof) which, individually or in the
aggregate represent fundamental change in the information set forth in
the registration statement;
(iii) To include any material information with respect to the
plan of distribution not previously disclosed in the registration
statement or any material change to such information in the
registration statement;
(2) That, for the purpose of determining any liability under the Securities
Act, each such post-effective amendment shall be deemed to be a new registration
statement relating to the securities offered therein, and the offering of such
securities at that time shall be deemed to be initial bona fide offering
thereof.
(3) To remove from registration by means of a post-effective amendment any
of the securities being registered which remain unsold at the termination of the
offering.
(4) The undersigned registrant hereby undertakes to deliver or cause to be
delivered with the prospectus, to each person to whom the prospectus is sent or
given, the latest annual report to security holders that is incorporated by
reference in the prospectus and furnished pursuant to and meeting the
requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of
1934; and, where interim financial information required to be presented by
Article 3 of Regulation S-X are not set forth in the prospectus, to deliver, or
cause to be delivered to each person to whom the prospectus is sent or given,
the latest quarterly report that is specifically incorporated by reference in
the prospectus to provide such interim financial information.
(5) For purposes of determining any liability under the Securities Act, the
information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form of
prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h)
under the Securities Act shall be deemed to be part of this registration
statement as of the time it was declared effective.
(6) For the purpose of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be deemed
to be a new registration statement relating to the securities offered therein,
and the offering of such securities at that time shall be deemed to be the
initial bona fide offering there.
(7) Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers, and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Commission such indemnification is
against public policy as expressed in the Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the registrant of expenses incurred or paid by a director,
officer of controlling person of the registrant in the successful defense of any
action, suit of proceeding) is asserted by such director, officer or controlling
person in connection with the securities being registered, the registrant will,
unless in the opinion of its counsel the matter has been settled by a
controlling precedent, submit to a court of appropriate jurisdiction the
question whether such indemnification by it is against public policy as
expressed in the Act and will be governed by the final adjudication of such
issue.
II-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-2 and has duly authorized this Registration
Statement to be signed on its behalf by the undersigned, thereunto duly
authorized, in the City of Houston, State of Texas, on April 6, 1999.
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
In accordance with the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following person in the capacities
and on the dates stated.
Name Title Date
---- ----- ----
/s/ Tyrone J. Fairbanks
- ----------------------------
Tyrone J. Fairbanks Chief Executive Officer
and Director April 6, 1999
/s/ Dean W. Drulias
- ----------------------------
Dean W. Drulias Executive Vice President,
General Counsel,
Corporate Secretary
and Director April 6, 1999
/s/ Graham S. Folsom
- ----------------------------
Graham S. Folsom Director April 6, 1999
- ----------------------------
Barry Feiner Director April 6, 1999
/s/ Gary Gelman
- ----------------------------
Gary Gelman Director April 6, 1999
/s/ D. R. Shaughnessy
- ----------------------------
D. R. Shaughnessy Director April 6, 1999
/s/ Dewey A. Stringer, III
- ----------------------------
Dewey A. Stringer, III Director April 6, 1999
II-4
<PAGE>
FORM OF AMENDED NOTE
REGISTERED #____
FORTUNE NATURAL RESOURCES CORPORATION
12% CONVERTIBLE SUBORDINATED PROMISSORY NOTE
DUE DECEMBER 31, 2007
$______________ MARCH 19, 1999
THIS NOTE IS ISSUED PURSUANT TO AN EXEMPTION FROM THE REGISTRATION
PROVISIONS OF THE SECURITIES ACT OF 1933 (THE "ACT") AND QUALIFICATION
PROVISIONS OF APPLICABLE STATE SECURITIES LAWS. NEITHER IT NOR THE
SHARES OF COMMON STOCK INTO WHICH IT CAN BE CONVERTED CAN BE SOLD,
HYPOTHECATED OR OTHERWISE TRANSFERRED UNLESS REGISTERED PURSUANT TO THE
ACT AND QUALIFIED UNDER APPLICABLE STATE LAW OR, IN THE OPINION OF
COUNSEL TO MAKER, AN EXEMPTION THEREFROM IS AVAILABLE.
FOR VALUE RECEIVED, the undersigned, FORTUNE NATURAL RESOURCES CORPORATION, a
Delaware corporation with offices at One Commerce Green, 515 West Greens Road,
Suite 720, Houston, Texas 77067 ("Maker"), promises to pay to
____________________________, with an address at ,
_______________________________ ("Payee"), on December 31, 2007 except as
otherwise provided herein (the "Maturity Date"), the principal amount of
______________________ ($__________) Dollars in lawful money of the United
States of America (the "Principal) together with all accrued interest.
This Note is one of a series of notes (collectively the "Notes"), all with the
same terms and conditions as those set forth herein, which may be issued by
Maker up to the aggregate principal amount of Four Million Five Hundred Thousand
($4,500,000) Dollars. Each Note is part of an offering of up to Four Million
Five Hundred Thousand ($4,500,000) Dollars in aggregate principal amount of
Notes (the "Offering") being conducted by Maker on a One Million Two Hundred
Fifty Thousand ($1,250,000) Dollars aggregate principal amount minimum or none
to Four Million Five Hundred Thousand ($4,500,000) Dollars aggregate principal
amount maximum best efforts basis. The Offering will terminate on the sooner of
the sale of all of the Notes or October 31, 1997 (unless extended to December 1,
1997).
The Note is (i) subordinated to certain of Maker's indebtedness defined herein
as "Senior Debt" and "Senior Bank Debt"; and (ii) convertible into Maker's
common stock, par value $0.01 per share (the "Common Stock"), all as set forth
below. It bears simple interest (the "Interest") at the annual rate of twelve
percent (12%), payable, in arrears, on the Interest Payment Dates (as defined in
Section 1 below), until the Principal and all accrued Interest thereon
(collectively the "Obligations") shall be paid in full.
1. Interest.
Maker will pay Interest on the first day of each January, April, July and
October (the "Interest Payment Dates") commencing on January 1, 1998. Interest
on the Note will accrue from the most recent date to which interest has been
paid or, if no interest has been paid, from the date of delivery of the Note.
Interest will be computed on the basis of a 360-day year of twelve 30 day
months.
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<PAGE>
2. Method of Payment.
Maker will pay Principal and Interest in money of the United States that at the
time of payment is legal tender for the payment of public and private debts.
Maker may, however, pay Principal and Interest by its check, subject to
collection, payable in such money. It may mail an Interest check to Payee's
address as it first appears on this Note or such other address as Payee shall
give by notice to Maker. Payee must surrender this Note to Maker to collect
Principal payments.
3. Conversion.
(a) Payee's right to Convert. Payee shall have the right, at any time commencing
on May 1, 1999 until the close of business on the business day preceding the day
the Obligations are paid in full, to cause the conversion of all or any portion
(if such portion is Fifty Thousand [$50,000] Dollars or a whole multiple of
Fifty Thousand [$50,000] Dollars) of the Principal outstanding at the time such
conversion is effected (the "Convertible Obligations") into shares of Common
Stock (the "Underlying Shares"). Payee shall forfeit all accrued but unpaid
Interest upon conversion. The price for conversion, subject to adjustment as
provided in Section 4, below, shall be $0.75. Anything to the contrary contained
herein not withstanding, on the first occasion, if at all, that Maker prior to
May 1, 1999, issues any shares of Common Stock (other than for any purpose
listed in PARAGRAPH 4 (A) below, or in satisfaction of any exercise of stock
options or stock purchase warrants) for a per share consideration less than the
conversion price in effect on the date of such issue, it shall, within ten
business days after such issuance, give notice of such issuance to Payee. Payee
shall have the one-time right (the "Alternate Conversion Right"), exercisable
within 20 business days thereafter (the "Alternate Conversion Right Notice
Period") to convert all, but not less than all, the Convertible Obligations into
Underlying Shares at a price equal to the conversion price in effect immediately
prior to such action (the "Existing Conversion Price") reduced by an amount
equal to the number obtained by dividing the number of shares of Common Stock so
issued and outstanding by the total number of shares of Common Stock issued and
outstanding after such issuance, multiplying the quotient by the difference
between the Existing Conversion Price and the price of the shares of Common
Stock so issued and subtracting the result from the Existing Conversion Price.
In the case of an issue of additional shares of Common Stock for cash, the
consideration received by Maker therefor shall be deemed to be the gross cash
proceeds received for such shares. In the case of an issuance of such shares of
Common Stock for other than cash, the value of the consideration received by
Maker therefor shall be deemed to be that placed thereon by the parties to the
transaction or, if no such value is stated, by the Board of Directors of Maker
acting in good faith and with respect to all aspects of the transaction. The
term "issue" shall be deemed to include the sale or other disposition of shares
of Common Stock held in Maker's treasury but not of any derivative security
convertible into Common Stock. The number of shares of Common Stock outstanding
at any given time shall not include shares of Common Stock in Maker's treasury.
The Alternate Conversion Right shall lapse and cease to exist if not exercised
by Payee within the Alternate Conversion Right Notice Period. No fractional
shares shall be issued on conversion.
(b) Definition of Closing Price. The "Closing Price" for each day shall mean the
last reported sales price regular way or, in case no such reported sale takes
place on such day, the closing bid price regular way, in either case on the
principal national securities exchange on which the Common Stock is listed or
admitted to trading or, if the Common Stock is not listed or admitted to trading
on any national securities exchange, the highest reported bid price as furnished
by the National Association of Securities Dealers, Inc. through NASDAQ or
similar organization if NASDAQ is no longer reporting such information, or by
the National Daily Quotation Bureau or similar organization if the Common Stock
is not then quoted on an inter-dealer quotation system. If on any such date the
Common Stock is not quoted by any such organization, the fair value of the
Common Stock on such date, as determined by Maker's Board of Directors, shall be
used.
2
<PAGE>
(c) Manner of Conversion. Payee may exercise his conversion right by giving
notice thereof to Maker setting forth the amount of the Convertible Obligations
to be converted. Within 15 days after the giving of such notice Maker shall
issue the number of Underlying Shares into which the Convertible Obligations are
to be converted in accordance with the conversion price and deliver to Payee a
certificate or certificates therefor, registered in his name, representing such
Shares against delivery to Maker of this Note marked paid in full. If only a
portion of the Convertible Obligations then outstanding is converted, Maker
shall deliver to Payee, together with the aforesaid certificate(s), a new
promissory note, in form and substance identical to this Note, except that the
principal amount thereof shall equal that portion of the Obligations then
outstanding which has not been converted. Payee shall represent in writing to
Maker prior to the receipt of the Underlying Shares that such Shares will be
acquired by him for investment only and not for resale or with a view to the
distribution thereof, and shall agree that any certificates representing the
Shares may bear a legend, conspicuously noting such restriction, as Maker shall
deem reasonably necessary or desirable to enable it to comply with any
applicable federal or state laws or regulations.
(d) Taxes on Shares Issued. The issue of stock certificates on conversions of
this Note shall be made without charge to Payee for any tax in respect of such
issue. Maker shall not, however, be required to pay any tax which may be payable
in respect of any transfer involved in the issue and delivery of Common Stock in
any name other than that of Payee, and Maker shall not be required to issue or
deliver any certificates representing such Common Stock unless and until the
person or persons requesting the issue thereof shall have paid to Maker the
amount of such tax or shall have established to the satisfaction of Maker that
such tax has been paid.
(e) Covenants of Maker Relating to Conversion. Maker covenants and agrees that
from and after the date hereof and until the date of repayment in full of the
Obligations:
(i) it shall provide, free from preemptive rights, out of its authorized
but unissued shares, or out of shares held in its treasury, sufficient
shares to provide for the conversion of this Note from time to time as the
Note presented for conversion;
(ii) all shares which may be issued upon conversion of this Note will upon
issue be validly issued, fully paid and non-assessable, free from all
taxes, liens and charges with respect to the issue thereof, and will not
be subject to the preemptive rights of any stockholder of Maker;
(iii)if any shares of Common Stock to be provided for the purpose of
conversion of this Note require registration with or approval of any
governmental authority under any federal or state law before such shares
may be validly issued upon conversion, Maker will in good faith and as
expeditiously as possible endeavor to secure such registration or
approval, as the case may be, and Maker's obligation to deliver shares of
the Common Stock upon conversion of this Note shall be abated until such
registration or approval is obtained; and
(iv) if, and thereafter so long as, the Common Stock shall be listed on
any national securities exchange, Maker will, if permitted by the rules of
such exchange, list and keep listed and for sale so long as the Common
Stock shall be so listed on such exchange, upon official notice of
issuance, all Common Stock issuable upon conversion of this Note.
3
<PAGE>
4. Adjustment in Conversion Price.
(a) Adjustment for Change in Capital Stock. Except as provided in PARAGRAPH 4
(M) below, if Maker shall (i) declare a dividend on its outstanding Common Stock
in shares of its capital stock, (ii) subdivide its outstanding Common Stock,
(iii) combine its outstanding Common Stock into a smaller number of shares, or
(iv) issue any shares of its capital stock by reclassification of its Common
Stock (including any such reclassification in connection with a consolidation or
merger in which Maker is the continuing corporation), then in each such case the
conversion privilege and the conversion price in effect immediately prior to
such action shall be adjusted so that if the Note is thereafter converted, Payee
may receive the number and kind of shares which he would have owned immediately
following such action if he had converted the Note immediately prior to such
action. Such adjustment shall be made successively whenever such an event shall
occur. The adjustment shall become effective immediately after the record date
in the case of a dividend or distribution and immediately after the effective
date in the case of a subdivision, combination or reclassification. If after an
adjustment Payee upon conversion of this Note may receive shares of two or more
classes of capital stock of Maker, Maker's Board of Directors shall determine
the allocation of the adjusted conversion price between the classes of capital
stock. After such allocation, the conversion privilege and conversion price of
each class of capital stock shall thereafter be subject to adjustment on terms
comparable to those applicable to Common Stock in this SECTION 4.
(b) Subscription Offerings. In case Maker shall issue to all of its existing
stockholders rights, options, or warrants entitling the holders thereof to
subscribe for or purchase Common Stock (or securities convertible into or
exchangeable for Common Stock) at a price per share (or having a conversion
price per share, in the case of a security convertible into or exchangeable for
Common Stock) less than the Current Market Price per share (as defined in
PARAGRAPH (D) below) on the record date for the determination of stockholders
entitled to receive such rights, then in each such case the conversion price
shall be adjusted by multiplying the conversion price in effect immediately
prior to such record or granting date by a fraction, of which the numerator
shall be the number of shares of Common Stock outstanding on such record or
granting date plus the number of shares of Common Stock which the aggregate
offering price of the total number of shares of Common Stock so to be offered
(or the aggregate initial conversion price of the convertible securities so to
be offered) would purchase at such Current Market Price and of which the
denominator shall be the number of shares of Common Stock outstanding on such
record or granting date plus the number of additional shares of Common Stock to
be offered for subscription or purchase (or into which the convertible or
exchangeable securities so to be offered are initially convertible or
exchangeable). Such adjustment shall become effective at the close of business
on such record date; provided, however, that, to the extent the shares of Common
Stock (or securities convertible into or exchangeable for shares of Common
Stock) are not delivered, the conversion price shall be readjusted after the
expiration of such rights, options, or warrants (but only to the extent that
this Note is not converted after such expiration), to the conversion price which
would then be in effect had the adjustments made upon the issuance of such
rights or warrants been made upon the basis of delivery of only the number of
shares of Common Stock (or securities convertible into or exchangeable for
shares of Common Stock) actually issued. In case any subscription price may be
paid in a consideration part or all of which shall be in a form other than cash,
the value of such consideration shall be as determined in good faith by Maker's
Board of Directors. Shares of Common Stock owned by or held for the account of
Maker or any majority-owned subsidiary shall not be deemed outstanding for the
purpose of any such computation.
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<PAGE>
(c) Other Rights to Acquire Common Stock. In case Maker shall distribute to all
holders of its Common stock evidences of its indebtedness or assets (excluding
cash dividends or distributions paid from retained earnings of Maker) or rights
or warrants to subscribe or purchase (excluding those referred to in PARAGRAPH
(B) above), then in each such case the conversion price shall be adjusted so
that the same shall equal the price determined by multiplying the conversion
price in effect immediately prior to the date of such distribution by a fraction
of which the numerator shall be the Current Market Price per share (as defined
in PARAGRAPH (D) below) of the Common Stock on the Record Date mentioned below
less the then fair market value (as determined by the Board of Directors of the
Company) of the portion of the assets or evidences of indebtedness so
distributed or of such rights or warrants applicable to one share of Common
Stock, and the denominator shall be the Current Market Price per share of the
Common Stock. Such adjustment shall become effective immediately after the
Record Date for the determination of shareholders entitled to receive such
distribution.
(d) Current Market Price. For the purpose of any computation under PARAGRAPHS 4
(B) and (C) above, the "Current Market Price" per share of Common Stock on any
date shall be deemed to be the average of the daily Closing Prices for the 30
consecutive trading days commencing 45 trading days before such date.
(e) Action to Permit Valid Issuance of Common Stock. Before taking any action
which would cause an adjustment reducing the conversion price below the then par
value, if any, of the shares of Common Stock issuable upon conversion of the
Notes, the Company will take all corporate action which may, in the opinion of
its counsel, be necessary in order that the Company may validly and legally
issue shares of such Common Stock at such adjusted conversion price.
(f) Minimum Adjustment. No adjustment in the conversion price shall be required
if such adjustment is less than 1% of the Existing Conversion Price; provided,
however, that any adjustments which by reason of this PARAGRAPH 4 (F) are not
required to be made shall be carried forward and taken into account in any
subsequent adjustment. All calculations under this Section 4 shall be made to
the nearest cent or to the nearest one-hundredth of a share, as the case may be.
Anything to the contrary notwithstanding, Maker shall be entitled to make such
reductions in the conversion price, in addition to those required by this
PARAGRAPH 4 (F), as it in its discretion shall determine to be advisable in
order that any stock dividends, subdivision of shares, distribution of rights to
purchase stock or securities, or distribution of securities convertible into or
exchangeable for stock hereafter made by the Company to its stockholders shall
not be taxable.
(g) Referral of Adjustment. In any case in which this SECTION 4 shall require
that an adjustment in the conversion price be made effective as of a record date
for a specified event, if the Note shall have been converted after such record
date Maker may elect to defer until the occurrence of such event issuing to
Payee the shares, if any, issuable upon such conversion over and above the
shares, if any, issuable upon such conversion on the basis of the conversion
price in effect prior to such adjustment; provided, however, that Maker shall
deliver to Payee a due bill or other appropriate instrument evidencing Payee's
right to receive such additional shares upon the occurrence of the event
requiring such adjustment.
(h) Number of Shares. Upon each adjustment of the conversion price as a result
of the calculations made in PARAGRAPHS 4 (A) through (C) above, the Note shall
thereafter evidence the right to purchase, at the adjusted conversion price,
that number of shares (calculated to the nearest one-hundredth) obtained by
dividing (i) the product obtained by multiplying the number of shares
purchasable upon conversion of the Note prior to adjustment of the number of
shares by the conversion price in effect prior to adjustment of the conversion
price by (ii) the conversion price in effect after such adjustment of the
conversion price.
5
<PAGE>
(i) When No Adjustment Required. No adjustment need be made for a transaction
referred to in PARAGRAPHS 4 (A) through (C) above if Payee is permitted to
participate in the transaction on a basis no less favorable than any other party
and at a level which would preserve Payee's percentage equity participation in
the Common Stock upon conversion of the Note. No adjustment need be made for
sales of Common Stock pursuant to a Company plan for reinvestment of dividends
or interest, the granting of options and/or the exercise of options outstanding
under any of Maker's currently existing stock option plans, the exercise of any
other of Maker's currently outstanding options, or any currently authorized
warrants, whether or not outstanding. No adjustment need be made for a change in
the par value or no par value of the Common Stock. If the Note becomes
convertible solely into cash, no adjustment need be made thereafter.
Interest will not accrue on the cash.
(j) Notice of Adjustment. Whenever the conversion price is adjusted, Maker shall
promptly mail to Payee a notice of the adjustment together with a certificate
from Maker's Chief Financial Officer briefly stating (i) the facts requiring the
adjustment, (ii) the adjusted conversion price and the manner of computing it,
and the date on which such adjustment becomes effective. The certificate shall
be evidence that the adjustment is correct, absent manifest error.
(k) Voluntary Reduction. Maker from time to time may reduce the conversion price
by any amount for any period of time if the period is at least 20 days and if
the reduction is irrevocable during the period. Whenever the conversion price is
reduced, Maker shall mail to Payee a notice of the reduction. Maker shall mail
the notice at least 15 days before the date the reduced conversion price takes
effect. The notice shall state the reduced conversion price and the period it
will be in effect. A reduction of the conversion price does not change or adjust
the conversion price otherwise in effect for purposes of PARAGRAPHS 4 (A)
through (C) above.
(l) Notice of Certain Transactions. If (i) Maker takes any action that would
require an adjustment in the conversion price pursuant to this SECTION 4; or
(ii) there is a liquidation or dissolution of Maker, Maker shall mail to Payee a
notice stating the proposed record date for a distribution or effective date of
a reclassification, consolidation, merger, transfer, lease, liquidation or
dissolution. Maker shall mail the notice at least 15 days before such date.
Failure to mail the notice or any defect in it shall not affect the validity of
the transaction.
(m) Reorganization of Company. If Maker and/or the holders of Common Stock are
parties to a merger, consolidation or a transaction in which (i) Maker transfers
or leases substantially all of its assets; (ii) Maker reclassifies or changes
its outstanding Common Stock; or (iii) the Common Stock is exchanged for
securities, cash or other assets; the person who is the transferee or lessee of
such assets or is obligated to deliver such securities, cash or other assets
shall assume the terms of this Note. If the issuer of securities deliverable
upon conversion of the Note is an affiliate of the surviving, transferee or
lessee corporation, that issuer shall join in such assumption. The assumption
agreement shall provide that the Payee may convert the Convertible Obligations
into the kind and amount of securities, cash or other assets which he would have
owned immediately after the consolidation, merger, transfer, lease or exchange
if he had converted the Note immediately before the effective date of the
transaction. The assumption agreement shall provide for adjustments which shall
be as nearly equivalent as may be practical to the adjustments provided for in
this SECTION 4. The successor company shall mail to Payee a notice briefly
describing the assumption agreement. If this Paragraph applies, PARAGRAPH 4 (A)
above does not apply.
(n) Maker Determination Final. Any determination that Maker or its Board of
Directors must make pursuant to SECTION 3 or this SECTION 4 shall be conclusive,
absent manifest error.
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5. Right to Registration.
(a) Payee's Demand Right to Registration. Upon receipt of notice (the
"Registration Request Notice") requesting registration under the Act of the
Underlying Shares from the holders of the majority of such Shares, on only one
occasion, after December 31, 1997, and through one year after the date on which
all of the Notes have been repaid and/or converted, Maker will offer to Payee
the opportunity to include this Note and his Underlying Shares (the
"Registerable Securities") in such registration. Maker will use its best efforts
to file with the Securities and Exchange Commission (the "Commission") as
promptly as practicable, a registration statement (the "Demand Registration
Statement"), utilizing year end audited financial statements, and will use its
best efforts to have the Demand Registration Statement declared effective and
remain effective until the earliest of two years thereafter, the date all the
Registerable Securities registered thereby have been sold, or, in the reasonable
opinion of maker's counsel, the Registerable Securities may be sold publicly
without registration. Maker will also use its best efforts to qualify the
Registerable Securities under the securities laws of the state where Payee
resides provided Maker is not required to execute a general consent to service
or to qualify to do business in such state. This offer to Payee shall be made
within 20 days after Maker receives the Registration Request Notice. If Payee
elects to include his Registerable Securities in the Demand Registration
Statement, he will, in a timely fashion, provide Maker and its counsel with such
information and execute such documents as Maker's counsel may reasonably require
to prepare and process the Demand Registration Statement. If Payee elects not to
include his Registerable Securities in the "Demand Registration Statement," he
shall have no further rights to the registration of his Registerable Securities
under THIS PARAGRAPH 5 (A).
(b) Payee's "Piggy Back" Registration Rights. If at any time after the date
hereof, Maker proposes to file a Registration Statement under the Act with
respect to any of its securities (except one relating to stock option or
employee benefit plans), Maker shall give written notice of its intention to
effect such filing to Payee at least 30 days prior to filing such Registration
Statement (the "Piggy-Back Registration Statement"). If Payee desires to include
his Registerable Securities in the Piggy-Back Registration Statement, he shall
notify Maker in writing within 15 days after receipt of such notice from Maker,
in which event Maker shall include Payee's Registerable Securities in the
Piggy-Back Registration Statement. If Payee elects to include his Registerable
Securities in the Piggy-Back Registration Statement as set forth herein, he
shall, in a timely fashion, provide Maker and its counsel with such information
and execute such documents as its counsel may reasonably require to prepare and
process the Piggy-Back Registration Statement. Anything to the contrary not
withstanding, in the event that the offering for which the Piggy-Back
Registration Statement has been filed is to be effected by an underwriter, such
underwriter may exclude the Registerable Securities from the Piggy-Back
Registration Statement.
(c) Copies of Registration Statements and Prospectuses. Maker will provide Payee
with a copy of the Demand Registration Statement or Piggy-Back Registration
Statement, as the case may be, and any amendments thereto, and copies of the
final prospectus included therein in such quantities as may reasonably be
required to permit Payee to sell his Registerable Securities after the Demand
Registration Statement or Piggy-Back Registration Statement, as the case may be,
is declared effective by the Commission.
(d) Maker's Obligation to Bear Expenses of Registration. Maker will bear all
expenses (except underwriting discounts and commission, if any, and the legal
fees and expenses, if any, of counsel to Payee) necessary and incidental to the
performance of its obligations under this SECTION 5.
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(e) Indemnification. Maker and Payee, if Payee's Registerable Securities are
included in a Registration Statement pursuant to this SECTION 5, shall provide
appropriate cross indemnities to each other covering the information supplied by
the indemnifying party for inclusion in the Registration Statement.
(f) Cancellation of Registration Rights. Anything to the contrary not
withstanding, Maker shall not be required to register any Underlying Shares
which, in the reasonable opinion of Maker's counsel, may be sold pursuant to the
exemption from registration provided by Section (k) of Rule 144 promulgated
under the Act.
6. Subordination; Pari Passu with other Notes.
(a) Senior Debt. This Note is subordinated to Senior Debt, which means (a) all
obligations and indebtedness of Maker, including but not limited to indebtedness
to Credit Lyonnais New York Branch, as agent (the "Agent") for itself and the
other lenders now or hereafter party to that certain Credit Agreement dated as
of July 11, 1997 among Maker, Agent and such lenders, as modified, amended or
supplemented (the "Credit Agreement") and the $1,028,000 in principal amount of
debentures due December 31, 1997 and all accrued interest thereon, whether
outstanding on the date hereof or hereafter created, and all indebtedness
secured by assets of Maker having a value (as determined by the Board of
Directors of Maker) of more than 50% of the outstanding principal amount of such
indebtedness or $100,000, whichever is less, (i) for borrowed money, (ii) for
money borrowed by others and guaranteed, directly or indirectly, by Maker, or
(iii) constituting purchase money indebtedness for the payment of which Maker is
directly or contingently liable, unless , in any such case, by the express terms
of the instrument creating or evidencing such indebtedness it is provided that
such indebtedness is not superior in right of payment to this Note or to other
indebtedness which is pari passu with, or subordinated to this Note, and (b) any
deferrals, renewals, increases or extensions of any such Senior Debt. As used in
the preceding sentence the term "purchase money indebtedness" shall mean
indebtedness evidenced by a note, debenture, bond or other similar instrument
issued to or assumed for a vendor as all or part of the purchase price of such
asset acquired by Maker. Senior Debt must be paid before the Note may be paid.
This Note shall be paid on a pari passu basis with all other Notes. Upon request
of Maker Payee shall execute such subordination agreements with holders of
Senior Debt as shall be reasonably requested.
(b) Subordination to Senior Bank Debt; Restrictions on Subordinated Debt.
Anything in this Note to the contrary notwithstanding, the indebtedness
evidenced by this Note, including without limitation, principal, premium, if
any, and interest and any and all fees, expenses, indemnities and all other
monies owing at any time pursuant to or in connection with this Note (the
"Subordinated Debt"), shall be subordinate and junior to all Senior Debt
evidenced by the Credit Agreement and the other documents, instruments and
agreements executed in connection therewith, and all modifications and
amendments thereto and all substitutions or replacements thereof (collectively,
the "Senior Bank Debt"), to the extent set forth below:
(i) If a Default (as defined in the Credit Agreement) or a Potential
Default (as defined in the Credit Agreement) shall occur, then, unless and
until such Default or Potential Default shall have been remedied by
indefeasible payment in full of all of the Senior Bank Debt in cash, or
otherwise cured, or expressly waived in writing by all affected holders of
Senior Bank Debt, the Maker shall not make and the holder of this Note
shall not accept or receive, any direct or indirect payment (whether of
principal, interest or other amounts) of or on account of any Subordinated
Debt, whether in cash or other property or by setoff or in any other
manner;
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(ii) In the event of any insolvency, bankruptcy, liquidation,
reorganization or other similar proceedings, or any receivership
proceedings in connection therewith, relative to the Maker, and in the
event of any proceedings for voluntary liquidation, dissolution or other
winding up of the Maker, whether or not involving insolvency or bankruptcy
proceedings, then all Senior Bank Debt shall first be indefeasibly paid in
full and in cash before any payment is made of, or on account of, any
Subordinated Debt;
(iii) In any of the proceedings referred to in subparagraph (2) above, the
holder of this Note hereby absolutely, irrevocably and unconditionally
assigns and sets over to Agent all of his rights to vote to approve or
reject any plan of reorganization in respect of Maker or any of its
subsidiaries, and any payment or distribution of any kind or character
whether in cash, property, stock or obligations, which may be payable or
deliverable by the Maker in respect of this Note shall be paid or
delivered directly to Agent, for the benefit of the holders of Senior Bank
Debt for the ratable application in payment thereof in accordance with the
priorities then existing among such holders, unless and until all Senior
Bank Debt shall have been indefeasibly paid in full and in cash;
(iv) In the event of any of the proceedings referred to in paragraph (2)
above, the holder of this Note will, at the Agent's request, file any
claim, proof of claim or other instrument of similar character necessary
to enforce the obligation of the Maker in respect of the Subordinated
Debt. In the event that the holder of this Note should fail to take such
action requested by the Agent, the Agent may, as attorney-in-fact for the
holder of this Note, take such action on behalf of the holder of this
Note, and the holder of this Note hereby irrevocably appoints the Agent as
attorney-in-fact for the holder of this Note to demand, sue for, collect
and receive any and all such moneys, dividends or other assets and give
acquittance therefor and to file any claim, proof of claim or other
instrument of similar character and to take such other proceedings in
Agent's own name(s) or in the name of the holder of this Note as the Agent
may deem necessary or advisable for the enforcement of the terms contained
in this Note; and the holder of this Note will execute and deliver to
Agent such other and further powers of attorney or other instruments as
Agent may request in order to accomplish the foregoing;
(v) Notwithstanding the holder of this Note's rights under applicable law
or any provision of this Note to the contrary, the holder of this Note
hereby acknowledges and agrees that he shall not take, pursue or engage
in, directly or indirectly, any Enforcement Action (hereinafter defined)
unless the Senior Bank Debt has been indefeasably paid in full (A) if a
Default (as defined in the Credit Agreement) or a Potential Default (as
defined in the Credit Agreement) has occurred which has not been cured or
waived by the holders of the Senior Bank Debt and which Default or
Potential Default results in the full amount of the Senior Bank Debt being
declared due and payable, or (B) during the period of time commencing on
the date that Agent obtains actual knowledge that a Default or Potential
Default has occurred which permits the holders of the Senior Bank Debt to
declare any amounts thereof due and payable, and ending on the earlier of
the date on which such Default or Potential Default shall have been cured
or waived by the holders of the Senior Bank Debt or the 90th day after the
commencement of such period. As used herein the term "Enforcement Action"
means any of the following: (1) the holder of this Note shall (A)
accelerate the Subordinated Debt or any portion thereof, or (B) take any
Enforcement Action or exercise any remedies against Maker to collect or
enforce any of its obligations and indebtedness under this Note; or (2)
the holder of this Note acquiesces in, petitions, or otherwise invokes or
causes any other person to invoke the process of the United States of
America, any state or other political subdivision thereof or any other
jurisdiction, any entity exercising executive, legislative, judicial,
regulatory, or administrative functions of or pertaining to government for
the purpose of commencing or sustaining a case against Maker, under a
federal or state bankruptcy, insolvency, or
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similar law or appointing a receiver, liquidator, assignee, trustee,
custodian, sequestrator, or other similar official of Maker or all of any
part of its property or assets or ordering the winding-up or liquidation
of the affairs of Maker. The holder of this Note hereby waives any right
it may have to require that the holders of the Senior Bank Debt marshal
any assets of Maker in favor of the holder of this Note.
(vi) The holder of this Note shall not institute any judicial or
administrative proceeding against Maker or the holders of the Senior Bank
Debt which directly or indirectly would interfere with or delay the
exercise by Agent or the holders of the Senior Bank Debt of their rights
and remedies in respect of any property of Maker or any other obligor of
the Senior Bank Debt constituting collateral security for the Senior Bank
Debt or under the Senior Credit Agreement. Without limiting the generality
of the foregoing, in the event of a bankruptcy or insolvency of Maker, the
holder of this Note shall not object to or oppose any efforts by the
holders of the Senior Bank Debt to obtain relief from the automatic stay
under Section 362 of the United States Bankruptcy Code or to seek to cause
such entity's bankruptcy estate to abandon property (or any portion
thereof) that is subject to liens and security interests in favor of the
Agent or the holders of the Senior Bank Debt.
(vii) If any payment or distribution of any character, whether in cash,
securities or other property, shall be received by the holder of this Note
(other than payments or distributions consisting of the Underlying Shares
made in exchange for the Convertible Obligations pursuant to SECTION 3 of
this Note) in contravention of any of the terms of this Note and before
all the Senior Bank Debt shall have been indefeasibly paid in full and in
cash, such payment or distribution shall be received in trust for the
benefit of the holders of the Senior Bank Debt at the time outstanding and
shall forthwith be paid over or delivered and transferred to the Agent for
the ratable application in payment thereof in accordance with the
priorities then existing among such holders;
(viii)Payment of the Subordinated Debt will not be secured by any security
interest or lien on any assets of, or by a guaranty from, any obligor of
the Senior Bank Debt unless all Senior Bank Debt has been indefeasibly
paid in full and in cash; and
(ix) The amount, the rate of interest charged, or the time, place, manner,
terms or amount of principal or interest payments of this Note, including,
without limitation, the provisions of this Paragraph 6, may not be altered
in any fashion (provided, however, that Maker and Payee may agree to alter
the number of Underlying Shares into which the Convertible Obligations may
be converted pursuant to Paragraph 3 of this Note), and, no portion of the
principal owing with respect to this Note may be paid prior to the
Maturity Date, without, in each instance, the prior express written
consent of Agent unless all Senior Bank Debt has been indefeasibly paid in
full and in cash.
(x) Notwithstanding anything herein to the contrary, nothing in this
Paragraph 6 shall limit the rights of Maker and the holder of this Note to
agree to any changes in the conversion provisions of this Note which might
result in the issuance of a greater or lesser number of shares of common
stock in satisfaction of Maker's obligations under this Note or the timing
of such conversion of Maker's obligation into common stock.
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(c) Rights of Holders of Senior Bank Debt. The subordination provisions of this
Note shall be deemed a continuing offer to all holders of Senior Bank Debt to
act in reliance on such provisions (but no such reliance shall be required to be
proven to receive the benefits hereof) and may be enforced by such holders, and
no right of Agent or any present or future holder of any senior Bank Debt to
enforce subordination as provided in this Note shall at any time in any way be
prejudiced or impaired by any act or failure to act on the part of the Maker or
by any act or failure to act by Agent or any such holder, or by any
non-compliance by the Maker with the terms, provisions and covenants of this
Note.
Without in any way limiting the generality of the foregoing, the holders of
Senior Bank Debt may, at any time and from time to time, without the consent of
or notice to the holder of this Note, and without impairing or releasing the
subordination provided in this Note or the obligations hereunder of the holder
of this Note to the holders of Senior Bank Debt, do any one or more of the
following: (i) change the manner, place or terms of payment or extend the time
of payment of, or renew or alter, or waive defaults under Senior Bank Debt, or
otherwise amend or supplement in any manner the Senior Bank Debt or any
instrument evidencing the same or any agreement under which the Senior Bank Debt
is outstanding; (ii) release any person or entity liable in any manner for the
payment or collection of Senior Bank Debt; (iii) sell, exchange, release or
otherwise deal with all or any part of the property by whomsoever at any time
pledged or mortgaged to secure, or howsoever securing, any of the Senior Bank
Debt; (iv) exercise or refrain from exercising any rights against the Maker and
any other person or entity, including any guarantor or surety; and (v) apply any
sums, by whomsoever paid or however realized, to Senior Bank Debt.
7. Covenants.
Maker covenants and agrees that from and after the date hereof and until the
date of repayment in full of the Obligations it shall comply with the following
conditions:
(i) Maintenance of Existence and Conduct of Business. Maker shall, and
shall cause each of its subsidiaries, if any, to (A) do or cause to be
done all things necessary to preserve and keep in full force and effect
its corporate existence and rights; and (B) continue to conduct its
business so that the business carried on in connection therewith may be
properly and advantageously conducted at all times.
(ii) Books and Records. Maker shall, and shall cause each of its
subsidiaries, if any, to keep adequate books and records of account with
respect to its business activities.
(iii) Insurance. Maker shall, and shall cause each of its subsidiaries, if
any, to maintain insurance policies insuring such risks as are customarily
insured against by companies engaged in businesses similar to those
operated by Maker or such subsidiaries, as the case may be. All such
policies are to be carried with reputable insurance carriers and shall be
in such amounts as are customarily insured against by companies with
similar assets and properties engaged in a similar business.
(iv) Compliance with Law. Maker shall, and shall cause each of its
subsidiaries, if any, to comply in all material respects with all federal,
state and local laws and regulations applicable to it or such
subsidiaries, as the case may be, which if breached would have a material
adverse effect on Maker's or such subsidiaries', as the case may be,
business or financial condition.
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8. Representations and Warranties of Maker.
Maker represents and warrants that it: (i) is a corporation duly organized,
validly existing and in good standing under the laws of the State of Delaware
and has all requisite corporate power to carry on its business as now conducted
and to own its properties and assets it now owns; (ii) is duly qualified or
licensed to do business as a foreign corporation in good standing in the
jurisdictions in which ownership of property or the conduct of its business
requires such qualification except jurisdictions in which the failure to qualify
to do business will have no material adverse effect on its business, prospects,
operations, properties, assets or condition (financial or otherwise); (iii) has
full power and authority to execute and deliver this Note, and that the
execution and delivery of this Note will not result in the breach of or default
under, with or without the giving of notice and/or the passage of time, any
other agreement, arrangement or indenture to which it is a party or by which it
may be bound, or the violation of any law, statute, rule, decree, judgment or
regulation binding upon it; and (iv) has taken and will take all acts required,
including but not limited to authorizing the signatory hereof on its behalf to
execute this Note, so that upon the execution and delivery of this Note, it
shall constitute the valid and legally binding obligation of Maker enforceable
in accordance with the terms thereof.
9. Defaults and Remedies.
(a) Events of Default. The occurrence or existence of any one or more of the
following events or conditions (regardless of the reasons therefor) shall
constitute an "Event of Default" hereunder:
(i) Maker shall fail to make any payment of Principal or Interest when due
and payable or declared due and payable pursuant to the terms hereof and
such failure shall remain uncured for a period of 15 days after notice
thereof has been given by Payee to Maker;
(ii) Maker shall fail at any time to be in material compliance with any of
the covenants set forth in PARAGRAPH 3 (C) or SECTION 7 of this Note, or
shall fail at any time to be in material compliance with or neglect to
perform, keep or observe any of the provisions of this Note to be complied
with, performed, kept or observed by Maker and such failure shall remain
uncured for a period of 30 days after notice thereof has been given by
Payee or the Agent to Maker;
(iii)Any representation or warranty made in this Note by Maker shall be
untrue or incorrect in any material respect as of the date when made or
deemed made;
(iv) A case or proceeding shall have been commenced against Maker, or any
of its subsidiaries, if any, in a court having competent jurisdiction
seeking a decree or order in respect of Maker, or any of its subsidiaries,
(A) under Title 11 of the United States Code, as now constituted or
hereafter amended, or any other applicable federal, state or foreign
bankruptcy or other similar law; (B) appointing a custodian, receiver,
liquidator, assignee, trustee or sequestrator (or similar official) of
Maker, or any of its subsidiaries, or any of their respective properties;
or (C) ordering the winding-up or liquidation of the affairs of Maker, or
any of its subsidiaries, and such case or proceeding shall remain unstayed
or undismissed for a period of 90 consecutive days or such court shall
enter a decree or order granting the relief sought in such case or
proceeding; or
(v) Maker, or any of its subsidiaries, if any, shall (A) file a petition
seeking relief under Title 11 of the United States Code, as now
constituted or hereafter amended, or any other applicable federal, state
or foreign bankruptcy or other similar law; or (B) consent to the
institution of proceedings thereunder or to the filing of any such
petition or to the
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appointment of or the taking of possession by a
custodian, receiver, liquidator, assignee, trustee or sequestrator (or
similar official) of Maker, or any of its subsidiaries, or any of their
respective properties.
(b) Remedies. Upon the occurrence of an event of Default specified in PARAGRAPHS
9 (IV) and (V) above, all Obligations then remaining unpaid hereunder shall
immediately become due and payable without notice. Upon the occurrence of any
other Event of Default, the holders of at least 51% in principal amount of the
Notes may thereafter, at their option immediately by notice to Maker, declare
all Obligations then remaining unpaid hereunder immediately due and payable,
whereupon the same shall forthwith mature and become due and payable, without
any further notice to Maker and without presentment, demand, protest or notice
of protest, all of which are hereby waived by Maker. Upon a declaration of
acceleration, the entire Obligations then remaining unpaid hereunder shall
become immediately due and payable in full plus all reasonable costs and
expenses of the collection and enforcement of this Note, including reasonable
attorney's fees and expenses, all of which shall be added to the amount due
under this Note. The rights, powers, privileges and remedies of Payee pursuant
to the terms hereof are cumulative and not exclusive of any other rights,
powers, privileges and remedies which Payee may have under this Note or any
other instrument or agreement.
10. Maker's Right to Prepay.
Maker may not repay this Note or any portion thereof prior to May 1, 1999.
Thereafter, Maker may prepay this Note or any portion thereof at any time on not
less than 30 nor more than 60 day's notice to Payee together with accrued
Interest to the date fixed for repayment. The repayment price shall be on a
decreasing scale commencing at 110% on May 1, 1999 and decreasing by 0.56% per
month to 100% on November 1, 2000 as follows:
Percent of Percent of
Date Principal Date Principal
---- ---------- ---- ----------
May 1, 1999 110.00 February 1, 2000 104.96
June 1, 1999 109.44 March 1, 2000 104.40
July 1, 1999 108.88 April 1, 2000 103.84
August 1, 1999 108.32 May 1, 2000 103.28
September 1, 1999 107.76 June 1, 2000 102.72
October 1, 1999 107.20 July 1, 2000 102.16
November 1, 1999 106.64 August 1, 2000 101.60
December 1, 1999 106.08 September 1, 2000 101.04
January 1, 2000 105.52 October 1, 2000 100.48
Repayment after October 1, 2000 will be at 100% of Principal. Anything to the
contrary not withstanding, Maker may prepay this Note at any time after April
30, 1999 on 30 day's notice without any premium or penalty if the Closing Price
of the Common Stock for 30 consecutive trading days immediately preceding the
day on which the repayment notice is sent equals or exceeds $4.50 per share.
11. Acknowledgment of Payee's Investment Representations.
By accepting this Note, Payee acknowledges that this Note has not been and,
except as provided herein, will not be registered under the Act or qualified
under any state securities laws and that the transferability thereof is
restricted by the registration provisions of the Act as well as such state laws.
Based upon the representations and agreements being made by him herein, this
Note is being issued to him pursuant to an exemption from such registration
provided by Section 4 (2) of the Act and applicable state securities law
qualification exemptions. Payee represents that he
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is acquiring the Note for his own account, for investment purposes only and not
with a view to resale or other distribution thereof, nor with the intention of
selling, transferring or otherwise disposing of all or any part of it for any
particular event or circumstance, except selling, transferring or disposing of
it only upon full compliance with all applicable provisions of the Act, the
Securities Exchange Act of 1934, the Rules and Regulations promulgated by the
Commission thereunder, and any applicable state securities laws. Payee further
understands and agrees that no transfer of this Note shall be valid unless made
in compliance with the restrictions set forth on the front of this Note,
effected on Maker's books by the registered holder hereof, in person or by an
attorney duly authorized in writing, and similarly noted hereon. Maker may
charge Payee a reasonable fee for any re registration, transfer or exchange of
this Note.
12. Limitation of Liability.
A director, officer, employee or stockholder, as such, of Maker shall not have
any liability for any obligations of Maker under this Note or for any claim
based on, in respect or by reason of such obligations or their creation. Payee,
by accepting this Note, waives and releases all such liability. The waiver and
release are part of the consideration for the issuance of this Note.
13. Limitation of Interest Payments.
Nothing contained in this Note or in any other agreement between Maker and Payee
requires Maker to pay or Payee to accept Interest in an amount which would
subject Payee to any penalty or forfeiture under applicable law. In no event
shall the total of all charges payable hereunder, whether of Interest or of such
other charges which may or might be characterized as interest, exceed the
maximum rate permitted to be charged under the laws of the States of New York or
Texas. Should Payee receive any payment which is or would be in excess of that
permitted to be charged under such laws, such payment shall have been and shall
be deemed to have been made in error and shall automatically be applied to
reduce the Principal outstanding on this Note.
14. Reservation of Shares.
Maker shall at all times reserve and keep available out of its authorized but
unissued stock, for the purpose of effecting the issuance of stock upon
conversion of this Note, such number of shares as shall from time to time be
sufficient to effect the issuance of shares of Common Stock upon conversion of
this Note.
15. Miscellaneous.
(a) Effect of Forbearance. No forbearance, indulgence, delay or failure to
exercise any right or remedy by Payee with respect to this Note shall operate as
a waiver or as an acquiescence in any default.
(b) Effect of Single or Partial Exercise of Right. No single or partial exercise
of any right or remedy by Payee shall preclude any other or further exercise
thereof or any exercise of any other right or remedy by Payee.
(c) Governing Law. This Note shall be construed and enforced in accordance with,
and the rights of the parties shall be governed by, the internal laws of the
State of Texas applicable to contracts made and to be performed entirely within
such State.
(d) Headings. The headings and captions of the various paragraphs herein are for
convenience of reference only and shall in no way modify any of the terms or
provisions of this Note.
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(e) Loss, Theft, Destruction or Mutilation. Upon receipt by Maker of evidence
reasonably satisfactory to it of loss, theft, destruction or mutilation of this
Note, Maker shall make and deliver or caused to be made and delivered to Payee a
new Note of like tenor in lieu of this Note.
(f) Modification of Note or Waiver of Terms Thereof Relating to Payee. No
modification or waiver of any of the provisions of this Note shall be effective
unless in writing and signed by Payee and then only to the extent set forth in
such writing, nor shall any such modification or waiver be applicable except in
the specific instance for which it is given. This Note may not be discharged
orally but only in writing duly executed by Payee.
(g) Notice. All offers, acceptances, notices, requests, demands and other
communications under this Note shall be in writing and, except as otherwise
provided herein, shall be deemed to have been given only when delivered in
person, via facsimile transmission if receipt thereof is confirmed by the
recipient, or, if mailed, when mailed by certified or registered mail prepaid,
to the parties at their respective addresses first set forth above, or at such
other address as may be given in writing in future by either party to the other.
(h) Successors and Assigns. This Note shall be binding upon Maker, its
successors, assigns and transferees, and shall inure to the benefit of and be
enforceable by Payee and its successors and assigns.
(i) Severability. If one or more of the provisions or portions of this Note
shall be deemed by any court or quasi-judicial authority to be invalid, illegal
or unenforceable in any respect, the invalidity, illegality or unenforceability
of the remaining provisions, or portions of provisions contained herein shall
not in any way be affected or impaired thereby, so long as this Note still
expresses the intent of the parties. If the intent of the parties cannot be
preserved, this Agreement shall either be renegotiated or rendered null and
void.
IN WITNESS WHEREOF, Maker has caused this Note to be executed on its behalf by
an officer thereunto duly authorized as of the date set forth above.
Fortune Natural Resources Corporation
a Delaware corporation
[SEAL]
By: ______________________________
Tyrone J. Fairbanks, President
and Chief Executive Officer
ATTEST: __________________________
Dean W. Drulias, Secretary
15
<PAGE>
FORM OF WARRANT
THE SECURITIES REPRESENTED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES
ACT OF 1933; THEY HAVE BEEN ACQUIRED BY THE HOLDER FOR INVESTMENT AND MAY NOT BE
PLEDGED, HYPOTHECATED, SOLD, TRANSFERRED OR OTHERWISE DISPOSED OF EXCEPT AS MAY
BE AUTHORIZED UNDER THE SECURITIES ACT OF 1933 AND THE RULES AND REGULATIONS
PROMULGATED THEREUNDER.
FORTUNE NATURAL RESOURCES CORPORATION
WARRANT _____________ WARRANTS
CERTIFICATE NO. _____ MARCH 19, 1999
WARRANT TO PURCHASE SHARES OF COMMON STOCK
THIS CERTIFIES that, for value received, ___________________________, or
registered assigns ("Holder"), is the registered holder of the number of
warrants set forth above (the "Warrants"), each of which entitles Holder to
purchase, subject to the terms and conditions set forth below, one fully paid
and non-assessable share of Common Stock of FORTUNE NATURAL RESOURCES
CORPORATION, a Delaware corporation (the "Company"), at a purchase price of
$1.00 (the "Purchase Price"), at any time or from time to time after the date
set forth above (the "Exercise Date") and on or prior to 5:00 P.M., Central
Standard Time on March 18, 2002 (the "Expiration Date"). The Purchase Price and
the number and kinds of securities of the Company purchasable upon the exercise
of the Warrants represented hereby are subject to modification or adjustment as
provided below. The Purchase Price shall be payable in lawful funds of the
United States. Upon presentation and surrender of this Warrant Certificate
together with the payment of the Purchase Price for the shares of Common Stock
thereby purchased and the Form of Notice of Exercise attached hereto duly
executed, at the place and in the manner specified in Section 4, below, the
Holder shall be entitled to receive a certificate or certificates for the shares
of Common Stock so purchased.
1. Registration and Transfer
1.1 General
The Company shall maintain books for the registration and transfer of
the Warrants. Prior to due presentment for registration of transfer of the
Warrants, the Company may deem and treat the registered Holder as the absolute
owner thereof.
1
<PAGE>
1.2 Transfer
The Warrants may not be assigned, or transferred without the prior
written consent of the Company, in its sole and absolute discretion;
1.3 Registration
Subject to Section 1.1, above, the Company shall register upon its
books any transfer of the Warrants upon surrender of this Warrant Certificate to
the Company accompanied (if so required by the Company) by a written instrument
of transfer duly executed by the registered Holder or by a duly authorized
attorney. Upon any such registration of transfer, a new Warrant Certificate
shall be issued to the transferee and the surrendered Warrant Certificate shall
be cancelled by the Company. If only a portion of the Warrants represented by
this Warrant Certificate are transferred, a new Warrant Certificate shall also
be issued to the transferor.
2. Loss or Mutilation
Upon receipt by the Company of reasonable evidence of the ownership
and the loss, theft, destruction or mutilation of this Warrant Certificate and,
in the case of loss, theft or destruction, of indemnity reasonably satisfactory
to the Company, or, in the case of mutilation, upon surrender and cancellation
of the mutilated Warrant Certificate, the Company shall execute and deliver in
lieu thereof a new Warrant Certificate representing an equal number of Warrants.
3. Adjustments
The Purchase Price and the number of shares purchasable upon the
exercise of the Warrants shall be subject to adjustment from time to time upon
the occurrence of certain events described herein.
3.1. Purchase Price Adjustment
(a) Split, Subdivision, or Combination of Shares
If the Company at any time while these Warrants
remain outstanding and unexpired shall split, subdivide, or combine the
securities as to which purchase rights hereunder exist, the Purchase Price shall
be proportionately increased or decreased as appropriate.
2
<PAGE>
(b) Common Stock Dividends
If the Company at any time while these Warrants
remain outstanding and unexpired shall pay a dividend with respect to Common
Stock payable in, or make any other distribution with respect to, the shares of
Common Stock, then the Purchase Price shall be adjusted, from and after the date
of determination of the shareholders entitled to receive any dividend or
distribution, to that price determined by multiplying the Purchase Price in
effect immediately prior to such date of determination by a fraction, the
numerator of which shall be the total number of shares of Common Stock
outstanding immediately prior to such dividend or distribution, and the
denominator of which shall be the total number of shares of Common Stock
outstanding immediately after such dividend or distribution.
(c) Other Dividends
If the Company, at any time while these Warrants
remain outstanding and unexpired, shall pay a dividend or make any other
distribution with respect to Common Stock payable in stock (other than Common
Stock) or other securities or property, the Holder hereof shall be entitled to
receive, upon exercise of the Warrants, in addition to the shares of Common
Stock otherwise receivable upon exercise hereof, the same number and kind of
stock other securities and property which the Holder would have received had the
Holder then held the shares of Common Stock receivable on exercise hereof on and
before the record date for such dividend or distribution.
(d) Reclassification and Recapitalization
In the event of any reclassification or
recapitalization of the Common Stock, the Purchase Price shall be appropriately
adjusted in good faith by the Board of Directors of the Company to reflect such
reclassification or recapitalization and to protect (i) the rights of the Holder
to receive, upon the exercise hereof, the same amount of securities or property
that it would have received had it exercised the Warrants immediately prior to
the date for determination of Holders of Common Stock entitled to receive
securities or property as a result of such reclassification or recapitalization,
and (ii) the Holder's rights to appropriate adjustment upon any further stock
dividend, stock split, reclassification, or recapitalization.
3.2 Adjustment of Number of Shares
Upon each adjustment in the Purchase Price to Section 3.1(a) or
Section 3.1(b) above, the number of shares of Common Stock purchasable hereunder
shall be adjusted to the nearest whole share to the product obtained by
multiplying the number of shares purchasable immediately prior to such
adjustment in the Purchase Price by a fraction, the numerator of which shall be
the Purchase Price immediately prior to such adjustment, and the denominator of
which shall be the Purchase Price immediately after such adjustment.
3
<PAGE>
3.3 Capital Reorganization, Merger, or Sale of Assets
If, at any time or from time to time, there shall be a capital
reorganization of the Common Stock (other than a subdivision, combination,
reclassification, or exchange of shares provided for elsewhere herein) or a
merger or consolidation of the Company with or into another corporation, or a
sale of all or substantially all of the Company's properties and assets to any
other person, the Holder shall thereafter be entitled to purchase (and it shall
be a condition to the consummation of any such reorganization, merger,
consolidation, or sale, that appropriate provision be made so that the Holder
shall thereafter be entitled to purchase), upon exercise of the Warrants, the
kind and amount of shares of stock or other securities or property in the
Company, or of the successor corporation resulting from such merger,
consolidation, or sale, to which a holder of Common Stock issuable upon exercise
would have been entitled on such capital reorganization, merger, consolidation,
or sale. In any such case, appropriate adjustment shall be made in the
application of the provisions of this Section 3 with respect to the rights of
the Holder after the reorganization, merger, consolidation, or sale to the end
that the provisions of this Section 3 (including adjustment of the Purchase
Price then in effect and the number of shares of Common Stock purchasable upon
exercise of the Warrants) shall be applicable after that event in as nearly
equivalent a manner as may be practicable.
3.4 Certificate as to Adjustment
Upon the occurrence of each adjustment or readjustment of the
Purchase Price and the number of shares of Common Stock pursuant to this Section
3, the Company, at its expense, shall promptly compute such adjustment or
readjustment in accordance with the terms hereof and cause its chief financial
officer to verify such computation and prepare and furnish to the Holder a
certificate setting forth such adjustment or readjustment and showing in detail
the facts upon which such adjustment or readjustment is based. The Company
shall, upon the written request at any time of the Holder, furnish or cause to
be furnished to the Holder a like certificate setting forth (a) such adjustment
and readjustment, (b) the Purchase Price at the time in effect, and (c) the
number of shares of Common Stock and the amount, if any, of other securities
and/or property which at the time would be receivable upon the exercise of the
Warrants. Such certificate shall set forth in reasonable detail such facts as
may be necessary to show the reason for and manner of computing such adjustment.
3.5 No Impairment
The Company will not, by amendment of its Certificate of
Incorporation or through any reorganization, recapitalization, transfer of
assets, consolidation, merger, dissolution, issue or sale of securities, or any
other voluntary action, avoid or seek to avoid the observance or performance or
any of the terms to be observed or performed hereunder by the Company, but will
at all times in good faith assist in the carrying out of all the provisions of
this Section 3 and in the taking of all such action as may be necessary or
appropriate in order to protect the exercise rights of the Holder against
impairment.
4
<PAGE>
3.6 Notices of Record Date
In the event of any taking by the Company of a record of the
holders of any class of securities for the purpose of determining the holders
thereof who are entitled to receive any dividend (other than a cash dividend) or
other distribution, any rights to subscribe for, purchase, or otherwise acquire
any shares of stock of any class or for any securities or property, or to
receive any other right, the Company shall mail to the Holder, at least thirty
(30) days prior to the date specified therein, a notice specifying the date on
which any such record is to be taken for the purpose of such dividend,
distribution, or right, in the amount and character of such dividend,
distribution, or right.
3.7 No Fractional Shares
No fractional shares shall be issued upon exercise of the
Warrants, and the number of shares of Common Stock to be issued shall be rounded
to the nearest full share. Such rounding shall be determined on the basis of the
total number of Warrants the Holder is at the time exercising and the number of
shares of Common Stock issuable upon such aggregate exercise.
4. Exercise of Warrants
The purchase rights represented by these Warrants are exercisable by
the Holder, in whole or in part, at any time and from time to time on or after
the Exercise Date and on or prior to the Expiration Date. The Warrants may be
exercised by surrender of this Warrant Certificate, with the Notice of Exercise
attached hereto duly executed, to the principal executive office of the Company,
presently is located at One Commerce Green, 515 W. Greens Rd., Suite 720,
Houston, Texas, 77067 (or such other office or agency of the Company as it may
designate by notice in writing to the registered Holder hereof at the address of
such Holder appearing on the books of the Company), and shall be accompanied by
payment in cash, check or bank draft, payable to the Company, in an amount equal
to the full purchase price for the shares of Common Stock of the Company
(hereinafter referred to as the "Shares") the Company shall deliver a
certificate or certificates representing the Shares as soon as practical, and,
in any event, within ten (10) days after the notice shall be received. The
certificate or certificates for the Shares shall be registered in the name of
the person or persons exercising the Warrants and shall be delivered, as
provided above, to the written order of the person or persons exercising the
Warrants. All shares of Common Stock which may be issued upon the exercise of
the Warrants as provided herein shall be fully paid and non-assessable and free
from all taxes, liens and charges with respect thereto. Holder shall not be
entitled to the privileges of share ownership as to any shares of Common Stock
not actually issued and delivered to it. Holder hereby certifies that all shares
of Common Stock in the Company purchased or to be purchased by it pursuant to
the exercise of the Warrants are being, or are to be, acquired by it for
investment and not with a view to the distribution thereof.
5
<PAGE>
5. Redemption
Any outstanding Warrants may be redeemed, at the option of the
Company, at $.01 per share of Common Stock purchasable upon exercise of such
Warrants, at any time after the closing per share price of the Common Stock on
the American Stock Exchange exceeds $4.50 for five (5) consecutive trading days.
All rights to exercise outstanding Warrants shall terminate at 5:00 P.M. Central
Time on the business day immediately preceding the date fixed for redemption.
The Company's right to redeem the Warrants may only be exercised by written
notice to the holders thereof sent not later than twenty (20) days following the
end of the five trading-day period referred to above, by first class mail,
postage prepaid. Such notice shall specify the redemption price, the date fixed
for redemption (not less than fifteen nor more than thirty days after the date
such notice is sent), the place where the Warrant certificates are to be
delivered and the redemption price paid, and that the right to exercise the
Warrants shall terminate at 5:00 P.M. Central Time on the business day
immediately preceding the date fixed for redemption.
6. General
The Company shall, at all times during the term of the Warrants,
reserve and keep available out of its authorized but unissued shares of Common
Stock such number of Common Stock as will be sufficient to satisfy the
requirements of this Warrant Certificate; and, if at any time, the number of
authorized but unissued shares of Common Stock shall be insufficient to effect
the exercise of the Warrants, in addition to such other remedies as shall be
available to the Holder, the Company shall take such corporate action as may, in
the opinion of the Company, be necessary to increase its authorized but unissued
shares of Common Stock to such number as shall be sufficient for such purposes.
The Company shall pay all original issue and transfer taxes with respect to the
issue and transfer of shares of Common Stock pursuant hereto and all other fees
and expenses necessarily incurred by the Company in connection therewith, and
will, from time to time, use its best efforts to comply with all laws and
regulations which, in the opinion of the Company, shall be applicable thereto.
7. Legends
It is understood that the certificates evidencing the Shares may bear
the following legend:
"THE SECURITIES REPRESENTED BY THIS CERTIFICATE HAVE NOT BEEN
REGISTERED UNDER THE SECURITIES ACT OF 1933; THEY HAVE BEEN ACQUIRED
BY THE HOLDER FOR INVESTMENT AND MAY NOT BE PLEDGED, HYPOTHECATED,
SOLD, TRANSFERRED, OR OTHERWISE DISPOSED OF EXCEPT AS MAY BE
AUTHORIZED UNDER THE SECURITIES ACT OF 1933 AND THE RULES AND
REGULATIONS PROMULGATED THEREUNDER".
6
<PAGE>
8. Notices
Any notice required by the provisions of this Warrant Certificate to
be given to the Holder shall be deemed given three (3) days after it is
deposited in the U.S. mail, certified and return receipt requested, addressed to
the Holder at its address appearing on the books of the Company or on the date
actually delivered in person.
9. Governing Law
This Warrant Certificate shall be governed by and construed in
accordance with the laws of the state of Texas.
IN WITNESS WHEREOF, the Company has caused this Warrant Certificate to be
duly executed as of the date first above written.
FORTUNE NATURAL RESOURCES CORPORATION
By: ___________________________________
TYRONE J. FAIRBANKS, President
and Chief Executive Officer
7
<PAGE>
NOTICE OF EXERCISE
TO: FORTUNE NATURAL RESOURCES CORPORATION:
The undersigned hereby (1) elects to exercise _________________
Warrants represented by the attached Warrant Certificate, and to purchase
___________ shares of Common Stock of Fortune Natural Resources Corporation
issuable upon the exercise of said Warrants, (2) tenders herewith payment of the
Purchase Price of such shares in full, and requests that certificates
representing such shares be issued in the name of and delivered to the following
[please print]:
_____________________________________________________
Social Security or Other Identification Number
_____________________________________________________
Name
_____________________________________________________
Street Address or Post Office Box
_____________________________________________________
City, State and Zip Code
Date: ____________________ _________________________________
Print Name of Holder
_________________________________
Signature
_________________________________
Title
April 1, 1999
Fortune Natural Resources Corporation
One Commerce Green
515 W. Greens Road, Suite 720
Houston, Texas 77067
Attn: Mr. Tyrone J. Fairbanks
President and Chief Executive Officer
Gentlemen:
As set forth in the Registration Statement on Form S-2, filed with the
Securities and Exchange Commission (the "Commission") under the Securities Act
of 1933, as amended (the "Securities Act"), on April 1, 1999 by Fortune Natural
Resources Corporation, a Delaware corporation (the "Company"), in connection
with the registration of $2,295,000 of 12% Convertible Subordinated Notes due
December 31, 2007 (the "Notes") and the shares of the Company's Common Stock,
$.01 par value (the "Common Stock"), issuable on conversion of the Notes or
exercise of the warrants (the "Warrants") issued by the Company to the holders
of these Notes (together with the notes, the "Securities") to be sold by the
selling security holders listed in the Registration Statement from time to time
pursuant to Rule 415 under the Securities Act (the "Selling Holders"), certain
legal matters in connection with the Securities are being passed on for the
Company by the undersigned.
In my capacity as General Counsel for the Company, I have examined the
Certificate of Incorporation of the Company, as filed with the Secretary of
State of Delaware and the Bylaws of the Company, both as amended to date; the
stock transfer records of the Company and the records of the official
proceedings of its board of directors through the date of this opinion; the
Notes and the Subscription Agreement and Investment Letter between the Company
and each of the Selling Holders; and, such other documents as I have deemed
necessary for the expression of the opinions contained herein.
Based upon the foregoing, and having regard for such legal considerations
as I deem relevant, I am of the opinion (limited, in all respects, to the laws
of the State of Delaware and federal law) that:
<PAGE>
Fortune Natural Resources Corporation
April 1, 1999
Page 2
(1) The Company is a corporation duly organized, validly existing and in good
standing under the laws of the State of Delaware;
(2) The Notes have been validly issued, and constitute valid and binding
obligations of the Company enforceable against it in accordance with their
terms, except as such enforcement is subject to any applicable bankruptcy,
insolvency, reorganization, fraudulent conveyance or transfer, moratorium
or other laws relating to or affecting creditors' rights generally and
(ii) general principles of equity (regardless of whether such
enforceability is considered is a proceeding in equity or at law).
(3) The shares of Common Stock to be issued by the Company upon the conversion
of the Notes or the exercise of the Warrants, when issued in accordance
with the terms and conditions of the Notes or Warrants, as the case may
be, have been duly authorized and reserved for issuance and, will be
validly issued, fully paid and nonassessable.
I hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and the use of my name in the related Prospectus under
the caption "Legal Matters".
Very truly yours,
/s/ Dean w. Drulias
- ---------------------------
Dean W. Drulias
General Counsel
DWD:mjk
CONSENT OF INDEPENDENT AUDITORS
The Board of Directors
Fortune Natural Resources Corporation:
We consent to the use of our reports included herein and to the reference to our
firm under the heading "Experts" in the prospectus.
/s/ KPMG LLP
---------------
Houston, Texas
April 1, 1999
HUDDLESTON & CO., INC.
PETROLEUM AND GEOLOGICAL ENGINEERS
1111 FANNIN-SUITE 1700
HOUSTON, TEXAS 77002
----------
(281) 658-0248
CONSENT OF INDEPENDENT PETROLEUM ENGINEER
April 1, 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
Registration Statement on Form S-2 of Fortune Natural Resources Corporation
("Fortune") to be filed with the Securities and Exchange Commission on or about
April 1, 1999, to the use of our name therein, and to the inclusions of or
reference to our report of Fortune's estimated future reserves and revenues
effective December 31, 1996, December 31, 1997 and December 31, 1998.
HUDDLESTON & CO., INC.
/s/ Peter D. Huddleston, P.E.
-------------------------------
Peter D. Huddleston, P.E.
