SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NO. 1-12334
FORTUNE NATURAL RESOURCES CORPORATION
(Exact Name of Registrant as specified in its charter)
Delaware 95-4114732
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Commerce Green, 515 W. Greens Rd.,
Suite 720, Houston, Texas 77067
(Address of Principal Executive Offices) (Zip Code)
281-872-1170
-------------------------
Issuer's telephone number
N/A
--------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No ___
Applicable only to corporate issuers:
State the number of shares outstanding of each of the issuer's classes of common
equity, as of the latest practicable date.
12,196,811 as of April 30, 1999
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
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FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
March 31, December 31,
1999 1998
----------- -----------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ........................ $ 1,029,000 $ 1,452,000
Accounts receivable .............................. 278,000 361,000
Prepaid expenses ................................. 60,000 74,000
----------- -----------
Total Current Assets .......................... 1,367,000 1,887,000
----------- -----------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method ..................... 26,997,000 26,800,000
Office and other ................................. 384,000 384,000
----------- -----------
27,381,000 27,184,000
Less--accumulated depletion, depreciation
and amortization................................ (20,938,000) (20,728,000)
----------- -----------
6,443,000 6,456,000
----------- -----------
OTHER ASSETS:
Deposits and other ............................... 51,000 51,000
Debt issuance costs (net of accumulated
amortization of $420,000 and $347,000 at March
31, 1999 and December 31, 1998, respectively) 25,000 98,000
----------- -----------
76,000 149,000
----------- -----------
TOTAL ASSETS ........................................ $ 7,886,000 $ 8,492,000
=========== ===========
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
March 31, December 31,
1999 1998
----------- -----------
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt................. $ 10,000 $ 10,000
Accounts payable.................................. 73,000 93,000
Accrued expenses.................................. 194,000 351,000
Royalties and working interests payable........... 45,000 12,000
Accrued interest.................................. 97,000 97,000
----------- -----------
Total Current Liabilities...................... 419,000 563,000
----------- -----------
LONG-TERM DEBT....................................... 3,225,000 3,225,000
----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value:
Authorized--2,000,000 shares
Issued and outstanding--None................... - -
Common stock, $.01 par value :
Authorized--40,000,000 shares
Issued and outstanding 12,156,812 and
12,134,675 at March 31, 1999 and
December 31, 1998, respectively.............. 122,000 121,000
Capital in excess of par value.................... 30,261,000 30,171,000
Accumulated deficit............................... (26,141,000) (25,588,000)
----------- -----------
NET STOCKHOLDERS' EQUITY............................. 4,242,000 4,704,000
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........... $ 7,886,000 $ 8,492,000
=========== ===========
</TABLE>
See accompanying notes to financial statements.
2
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<TABLE>
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FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
For the Three Months Ended
------------------------
March 31, March 31,
1999 1998
---------- ----------
(Unaudited)
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REVENUES
Sales of oil and gas, net of royalties........... $ 255,000 $ 706,000
Other income..................................... 15,000 17,000
---------- ----------
270,000 723,000
COSTS AND EXPENSES
Production and operating......................... 90,000 227,000
Provision for depletion, depreciation
and amortization............................... 210,000 570,000
General and administrative....................... 291,000 459,000
Note restructuring cost.......................... 61,000 -
Interest paid in cash............................ 97,000 110,000
Interest - amortization of deferred
financing cost................................. 74,000 96,000
---------- ----------
823,000 1,462,000
---------- ----------
LOSS BEFORE PROVISION FOR INCOME TAXES.............. (553,000) (739,000)
PROVISION FOR INCOME TAXES.......................... - -
---------- ----------
NET LOSS............................................ $ (553,000) $ (739,000)
========== ==========
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING......................... 12,138,000 12,122,000
========== ==========
NET LOSS PER COMMON SHARE (BASIC AND DILUTED)....... $ (0.05) $ (0.06)
========== ==========
</TABLE>
See accompanying notes to financial statements.
3
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<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1998
AND THE THREE MONTHS ENDED MARCH 31, 1999
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, 1997......... 12,118,982 $121,000 $30,283,000 $(38,000) $(22,313,000) $ 8,053,000
Common stock issued for
exercise of warrants............. 5,512 - 13,000 - - 13,000
Common stock contributed to
401(k) Plan...................... 10,185 - 24,000 - - 24,000
Cancellation of treasury stock..... - - (38,000) 38,000 - -
Voluntary exchange of public
warrants for private warrants.... - - (59,000) - - (59,000)
Repurchase of outstanding
private warrants................. - - (52,000) - - (52,000)
Common stock returned to treasury.. (4) - - - - -
Net loss........................... - - - - (3,275,000) (3,275,000)
---------- -------- ----------- -------- ------------ -----------
BALANCE, December 31, 1998......... 12,134,675 $121,000 $30,171,000 $ - (25,588,000) $ 4,704,000
========== ======== =========== ======== ============ ===========
Common stock contributed to
401(k) Plan...................... 22,137 1,000 29,000 - - 30,000
Warrants issued for
note restructuring............... - - 61,000 - - 61,000
Net loss........................... - - - - (553,000) (553,000)
---------- -------- ----------- -------- ------------ -----------
BALANCE, March 31, 1999
(Unaudited)...................... 12,156,812 $122,000 $30,261,000 $ - $(26,141,000) $ 4,242,000
========== ======== =========== ======== ============ ===========
</TABLE>
See accompanying notes to financial statements.
4
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<TABLE>
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FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
For the Three Months Ended
-----------------------
March 31, March 31,
1999 1998
---------- ----------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss......................................... $ (553,000) $ (739,000)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depletion, depreciation and amortization...... 210,000 570,000
Non-cash compensation expense................. 20,000 -
Amortization of deferred financing cost....... 74,000 96,000
Note restructuring cost....................... 61,000 -
Changes in assets and liabilities:
Accounts receivable........................... 83,000 216,000
Prepaids...................................... 14,000 -
Accounts payable and accrued expenses......... (177,000) (386,000)
Royalties and working interest payable........ 33,000 (12,000)
Accrued interest.............................. - (76,000)
Other......................................... 9,000 23,000
---------- ----------
Net cash used in operating activities............ (226,000) (308,000)
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties.......... (197,000) (850,000)
Proceeds from sale of properties and equipment... - 4,695,000
Expenditures for other property and
equipment and other assets..................... - (3,000)
---------- ----------
Net cash provided by (used in)
investing activities........................... (197,000) 3,842,000
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long term debt...................... - (540,000)
Proceeds from issuance of common stock........... - 11,000
---------- ----------
Net cash used in financing activities............ - (529,000)
---------- ----------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS.............................. (423,000) 3,005,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD...... 1,452,000 1,667,000
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD............ $1,029,000 $4,672,000
========== ==========
Supplemental information:
Interest paid in cash............................ $ 97,000 $ 110,000
Non-cash transactions
Common stock issued for 401(k) Plan contribution. 30,000 24,000
</TABLE>
See accompanying notes to financial statements
5
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FORTUNE NATURAL RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
March 31, 1999
(1) LINE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
AND PROCEDURES
The condensed financial statements at March 31, 1999, and for the three
months then ended included herein have been prepared by Fortune Natural
Resources Corporation, without audit, pursuant to the Rules and Regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such Rules and Regulations. However, Fortune believes that the
disclosures are adequate to make the information presented not misleading. These
condensed financial statements should be read in conjunction with the financial
statements and the notes thereto included in Fortune's latest annual report on
Form 10-K. Certain reclassifications have been made to prior period amounts to
conform to presentation in the current period. In Fortune's opinion, the
financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly its financial position for
the dates presented and the results of its operations and its cash flows for the
periods presented. The results of the operations for these interim periods are
not necessarily indicative of the results for the full year.
(2) LONG-TERM DEBT
At March 31, 1999, a summary of long-term debt is as follows:
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March 31, December 31,
1999 1998
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Convertible Subordinated Notes
due December 31, 2007..................... $ 3,225,000 $ 3,225,000
Credit Lyonnais credit facility
due July 11, 1999,........................ 10,000 10,000
------------ ------------
Total long-term debt....................... 3,235,000 3,235,000
Less current installments.................. (10,000) (10,000)
------------ ------------
Long-term debt, excluding
current installments...................... $ 3,225,000 $ 3,225,000
</TABLE>
In March 1999, noteholders representing $2,295,000 principle amount of the
Convertible Subordinated Notes agreed to amend the conversion price of their
notes. As a result, the amended notes are convertible into Fortune's common
stock at a conversion price of $0.75 per share, subject to adjustment for
certain recapitalizations or dividends of Fortune. The remaining $930,000
principal amount of notes are convertible into Fortune's common stock at a
conversion price of approximately $0.33 per share, subject to adjustment for
certain recapitalizations or dividends of Fortune. As of May 1, 1999, all notes
are convertible by the holders and/or redeemable by Fortune. The notes are
redeemable by Fortune at a premium that reduces monthly from 10% to zero from
May 1999 to November 2000. Any such premium on redemption is waived if Fortune's
common stock price averages at least $4.50 per share for 30 consecutive trading
days. The notes are subordinate to all of Fortune's secured debt, including the
credit facility with Credit Lyonnais. The notes bear interest at a rate of 12%
per year, payable quarterly. The costs incurred to issue the original notes is
being amortized as additional interest expense over the 18-month period ended
May 1, 1999, the first date that the notes were convertible. As a result of this
amortization of issuance costs, the effective interest rate of the notes over
this 18-month period was 21.2%. If the notes were held to maturity, the
effective interest rate to maturity would be 13.4%.
For agreeing to amend their conversion price, the amending noteholders
received one three-year warrant, exercisable at $1 each, for each share into
which each of their notes is now convertible. Fortune valued this warrant at
$0.02 per warrant and expensed the value of all such warrants during the first
quarter of 1999 as note restructuring cost.
6
<PAGE>
Fortune has in place a $20 million credit facility with Credit Lyonnais New
York Branch. 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. (See note 6). Prior to its 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. Once the borrowing base is redetermined,
Fortune may borrow up to that amount for acquisitions and development projects
approved by Credit Lyonnais at either 1.25% above Credit Lyonnais' base rate or
4% above LIBOR. The credit facility is secured by a mortgage on all of Fortune's
existing proved oil and gas properties. Fortune is also required to pay a
commitment fee of 0.5% on the unused portion, if any, of the borrowing base.
Primarily as a result of the lower revenues after the sale of East Bayou
Sorrel, Fortune was unable to meet the 3 to 1 coverage ratio of cash flow to
fixed-charges which is required by the credit facility for the twelve-months
period ended March 31, 1999. Fortune has received a waiver of this covenant from
the bank for the period ended March 31, 1999.
The $10,000 balance on the credit facility matures in 1999.
(3) INCOME TAX EXPENSE
No provision for income taxes was required for the three months ended March
31, 1999.
At March 31, 1999, Fortune estimates it had cumulative net operating loss
carryforwards for federal income tax purposes of approximately $14 million which
are significantly restricted under IRC Section 382. These carryforwards are
available to offset future federal taxable income, if any, with various
expirations through 2014. Fortune also has net operating loss carryforwards in
certain states, including California, New Mexico and Texas, with various
expiration dates and restrictions. Fortune is uncertain as to the recoverability
of these deferred tax assets and has therefore applied a 100% valuation
allowance.
Fortune has available IRC Section 29 Tax Credits that may be used to reduce
or eliminate any corporate taxable income in future years. It is uncertain at
this time to what extent Fortune will be able to utilize these federal tax
credits, as their utilization is dependent upon the amount, if any, of future
federal income tax incurred, after application of the company's net operating
loss carryforwards.
(4) LEGAL PROCEEDINGS
There are no material pending legal proceedings involving any of Fortune's
properties or which involve a claim for damages which exceed 10% of the
company's current assets.
On April 16, 1996, Fortune was served with two lawsuits which had been filed
in the Federal District Court in New York by purchasers of Fortune common stock
in an offering in December 1995 under Regulation S. Under the terms of the
subscription agreement pursuant to which the plaintiffs acquired their shares,
each was entitled to receive additional shares of Fortune common stock if the
market price fell below a stated level during a specified period following the
40-day holding period prescribed by Regulation S. Fortune responded to the
suits, admitting that the stock price declined but alleged that suspicious
trading activity in Fortune stock occurred immediately prior to and during the
time period in which the additional-share allocation was computed. Fortune
believes that it has discovered evidence of active market manipulation in the
common stock by these plaintiffs; accordingly, it has commenced a countersuit
for damages suffered by Fortune and its shareholders as a result of these acts
and has also added certain third-party defendants whose actions furthered this
market manipulation. Fortune intends to continue to vigorously defend
plaintiffs' actions and prosecute its own counterclaims. Discovery is proceeding
on this matter and a trial date is expected to be set soon.
(5) COMPUTATION OF LOSS PER SHARE
Basic net loss per common share is computed by dividing net loss by the
weighted average number of common shares outstanding. Diluted earnings per
common share are not presented, since the issuance or conversion of additional
securities would have an antidilutive effect.
7
<PAGE>
(6) SALE OF EAST BAYOU SORREL
On March 31, 1998, Fortune sold its interest in the East Bayou Sorrel
field, Iberville Parish, Louisiana to National Energy Group, Inc. for cash in
the amount of $4,695,000. The properties sold consisted of Fortune's interest in
the Schwing #1 and #2 wells and associated leases, facilities and interests.
The Schwing #1 and #2 wells began producing in January 1997 and June 1997,
respectively. Although both wells were shut-in from March 13, 1998 through the
date of the sale to repair production facilities, they accounted for a
significant portion of Fortune's oil and gas through that date. Selected
unaudited financial information attributable to Fortune's interest in the East
Bayou Sorrel field as reported in its 1998 financial results is as follows:
Three Months Ended
March 31, 1998
------------------
(unaudited)
Production
Oil (Bbls) 12,000
Gas (Mcf) 18,000
Oil and gas revenues $230,000
Production and operating expense 55,000
Provision for depletion, depreciation
and amortization 54,000
This represented 33% and 30% of Fortune's oil and gas revenues and
production for the first quarter of 1998. Consequently, Fortune's revenues and
cash flow from operations have decreased significantly since the sale.
Because the sale of East Bayou Sorrel represented less than 25% of Fortune's
reserve quantities, the entire proceeds of $4,695,000 was credited to
capitalized oil and gas properties as of March 31, 1998.
(7) IMPAIRMENT TO OIL AND GAS PROPERTIES
Although gas prices were depressed in March 1999, both oil and gas prices
have risen significantly since March 31, 1999. Fortune used the current higher
oil and gas prices in its first quarter 1999 ceiling test; accordingly it did
not record a ceiling impairment during the first quarter. Had we used March 1999
prices in this ceiling test, we would have recorded an impairment to oil and gas
properties of approximately $1.2 million as of March 31, 1999.
8
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FORTUNE NATURAL RESOURCES CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
QUARTER ENDED MARCH 31, 1999 AND 1998
Fortune's operating results continue to suffer from low oil and gas prices
and delays in adding production. Fortune's average first quarter 1999 oil and
gas prices of $9.99 per barrel and $1.80 per Mcf were not only lower than the
prior quarter, they were the lowest prices we have seen in years. Both oil and
gas prices have increased significantly since March 31, 1999. As of May 7, 1999,
we estimate that we are receiving $15.70 per barrel and $2.40 per Mcf. These
improved prices allowed Fortune to avoid a substantial ceiling test impairment
expense during the first quarter of 1999. Fortune's revenues have not yet been
impacted by the successful drilling results, discussed below, at Espiritu Santo
Bay, the Bacon prospect in Mississippi and South Timbalier 86. Fortune expects
revenues to improve in the second quarter of 1999 with the impact of this new
production. In spite of poor prices and production this quarter, Fortune's
reported net loss of $553,000 was the second lowest quarterly loss in the last
two years. This results from the cost decreases discussed below.
During the first quarter of 1999, Fortune's net loss improved to $553,000
compared to a net loss of $739,000 for the same 1998 period. Although revenues
were much lower in 1999, substantially lower costs more than offset this
decline. Significantly lower oil and gas prices and production resulted in net
oil and gas revenues decreasing by $451,000 (64%) in the first quarter of 1999,
compared to the same 1998 period. The East Bayou Sorrel field, which accounted
for 33% and 30% of first quarter 1998 production and revenues, was sold on March
31, 1998 for $4.7 million. See note 6 to the financial statements for a
discussion of this sale and the impact on the company's operating results.
Fortune's oil production decreased 85% during the first quarter of 1999
versus 1998. Gas production decreased 26% during the first quarter of 1999
versus 1998. The sale of East Bayou Sorrel and depletion were the primary
contributors to these decreases.
Gas prices on Fortune's production averaged $1.80 per MCF for the first
quarter of 1999 as compared to $2.37 per MCF for the same 1998 period (a 24%
decrease). Oil prices averaged $9.99 per barrel for the first quarter of 1999
compared to $14.28 per barrel for the same 1998 period (a 30% decrease).
Production and operating expense decreased by $137,000 (61)% for the first
quarter of 1999 versus 1998 because of the lower production discussed above and
the absence of workovers and operating problems during 1999.
General and administrative expense decreased by $168,000 (37%) primarily
because of reductions which have been made in response to lower oil and gas
prices. In connection with Fortune's efforts to reduce cash outlays, the board
of directors voted, effective January 1, 1999, to begin paying the $2,500 per
quarter outside director fees in Fortune common stock instead of cash.
Interest expense paid in cash decreased by $13,000 (12%) for the first
quarter of 1999 over 1998 due to a lower debt balance. The lower debt balance
resulted from Fortune paying off a portion of its credit facility at March 31,
1998 with a portion of the proceeds of the sale of East Bayou Sorrel. Non-cash
amortization of debt financing costs has declined because certain amounts have
been fully amortized. All such costs will be fully amortized at the end of April
1999.
The Company's provision for depletion, depreciation and amortization (DD&A)
decreased by $360,000 (63%) in the first quarter of 1999 as compared to 1998
primarily because of lower production and a lower property balance as a result
of the sale of the East Bayou Sorrel property and past ceiling test impairments.
9
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Although gas prices were depressed in March 1999, both oil and gas prices
have risen since March 31, 1999 and currently exceed levels not seen for several
months. Fortune used the higher current oil and gas prices in its first quarter
1999 ceiling test; accordingly we did not record a ceiling impairment during the
first quarter. Had we used estimated March 1999 prices in this ceiling test, we
would have recorded an impairment to oil and gas properties of approximately
$1.2 million as of March 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
CASH BALANCE, WORKING CAPITAL AND CASH FLOWS FROM OPERATING ACTIVITIES
Fortune used less cash in its operating activities in 1999 compared to 1998
primarily because of the effect of changes in non-cash working capital accounts.
Before considering the effect of changes in these other working capital
accounts, operating cash flow used was $(188,000) for 1999 compared to $(73,000)
for 1998. Lower oil and gas prices and production, as discussed above, accounts
for this decrease in cash flow. Working capital at March 31, 1999 decreased from
December 31,1998 because of the negative cash flow from operating activities and
the capital expenditures discussed below. Fortune expects cash flow to increase
in future quarters as the production from two recently completed wells at
Espiritu Santo Bay, the recently completed farmout well at South Timbalier 86
and a well being completed in Mississippi begins to have an impact. These wells
are discussed below. Also, oil and gas prices have increased since March 31,
1999 and should positively impact cash flow if they stay up.
CASH USED IN INVESTING ACTIVITIES - CAPITAL EXPENDITURES
Expenditures for oil and gas properties for the first quarter of 1999 were
$197,000 compared to $850,000 for 1998. The 1999 expenditures include primarily:
- additional leases at Espiritu Santo Bay;
- seismic interpretation at Espiritu Santo Bay and LaRosa;
- completion expenditures for two wells at Espiritu Santo Bay,
ST 216 #16 and ST 210 #5; and
- completion expenditures for the Bacon prospect well drilled in
Mississippi.
The 1998 expenditures include primarily:
- drilling and completion expenditures for the third well at East
Bayou Sorrel, which was temporarily plugged and abandoned on
March 5, 1998;
- drilling and completion operations at LaRosa; and
- drilling costs for a dry hole at the S.W. Segno prospect.
Fortune believes that it has sufficient capital to drill its deep frio
target at Espiritu Santo Bay. However, if this well is unsuccessful or it
encounters significant drilling problems or delays, Fortune may need to reduce
its costs further or raise additional capital to pursue its business strategy.
OIL AND GAS PRICES
Conditions outside of our control influence the prices we receive for oil
and gas. As of May 7, 1999, Fortune was receiving an average of approximately
$15.70 per barrel for its oil production and $2.40 per MCF for its gas
production.
"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
10
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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 they do not achieve compliance. These indirect third parties include oil and
gas refiners, gas and oil transmission companies, third party banking
institutions, suppliers of suppliers, etc. Although Fortune has no practical way
of assessing the viability of these companies, Fortune believes that its risks
are no greater in this regard than businesses and the public in general. Fortune
will continue to monitor the status of year 2000 compliance issues to determine
the impact, if any, on its operations.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
133 establishes accounting and reporting standards for derivative instruments,
including derivative instruments embedded in other contracts and for hedging
activities. SFAS 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999. As it has not historically utilized derivative
instruments, the impact upon Fortune of SFAS 133 is not expected to have an
effect on the reporting of future operating results.
FORWARD LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements. Forward-looking
statements include statements regarding future oil and gas production and
prices, future exploration and development spending, future drilling and
operating plans, reserve and production potential of Fortune's properties and
prospects, Fortune's business strategy, and management's plans and expectations.
Actual events or results could differ materially from those discussed in the
forward-looking statements as a result of various risk factors including the
factors described below.
FORTUNE'S RELIANCE ON EXPLORATORY PROJECTS INCREASES THE RISKS INHERENT IN
THE OIL AND GAS INDUSTRY. Our current investments are primarily in exploration
projects, where the risks are substantially greater than in the case of wells
drilled into already producing formations. We anticipate that one or more of our
next wells will be designed to test the deeper formations beneath known
production in Espiritu Santo Bay. These formations have not been extensively
tested to date, leaving seismic imaging as one of the few tools available to aid
in understanding subsurface geology. The exploration risks, therefore, are
higher on this project than they might be where a greater number of underground
references exist. Fortune has realized less success than originally anticipated
in developing some of its recent prospects and we expect that a substantial
number of our future projects could experience similar results.
FORTUNE HAS INCURRED NET LOSSES FOR EACH OF THE LAST THREE years. Fortune
has incurred substantial net losses for several years. Although we are making
significant budget cuts in 1999, oil and gas prices continue to fluctuate
significantly. This makes it likely that these losses will continue. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
FORTUNE IS NOT CURRENTLY REPLACING ALL OF ITS EXISTING RESERVES. We are not
adding reserves at present at the same pace at which they are being produced.
Therefore, without adding additional reserves in the future, our oil and gas
reserves and production will decline.
11
<PAGE>
OUR REVENUE IS DEPENDENT UPON A LIMITED NUMBER OF PRODUCING WELLS.
Approximately 40% of our oil and gas revenues, cash flow, and proved oil and gas
reserves are currently accounted for by a single well at South Timbalier Block
76. This well was shut-in for repairs for one month in 1997 and for over two
months during 1996 as the result of mechanical failures. A significant
curtailment or loss of production for a prolonged period before we could replace
the reserves through new discoveries or acquisitions would have a material
adverse effect on our projected operating results and financial condition.
OUR NEED FOR WORKING CAPITAL MAY AFFECT OUR LEVEL OF PARTICIPATION IN
VARIOUS PROJECTS. Investment in oil and gas exploration requires the commitment
of substantial amounts of capital over significant periods of time. We may not
have sufficient liquid capital resources to participate at our existing working
interest level if the operators of any of our properties 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.
ACCOUNTING RULES MAY RESULT IN ADDITIONAL WRITE-DOWNS OF PROPERTY VALUES.
We report our operations using the full-cost method of accounting for oil and
gas properties. Under these rules, the net capitalized costs of properties may
not exceed a "ceiling" limit of the tax-effected, discounted present value of
estimated future net revenues from proved reserves, plus the lower of cost or
fair market value of unproved properties. The risk that we will be required to
write down the carrying value of our properties increases when oil and gas
prices are depressed or unusually volatile or when previously unevaluated
properties are determined to be worth less than their cost. Fortune has
recognized significant impairments in past periods. Had we used March 1999
prices in the March 31, 1999 ceiling test, we would have recorded an impairment
to oil and gas properties of approximately $1.2 million as of that date. Price
increases after quarter-end allowed Fortune to avoid a ceiling test impairment
for the first quarter of 1999. As a result of continued fluctuating oil and gas
prices, it is likely that we will incur further impairments in future periods.
THE MARKET FOR FORTUNE COMMON STOCK IS LIMITED. On February 11, 1999,
Fortune was notified by the American Stock Exchange that its stock would be
delisted from the exchange effective March 1, 1999. Fortune has failed to comply
with the exchange's continued listing guidelines because it has not reported a
profit in any of the last five years. We have appealed the delisting decision,
but our appeal, which is currently scheduled to be heard June 14, 1999, may not
be successful. If the appeal is unsuccessful, trades in Fortune's stock will be
reported on the OTC Bulletin Board or regional exchanges in the near future.
Because of the current low volume of trading in Fortune stock, there may not be
a ready market for our stock. Fortune is not now aware of any broker/dealer who
intends to make a market in Fortune stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DISCLOSURE ABOUT MARKET RISK
Fortune is exposed to market risk, including adverse changes in oil and gas
prices and interest rates as discussed below. Fortune does not currently use
derivative financial instruments to mitigate fluctuations in oil and gas prices
or interest rates.
OIL AND GAS PRICE RISK. Fortune's oil and gas revenues can be significantly
affected as oil and gas prices fluctuate widely in response to changing market
forces. These fluctuations can be reduced through the proper use of oil and gas
price hedging tools. We currently do not use oil and gas price hedges because we
do not believe that Fortune has sufficient production volumes to facilitate
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.
12
<PAGE>
Fortune's debt structure is comprised of:
Stated Balance
Interest Rate March 31, 1999 Matures
------------- -------------- -------
12% Fixed $3,225,000 2007
Variable at banks
Base rate + 1 1/4% or
LIBOR + 4% $10,000 1999
Changes in interest rates will not currently have a significant impact on
Fortune's interest expense.
13
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See note 4 of the footnotes to the financial statements in Part I herein
for a description of legal proceedings. On March 31, 1999 the court having
jurisdiction over the matter discussed in note 4 lifted its stay and granted
Fortune leave to pursue its claims against certain third-party defendants.
Discovery is proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
Exhibit No. 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)
27.1* Financial Data Schedule.
(B) REPORTS ON FORM 8-K / 8K-A
A report on Form 8 was filed with the Securities and Exchange Common on
March 22, 1999 to report Fortune's press release announcing the amendment to its
12% convertible subordinated notes due December 31, 2007.
A report on Form 8-K was filed with the Securities and Exchange Commission
on May 13, 1999 to report Fortune's press releases of its recent exploration
results and its first quarter 1999 financial results.
*Filed herewith.
14
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FORTUNE NATURAL RESOURCES CORPORATION
By: /s/ TYRONE J. FAIRBANKS
--------------------------------
Tyrone J. Fairbanks
President and Chief Executive Officer
By: /s/ J. MICHAEL URBAN
--------------------------------
J. Michael Urban
Vice President and Chief Financial
and Accounting Officer
Date: May 13, 1999
15
<PAGE>
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