AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON FEBRUARY 16, 1999
REGISTRATION STATEMENT NO. 333-65847
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------
PRE-EFFECTIVE AMENDMENT NO. 2 TO
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)
COPIES TO:
RITA J. LEADER
BOYER, EWING & HARRIS INCORPORATED
THE COASTAL TOWER
NINE GREENWAY PLAZA, SUITE 3100
HOUSTON, TEXAS 77046
(713) 871-2025
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. [ ]
------------------------------
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 FEBRUARY 16, 1999
[FORTUNE LOGO]
FORTUNE NATURAL RESOURCES CORPORATION
$3,225,000
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 7 for a discussion of delisting proceedings. On February 12,
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 February 16, 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. Its telephone number at that address is (281)
872-1170. In 1997 Fortune changed its name from Fortune Petroleum Corporation to
"Fortune Natural Resources Corporation," the name under which Fortune 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 .................... $3,225,000 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 the lower of $3.00 per
share or 5% above the average
closing prices for the 60 days
prior to May 1, 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 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."
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, 1997 and the unaudited financial
information for the nine months ended September 30, 1998 and 1997, are derived
from, and qualified by reference to, Fortune's audited and unaudited financial
statements, appearing elsewhere herein. The Summary Condensed Financial Data
should be read in conjunction with the audited and unaudited financial
statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" appearing elsewhere herein. The results for the nine
months ended September 30, 1998 are not necessarily indicative of results for
the full year.
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, 1997, 1996, and 1995 by the amount of $5,562, $895, and $5,006,
respectively. The deficiencies for the periods ended September 30, 1998, and
1997 are $1,969 and $4,862, respectively. The pro forma earnings to fixed
charges deficiencies for the periods indicated would not differ from the actual
deficiencies.
Summary Condensed Financial Data
(dollars and shares in thousands, except per share, Bbl and Mcf data)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30, YEARS ENDED DECEMBER 31,
---------------------- ----------------------------------
1998 1997 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(unaudited)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total revenues................................... $ 1,629 $ 3,007 $ 4,005 $ 4,040 $ 3,143
Loss on sale of oil and gas properties........... $ - $ - $ - $ - $ 3,607
Impairment to oil and gas properties............. $ 860 $ 3,200 $ 3,650 $ - $ -
Net loss......................................... $ (2,629) $ (5,084) $ (5,958) $ (1,330) $ (5,876)
Net loss per share (basic and diluted)........... $ (0.22) $ (0.42) $ (0.49) $ (0.12) $ (0.90)
Net weighted average shares outstanding.......... 12,130 12,075 12,086 11,351 6,556
OPERATING DATA:
Net Production:
Crude oil and condensate (Bbl)................. 36,000 64,000 87,000 57,000 92,000
Natural gas (Mcf).............................. 463,000 643,000 821,000 1,038,000 909,000
Gas equivalent (MCFE).......................... 676,000 1,026,000 1,343,000 1,383,000 1,461,000
Average Sales Price:
Crude oil and condensate ($ per Bbl)........... $ 13.38 $ 19.20 $ 19.04 $ 20.24 $ 14.66
Natural gas ($ per Mcf)........................ $ 2.23 $ 2.56 $ 2.66 $ 2.56 $ 1.77
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------ ----------------------------------
1998 1997 1996 1995
------------ ----------- --------- ----------
(unaudited)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets..................................... $ 9,156 $ 12,626 $ 16,335 $ 17,800
Total debt....................................... $ 3,235 $ 3,775 $ 2,933 $ 4,897
Net stockholders' equity......................... $ 5,350 $ 8,053 $ 13,037 $ 12,314
</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,
----------------------------------
1997 1996 1995
----------- --------- ----------
<S> <C> <C> <C>
RESERVES:
Estimated Net Proved Reserves:
Crude oil and condensate (MBbls).......................... 257 249 347
Natural gas (Bcf)......................................... 3.2 3.5 5.9
Estimated future net revenues before income taxes 8,410 $ 14,112 $ 12,600
Present value of estimated future net revenues
before income taxes (discounted at 10% per annum)......... $ 6,503 $ 10,820 $ 8,942
</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 commodity 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 accurately 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 has recently changed its business strategy 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 and during
the nine months ended September 30, 1998. The losses equaled $5,958,000,
$1,330,000 and $5,876,000 for 1997, 1996 and 1995, respectively, and $2,629,000
for the nine months ended September 30, 1998. These losses may 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 our 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 "Risks Associated
with the Oil and Gas Industry - Operating Hazards" and "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, 1997, Fortune incurred over $16 million of
capital costs in its oil and gas exploration, development and acquisition
activities. Approximately $4.9 million of this amount was spent in 1997. 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 currently participate in exploration projects but
do not operate those 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 entity selected to act as
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
natural resource companies, including our competitors. In the current
environment of low oil and gas prices, many companies may determine that
projects which have previously been agreed upon are no longer economically
feasible. We are vulnerable to decisions not to participate which may be taken
by some of our partners. If this were to occur, projects could be delayed or
cancelled completely.
Accounting rules may result in write-downs of property values beyond those
which have already occurred. We report our operations using the full-cost method
of accounting for oil and gas properties. Under these rules, all costs incurred
in connection with exploration and development 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, 1997 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 $3.3 million impairment to our properties in 1994, a
$3.7 million impairment in 1997, and a $860,000 impairment for the nine-month
period ended September 30, 1998. As a result of continued low oil and gas
prices, we may incur further impairments for the balance of 1998.
All our properties are pledged to secure debt. All of our producing
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 in order to
fund acquisitions 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.
6
<PAGE>
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. Management is currently considering
whether to appeal the delisting. If it does not appeal or if the appeal is
unsuccessful, trades in Fortune's stock will be reported on the OTC Bulletin
Board beginning no earlier than March 1, 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.
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. The average gas prices which we received were
$2.66, $2.56 and $1.77 per Mcf in 1997, 1996 and 1995, respectively. The average
oil prices which we received were $19.04, $20.24 and $14.66 per Bbl in 1997,
1996 and 1995, respectively. The average oil and gas prices which we received
through December 31, 1998 were $13.08 per Bbl and $2.19 per Mcf, respectively.
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.
7
<PAGE>
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.
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.
Weather hazards may cause delays and damages. Our oil and gas operations
have been impacted in the past by weather conditions, including severe rains,
winter conditions, and hurricanes. These conditions interrupted or curtailed
production and drilling operations and damage equipment and facilities. We fully
expect such conditions to recur from time to time.
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.
8
<PAGE>
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.
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. At December 31, 1998, 12,134,675 shares of our common
stock were outstanding, of which 11,566,054 shares were freely tradeable and
568,621 shares were "restricted securities" as that term is defined in Rule 144
under the Securities Act. At that date, we also had outstanding options and
private warrants to acquire 6,604,827 shares of common stock. Beginning May 1,
1999, the notes are convertible into Fortune common stock at a conversion price
based on the stock's average closing price from March 2 through April 30. If the
conversion price were based on the closing price of the stock on February 12,
1999, more than 9,800,000 additional shares would be issuable upon conversion of
the notes. The issuance of substantial additional shares or sales of substantial
amounts of the common stock in the public market could adversely affect the
market price of the common stock. See "Description of Securities."
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.
9
<PAGE>
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."
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.
10
<PAGE>
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.
11
<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 is considering whether
to appeal this decision. 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 (through February 12).. 1/2 1/4
At February 12, 1999, the closing price of the common stock was $0.31 per
share. At December 31, 1998, there were 12,134,675 shares of common stock
outstanding held of record by approximately 3,000 stockholders.
12
<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, 1997 and the unaudited financial information
for the nine months ended September 1998 and 1997 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 audited and unaudited financial statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing elsewhere herein. The results for the nine months ended
September 30, 1998 are not necessarily indicative of results of the full year.
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. The pro
forma ratio is computed in a similar manner. Earnings were insufficient to cover
fixed charges for the years ended December 31, 1997, 1996, 1995, 1994 and 1993
by the amount of $5,562, $895, $5,006, $3,993 and $3,392, respectively. The
deficiency for the periods ended September 30, 1998 and 1997 are $1,969 and
$4,862, respectively. The pro forma earnings to fixed charges deficiencies for
the periods indicated are not different from the actual deficiencies.
(dollars and shares in thousands, except per share, Bbl, and Mcf data)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEARS ENDED DECEMBER 31,
--------------------- ---------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- -------- --------- --------- -------- --------
(unaudited)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Total Revenues.................... $ 1,629 $ 3,007 $ 4,005 $ 4,040 $ 3,143 $ 3,397 $ 2,834
Loss on sale of oil and
gas properties................... $ - $ - $ - $ - $ 3,607 $ - $ -
Impairment to oil and gas
properties ...................... $ 860 $ 3,200 $ 3,650 $ - $ - $ 3,347 $ 2,993
Net loss.......................... $ (2,629) $ (5,084) $ (5,958) $ (1,330) $ (5,876) $ (4,453) $ (3,703)
Net loss per share................ $ (0.22) $ (0.42) $ (0.49) $ (0.12) $ (0.90) $ (1.69) $ (2.09)
Net weighted average shares
outstanding..................... 12,130 12,075 12,086 11,351 6,556 2,639 1,773
OPERATING DATA:
Net Production:
Crude oil and condensate (Bbl).. 36,000 64,000 87,000 57,000 92,000 88,000 79,000
Natural gas (Mcf)............... 463,000 643,000 821,000 1,038,000 909,000 1,017,000 724,000
Gas equivalent (MCFE)........... 676,000 1,026,000 1,343,000 1,383,000 1,461,000 1,542,000 1,196,000
Average Sales Price:
Crude oil and condensate
($ per Bbl)................... $ 13.38 $ 19.20 $ 19.04 $ 20.24 $ 14.66 $ 14.14 $ 14.33
Natural gas ($ per Mcf)......... $ 2.23 $ 2.56 $ 2.66 $ 2.56 $ 1.77 $ 2.09 $ 2.28
</TABLE>
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------ ----------------------------------------------------------
1998 1997 1996 1995 1994 1993
------------ -------- --------- --------- -------- ---------
(unaudited)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total assets...................... $ 9,156 $ 12,626 $ 16,335 $ 17,800 $ 10,066 $ 10,429
Total debt........................ $ 3,235 $ 3,775 $ 2,933 $ 4,897 $ 7,123 $ 3,003
Net Stockholders' Equity.......... $ 5,350 $ 8,053 $ 13,037 $ 12,314 $ 2,130 $ 6,588
</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,
----------------------------------------------------------
1997 1996 1995 1994 1993
-------- --------- --------- -------- ---------
<S> <C> <C> <C> <C> <C>
RESERVES:
Estimated net proved reserves:
Crude oil and condensate (MBbl)......... 257 249 347 1,647 813
Natural gas (Bcf)....................... 3.2 3.5 5.9 5.9 5.6
Estimated future net revenues
Before income taxes................... $ 8,410 $ 14,112 $ 12,600 $15,932 $ 12,835
Present value of estimated future
net revenues before income taxes
(discounted at 10% per annum)........... $ 6,503 $ 10,820 $ 8,942 $ 8,148 $ 8,554
</TABLE>
13
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview
All of Fortune's operating revenues are derived from the production and
sale of oil and gas. Prior to mid-1994, Fortune was engaged principally in the
purchase and production of oil and gas reserves, primarily in California. In
mid-1994, Fortune changed its business strategy and now concentrates in
exploration projects onshore and offshore Louisiana and Texas and in the related
transition zone.
Operating revenues have decreased in the first nine months of 1998 because
Fortune sold its interest in East Bayou Sorrel on March 31, 1998. Operating
revenues increased slightly from 1996 to 1997, primarily because production from
the East Bayou Sorrel exploration success more than offset depletion declines
and the reduced revenues from the effect of selling a portion of South Timbalier
Block 76 in early 1996. In 1996 Fortune sold its California properties, but 1996
revenues increased from 1995 as production from the South Timbalier Block 76
acquired in late 1995 contributed to revenues for a full year.
Results in 1997 were adversely affected by substantial impairments to oil
and gas properties, debt conversion expense and stock offering costs. Results in
1995 were adversely affected by a substantial loss on sale related to Fortune's
California properties. No such loss or expense was recorded in 1996. General and
administrative expense increased significantly in 1996 because of the addition
of executive personnel and litigation costs. General and administrative expense
has decreased during the first nine months of 1998 because of lower litigation
costs.
Fortune experienced substantial net losses in 1997, 1995 and the first nine
months of 1998 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
1995 because of low gas prices during early 1995 and the shut-in of one of
Fortune's primary California properties. Operations consumed cash during the
first nine months of 1998 because of the lower revenues discussed above and
lower prices received by Fortune for its production. Substantial sales of equity
securities in 1995 resulted in significant increases in the weighted average
shares outstanding in 1996. Net loss per share decreased in 1996 as a result of
a decrease in the net loss from operations and an increase in the weighted
average shares outstanding.
Fortune made substantial net investments in oil and gas properties in 1997
and 1995, and a somewhat smaller net investment in 1996. From 1995 through the
first nine months of 1998, Fortune's primary sources of capital have been the
sale of equity and proceeds from the sale of oil and gas properties. During this
same period, 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 and that this increased
cash flow will be the basis for future company growth. However, there can be no
assurance that Fortune will be successful in exploiting any of its projects.
Furthermore, while Fortune's working capital increased significantly, 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
Nine Months Ended September 30, 1998 and 1997
During the nine months ended September 30, 1998, Fortune had a net loss of
$2,629,000 compared to a net loss of $5,084,000 for the same 1997 period. The
higher 1997 loss was primarily attributable to the $316,000 non-cash debt
conversion expense incurred in connection with closing Fortune's Exchange Offer
on February 26, 1997, the $269,000 of stock offering costs incurred in 1997 for
the public offering which was withdrawn in April 1997, the $3,200,000 non-cash
impairments to oil and gas properties recorded in 1997 and increased
depreciation, depletion and amortization expense in 1997.
14
<PAGE>
Net oil and gas revenues in the first nine months of 1998 decreased by
$1,359,000, or 47%, compared to the same 1997 period. The decrease primarily
resulted from significantly lower oil and gas prices and oil and gas production
in 1998. 1997 revenues included revenues from 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.
Oil production decreased 44% to 35,600 barrels during the first nine months
of 1998 versus 1997 as a result of the sale of East Bayou Sorrel. Gas production
decreased 28% to 462,700 MCF during the first nine months of 1998 versus 1997,
also primarily because of the sale of East Bayou Sorrel.
For the first nine months of 1998, Fortune's natural gas prices averaged
$2.23 per MCF as compared to $2.56 per MCF for the same 1997 period, a 13%
decrease. Oil prices averaged $13.38 per barrel for the first nine months of
1998 compared to $19.20 per barrel for the same 1997 period, a 30% decrease.
Production and operating expense decreased by $463,000, or 49%, for the
first nine months of 1998 over 1997. Production and operating expense in 1997
included approximately $400,000 of costs attributable to a workover at South
Timbalier Block 76.
General and administrative expense decreased $339,000, or 23%, for the
first nine months of 1998 versus 1997 primarily because of lower litigation
costs in 1998 in connection with the 1995 Regulation S offering, discussed in
note 4 to the September 30, 1998 financial statements, and lower personnel
costs.
Interest expense paid in cash increased by $146,000, or 91%, for the first
nine months of 1998 versus 1997 due to the higher debt balance. Non-cash
amortization of debt financing costs increased by $291,000 during 1998 because
of Fortune's notes offering in December 1997 and credit facility refinancing in
July 1997. Fortune's provision for depletion, depreciation and amortization
decreased by $489,000, or 30%, in the first nine months of 1998 as compared to
1997 because of the impact of impairments to oil and gas properties and the sale
of East Bayou Sorrel.
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: $3.7 million non-cash impairments to oil and gas
properties, a $316,000 non-cash debt conversion expense incurred in connection
with closing Fortune's 1992 debenture exchange offer in February 1997 and
$323,000 of stock offering costs expensed as a result of Fortune withdrawing a
proposed public offering in April 1997. See notes 2 and 5 to the December 31,
1997 Financial Statements.
Net oil and gas revenues increased slightly in 1997 compared to 1996. 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 from permanent production facilities in January 1997. The second
well at East Bayou Sorrel was completed and placed on production on June 23,
1997. As discussed above, Fortune's entire interest in the East Bayou Sorrel
Field was sold effective March 31, 1998.
Oil production increased 52% in 1997 compared to 1996 as a result of the
Bayou Sorrel discovery. Gas production decreased 21% in 1997 versus 1996,
primarily because of the reduced ownership interest in 1997 in South Timbalier
Block 76, as discussed above, and natural depletion on Fortune's properties. Gas
prices for Fortune's production averaged $2.66 per Mcf in 1997 as compared to
$2.56 per Mcf in 1996. Oil prices averaged $19.04 per Bbl in 1997 compared to
$20.24 per Bbl in 1996.
Production and operating expenses decreased by $78,000, or 7%, in 1997
compared to 1996. The decrease results primarily from Fortune's sale of 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.
15
<PAGE>
Interest expense decreased by $39,000, or 9%, for 1997 compared to 1996 due
to the lower average debt balance for most of 1997. Fortune's debt balance
increased during the fourth quarter of 1997. See "- Liquidity."
Fortune's provision for depletion, depreciation and amortization increased
to $1.62 per MCFE in 1997 compared to $1.14 per MCFE in 1996 because of higher
average property costs and lower average proved reserves in 1997.
Years ended December 31, 1996 and 1995
Fortune had a net loss of $1.3 million in 1996 compared to a net loss of
$5.9 million in 1995. The higher net loss in 1995 was primarily attributable to
a $3.6 million loss on the sale of the California properties.
Net revenues from sales of oil and gas increased 29% to $3.8 million for
1996 compared to 1995. The increase resulted primarily from the combination of
higher gas prices and a full year of production from South Timbalier Block 76.
The 1995 production was adversely affected by a 5 1/2 month shut down of
Fortune's Hopper Canyon, California oil field due to storm damage. Although 1996
revenues were up, they were adversely affected by a two month shut down of
Fortune's South Timbalier Block 76 well due to a mechanical failure in the
second quarter of 1996. This well accounted for about 50% of Fortune's oil and
gas revenues in 1996. Fortune incurred approximately $300,000 in workover costs
to repair the problem, most of which was expensed as production and operating
expense in June and July 1996.
Gas prices for Fortune's production averaged $2.56 per Mcf for 1996 as
compared to $1.77 per Mcf for 1995. Oil prices averaged $20.24 per Bbl in 1996
compared to $14.66 per Bbl in 1995. These higher average prices contributed to
the increase in revenues.
Production and operating expenses decreased by $342,000, or 23%, in 1996
compared to 1995 despite the expense of the South Timbalier workover discussed
above. The decrease in operating expenses resulted primarily from Fortune's sale
of its California properties in early 1996.
In 1996, Fortune's general and administrative expenses increased by
$712,000, or 59%, over 1995. The increase was due primarily to higher legal fees
resulting from certain litigation, costs incurred in the sale of Fortune's
California properties, increased shareholder reporting expense and increased
personnel expense. Fortune also incurred non-recurring office relocation and
severance costs of $216,000 during 1996 in connection with Fortune's move to
Houston. Interest expense decreased by $435,000, or 50%, for 1996 compared to
1995 due to the lower debt balance in 1996. The lower depletable property
balance, resulting from the 1995 sale of the California properties recorded in
December 1995, led to a decrease in Fortune's provision for depletion,
depreciation and amortization of $193,000, or 11%, in 1996 as compared to 1995.
Depletion, depreciation and amortization decreased from $1.22 per MCFE in 1995
to $1.14 per MCFE in 1996.
Liquidity
Cash Balance, Working Capital and Cash Flows from Operating Activities
- - 1998
Although cash flow from operating activities declined in the first nine
months of 1998, working capital increased $780,000 at September 30, 1998.
Fortune's operating activities during the first nine months of 1998 consumed
cash flow in the amount of $324,000 as compared to cash flow provided from
operating activities of $816,000 for the first nine months of 1997. This
decrease results primarily from the significant increase in payables in 1997
versus a decrease in 1998. Before considering the effect of changes in assets
and liabilities, operating cash flow was ($276,000) for 1998 as compared to
$483,000 for 1997. Lower oil and gas revenues and higher cash interest expense
were the primary contributors to the 1998 decrease in cash flow. Fortune's
significantly higher working capital balance of $2,156,000 at September 30,
compares to a December 31, 1997 balance of $1,376,000. The proceeds received
from the sale of East Bayou Sorrel were the primary contributor to this
significant increase in working capital. Management believes that, even in the
face of fluctuating commodity prices, this increase in cash and working capital
as a result of the sale of East Bayou Sorrel provides Fortune with adequate
capital to fully fund its capital program during 1998.
16
<PAGE>
Fortune's internal liquidity and capital resources in the near term will
consist of working capital and cash flow from its oil and gas operations and its
unused borrowing capacity, if any, under its bank credit facility.
- - 1997 and 1996
Although Fortune's cash balance decreased from 1996 to 1997, working
capital increased significantly to $1,376,000 at December 31, 1997 compared to
$276,000 at December 31, 1996. 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.
Fortune's net cash flow provided by operating activities increased in 1997
to $1,379,000 as compared to $607,000 in 1996. Changes in accounts receivable
and accounts payable were significant components of these net cash flow amounts
in both years. 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 to $755,000
compared to $391,000 in 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.
- - 1996 and 1995
Fortune's cash flow provided by operating activities increased for 1996 to
$607,000 as compared to an operating cash flow deficit of ($744,000) for 1995.
This increase resulted from higher gas prices and higher gas production in 1996
as discussed above. Fluctuations in current asset and liability accounts also
contributed to the variance. Cash flow in 1996 was adversely affected by the
shut-in of the South Timbalier Block 76 well for over two months in the second
quarter of 1996, resulting in a loss of revenues from the well, and workover
expenses incurred to bring the well back on production.
Capital Resources
Cash Used in Investing Activities - Capital Expenditures
- - 1998
Cash expenditures for oil and gas properties for the first nine months of
1998 were $3,032,000 as compared to $3,414,000 for the same period in 1997. The
1998 expenditures have been incurred primarily in connection with 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 in
Refugio County, Texas 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.
Seven wells had been drilled based upon the 3D seismic through December 1, 1998.
Four wells were completed as producers, three wells have been plugged and
abandoned. During 1998, Fortune has incurred $750,000 of seismic interpretation,
leasing and drilling costs through the third quarter. Fortune holds a 37.5%
working interest in the producing wells and an 18.75% working interest in the
prospective projects covered by this 3D seismic survey.
The second project is offshore Texas in the intracoastal waters of Espiritu
Santo Bay, Calhoun County. This involves a 135-square mile proprietary 3D
seismic survey in which Fortune owns a 12.5% working interest. The area covered
by the survey also includes producing fields. This survey was completed in 1997
and is still being interpreted. Five wells have been drilled to date; two have
been plugged, two are being completed and the fifth is a potential discovery
which may need to be redrilled as the result of experiencing an underground
blowout. Additional drilling is planned for this project. During 1998, Fortune
has incurred $725,000 of seismic interpretation, leasing costs and well
operations through the third quarter.
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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. Through September
30, 1998, Fortune has incurred approximately $731,000 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, 1996 and 1995 were $4.9 million, $3.2 million and $5.7 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 at East Bayou Sorrel, Lirette, DABM and South Lake Arthur and
for continued lease and seismic acquisition offshore Louisiana. Capital
expenditures for 1995 were principally attributable to capital expended to
acquire, explore and develop Fortune's New Mexico, LaRosa and AWP properties;
begin the acquisition of seismic and leases offshore Louisiana; acquire South
Timbalier Block 76 for $2.2 million; and drill the exploratory well at Aurora.
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 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."
Fortune's net capital expenditures for its acquisition, exploration and
development activities in 1998 are currently estimated to range from
approximately $1.5 to $4.0 million, depending on Fortune's capital resources.
Fortune intends to provide for these expenditures with its available cash, its
cash flow from operations and, to the extent approved in advance by the bank,
its bank credit facility. Should funds not be available to Fortune as required
for participation in the projects, Fortune can reduce its working interest share
of the projects. Should Fortune's working interest in exploration projects be
reduced, Fortune would not derive as great a benefit in the event of an
exploration success.
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. Primarily as a result of the lower revenues in the current quarter,
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 September 30, 1998. Fortune received a waiver of this covenant from
the bank for the period ended September 30, 1998.
- 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 "Description of the Notes"
for the terms of the notes.
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- Credit Facility
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. 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. 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 Lyonnais 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 of the borrowing base.
Primarily as a result of the lower revenues in 1998 as a result 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 September 30, 1998. Fortune
received a waiver of this covenant from the bank for the period ended September
30, 1998.
- Debentures
On February 26, 1997, Fortune closed an exchange offer for the Convertible
Subordinated Debentures due December 31, 1997 which resulted in $697,000
principal amount of debentures being exchanged for 218,858 shares of common
stock and 174,250 common stock warrants. Consequently, the balance would have
been 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 for common
stock and common stock warrants, Fortune recorded a non-cash debt conversion
expense of approximately $316,000 during the first quarter of 1997. The non-cash
debt conversion expense represents the difference between the fair market value
of all of the common stock and warrants issued in connection with 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 the 1992
Indenture prior to the exchange offer.
- Cash Provided from Equity Transactions
Fortune's primary source of capital during 1996 and 1995 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. On
December 11, 1995, Fortune received approximately $3.3 million of net proceeds
in a private placement of 1,321,117 shares of common stock. The proceeds were
used to acquire a producing property and for general corporate purposes. See
"Description of Business - Property Acquisition Activities - South Timbalier
Block 76 Acquisition."
On June 30, 1995, Fortune closed an underwriting of 4,100,000 shares of
common stock at a price of $2.00 per share. On July 5, 1995, the underwriters
exercised their over-allotment option for an additional 500,000 shares. Fortune
netted approximately $8.1 million after deduction of underwriting discounts and
costs of the offering. In February 1995, Fortune netted $795,000 in a private
placement of common stock. The proceeds were used to fund the initial
contribution to the joint venture with Zydeco. See "Business and Properties -
Significant Properties and Activities - Joint Venture with Zydeco."
Oil and Gas Prices and Reserves
Conditions outside of Fortune's control influence the price Fortune
receives for its oil and gas production. See "Risk Factors - Risks Associated
with the Oil and Gas Industry -Oil and gas prices are volatile and have been
depressed recently." Fortune's revenues, profitability and future rate of growth
are substantially dependent upon prevailing market prices for natural gas and
oil, which can be extremely volatile and in recent years have been depressed by
excess domestic and imported supplies. These fluctuating oil and gas prices have
contributed to impairments to oil and gas properties such as the $3.7 million
impairment recorded in 1997 and the $860,000 impairments recorded during the
first nine months of 1998. As a result of lower oil and gas prices in 1998,
Fortune may incur further impairments in 1998. As of January 6, 1999, Fortune
was receiving an average of approximately $10.75 per barrel for its oil
production and $1.90 per Mcf for its gas production.
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Fortune's December 31, 1997 oil and gas reserve report prepared by
Huddleston & Co. Inc., of Houston, Texas, its independent petroleum engineers,
indicated a net present value, discounted at 10%, of Fortune's proved reserves
equal to $6.5 million, compared to a $10.8 million discounted value at December
31, 1996. Of that total value, the proved developed producing wells had a
discounted present value of $3.4 million at December 31, 1997 compared to $6.3
million at December 31, 1996. The decrease in the present value of the reserves
is primarily attributable to significantly lower oil and gas prices at year-end
1997 versus 1996. Total net proved reserves at December 31, 1997 were 257,000
Bbls of oil and 3.2 Bcf of gas compared to 249,000 Bbls of oil and 3.5 Bcf of
gas at December 31, 1996. See "Business and Properties - Exploration
Activities." 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. Fortune sold its entire interest in East Bayou Sorrel on
March 31, 1998. See Note 6 to the September 30, 1998 Financial Statements. As a
result of this sale and lower oil and gas prices, Fortune expects the net
present value of its proved reserves to be lower at December 31, 1998.
"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 for have represented either to be in compliance or have communicated their
plans and timetables for compliance. This process, however, is ongoing. Fortune
has begun making contingency plans in the event that its third parties are
unable to achieve compliance. With respect to product purchasers, systems
providers, consultants, its bank, and its stock transfer agent, for example,
Fortune does not have any contracts that extend beyond January 1999 and it will
change to goods and service providers who are year 2000 compliant, if necessary.
With respect to operators of its properties, 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 reviewing 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 whom
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 risk 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 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information" .
SFAS 131 establishes standards for the way public enterprises are to report
information about operating segments in annual financial statements and requires
the reporting of selected information about operating segments in interim
financial reports issued to shareholders. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. SFAS 131 is effective for periods beginning after December 15, 1997.
Fortune does not believe that this SFAS will currently result in any significant
new disclosures in its financial statements.
In February 1998, the FASB issued Statement of Financial Accounting
Standards No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits." SFAS 132 revises employers' disclosures about pension
and other postretirement benefit plans. It does not change the measurement or
recognition of those plans. SFAS 132 is effective for fiscal years beginning
after December 15, 1997. Fortune does not expect SFAS 132 to have a significant
effect on its financial reporting.
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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BUSINESS AND PROPERTIES
General
Fortune Natural Resources Corporation is an independent public oil and gas
company whose primary focus is on exploration for and development of domestic
oil and gas properties. Fortune's principal properties are located onshore and
offshore Louisiana and Texas.
During 1995, Fortune implemented a program of exploration 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
evaluation of drilling prospects than traditional 2D evaluation methods. Since
implementing this program in early 1995, Fortune has been acquiring, with other
industry partners, interests in oil and gas prospects in the Louisiana Gulf
Coast and is continually evaluating 3D and 2D exploration projects.
Fortune also seeks to take advantage of attractive acquisition targets
which will enable it to acquire producing properties at an attractive price. 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
seeks to mitigate the risks of exploration drilling by generally taking minority
interests in projects with large potential reserves as well as additional
development potential. Together with other industry partners, Fortune has
invested in seismic exploration programs to identify new exploration prospects,
in exploration prospects ready to drill, and in producing properties believed to
have 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 intracoastal waters and Matagorda
Island 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
and its project partners with a more accurate and complete prospect evaluation,
materially increasing the likelihood of finding commercial quantities of oil and
gas at lower average reserve finding costs.
Although Fortune does not currently operate properties or originate
exploration prospects, it actively participates in the evaluation of
opportunities presented by its industry partners, both at the time of its
initial investment in a prospect and thereafter during the evaluation and
selection of drilling locations. 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 by major oil companies in recent years and the
reorganization of many independent oil companies, Fortune has found that highly
qualified prospect originators and technical advisors are available as
consultants and joint venturers, enabling Fortune to acquire expert technical
assistance in its target geographic areas while avoiding the overhead associated
with a larger number of employees.
Currently, 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, Fortune has no
reason to believe that these consultants will cease providing services in the
foreseeable future.
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In furtherance of its business strategy, Fortune entered into 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. See Note 7 to the September 30, 1998 Financial Statements.
Subsequently, merger discussions with each of these entities were terminated
prior to the execution of a definitive merger agreement.
Exploration Activities
Fortune reviews prospects developed by companies that have particular
expertise in specific exploration areas and uses its 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
producing properties and prospects in early 1996.
Fortune continues to examine attractive acquisition opportunities and will
seek to acquire producing properties on a selected basis. In furtherance of that
objective, Fortune acquired an interest in South Timbalier Block 76 in December
1995.
Significant Properties and Activities
Espiritu Santo Bay Proprietary 3D Seismic Exploration Joint Venture
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, and certain surrounding areas.
Fortune owns a 12.5% working interest in the joint venture which has undertaken
a 135 square mile proprietary 3D seismic venture. Fortune and its working
interest partners currently own 17,794 leasehold acres and hold options to
acquire leases on an additional 20,015 acres within the area of the seismic
survey.
The term of the joint venture agreement extends through July 15, 2002 but
may be extended if necessary. Under the Agreement, upon delineation of each
exploration prospect, Fortune 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. Seismic acquisition activities commenced in April
1997 and were completed in September 1997. The seismic data has been processed
and is continually being interpreted. Over a dozen prospects have been
delineated to date, however no assurance can be given that any commercial
quantities of hydrocarbons will be discovered. Drilling began in September 1998.
Five wells have been drilled to date; two have been plugged, two are being
completed and the fifth is a potential discovery which may need to be redrilled
as the result of experiencing an underground blowout.
On March 13, 1997, each of the Espiritu Santo Bay 3-D Seismic Project joint
venture partners, including Fortune, elected to acquire their pro-rata shares of
the Steamboat Pass Field, Calhoun County, Texas from Neumin Production Company.
The Steamboat Pass Field is in Espiritu Santo Bay. The acquisition also entitles
Fortune to its pro-rata share of the existing facilities located on site.
Fortune acquired a 12.5% working interest in the 5,766 acres held for production
in the field. The acquisition was made in exchange for the assumption of
Neumin's future obligation to plug and abandon the field. The cost of such
abandonment is not expected to be material to Fortune. The transaction closed on
April 18, 1997.
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La Rosa Proprietary 3D Seismic Exploration Program
In 1994, Fortune acquired an undivided 50% interest in the LaRosa Field, a
producing oil and gas field in Refugio County, Texas. In January 1997, Fortune's
working interest was reduced to a 37.5% working interest as the result of an
after-payout back-in negotiated at the time of purchase. On February 13, 1997,
Fortune and its working interest 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 and in any new exploration
opportunities generated by that program in exchange for the payment of all of
Fortune's costs of such 3D survey. Accordingly, Fortune currently owns an
undivided 18.75% working interest in all newly-generated prospects. Fortune
maintains its 37.5% working interest in all production from wellbores existing
prior to the commencement of the 3D seismic survey.
Fortune and its working interest partners currently own 5,616 acres in the
field and hold seismic options to acquire up to an additional 6,462 acres. The
first well drilled based upon the 3D data was spudded December 2, 1997; since
then six additional wells have been drilled. Four of these wells have been
completed and three have been plugged and abandoned. Further drilling has been
suspended pending a review of the results obtained from the first phase of this
drilling program.
Southwest Segno, Liberty County, Texas
On September 24, 1997, Fortune entered into a Participation 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.
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, or a 12.5% net revenue
interest, in this 5,000 acre producing oil and gas property. This property
includes a producing well which was completed in 1990, drilling and production
platform and a transmission line. The effective date of the acquisition was June
1, 1995, so 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 Block 76 plus 150,000 common
stock purchase warrants at prices from $4.625 to $6.00 per share, all of which
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, or a
9.375% net revenue interest, effective January 1, 1996.
On April 29, 1996, the Block 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 Fortune's investment, and Fortune
is evaluating the possibilities for additional wells.
In order to finance the acquisition of the South Timbalier Block and to
provide Fortune with additional working capital, Fortune issued 1,321,117 shares
of its common stock to a group of overseas investors in a transaction which
qualified for an exemption from the registration requirements of the Securities
Act under Regulation S. From this sale in December 1995, Fortune netted
approximately $3.3 million after payment of expenses of the offering. The shares
were sold subject to certain "reset" provisions pursuant to which the purchasers
could receive additional shares if the price of the common stock were to drop.
Despite a drop in the price of the common stock during the calculation period,
Fortune does not expect that it will be required to issue any reset shares. See
"- Legal Proceedings."
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Ship Shoal Blocks 43 and 67 - state waters, offshore Louisiana
On April 24, 1998 and July 1, 1998, Fortune entered into agreements with
Rozel Energy, LLC to participate 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 and were
subsequently plugged and abandoned as dry holes.
The agreement on Block 67 provided for the payment by Fortune of $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
judged to be present in economic quantities and the well was plugged and
abandoned.
Joint Venture with Zydeco
Fortune owns varying working or royalty interests in eighteen projects
located in the transition zone and Timbalier Trench regions offshore Louisiana.
Each of these joint venture projects was acquired by a joint venture formed with
Zydeco to identify, evaluate and explore oil and gas prospects in this area.
Each of these projects was 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
budgeted 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 six of the joint venture projects to industry
partners, retaining overriding royalties and/or the right to participate as a
working interest owner and has a 100% working interest on one of the projects.
It has retained its 50% working interest in the remaining projects. One of the
prospects which was farmed out, located on South Timbalier Block 86, was drilled
by Sonat Exploration Company, which successfully completed its well late in
1998. Fortune has a 3.166% override before payout, convertible to either a 12.5%
working interest or 4% override after payout, in this project.
Fortune does not currently expect that wells will be drilled on all of the
joint venture projects or that it will, except in certain circumstances, retain
a working interest of more than 25% in any wells that are drilled. In keeping
with its strategy of balancing risk, Fortune intends to farm out its remaining
interest to other oil companies. Under a farmout arrangement, Fortune would be
relieved of all or part of its obligation to pay drilling expenses, and could
recover its acquisition and exploration costs but would wind up with a smaller
interest in any given prospect. Fortune may not be able to farm out any of the
projects or to enter into farmouts on the terms described above. Each of the
parties in the joint venture has a right to farm out a portion or all of its
interest in each prospect to the other under a "put" arrangement in the
exploration agreement.
The joint venture projects are in various stages of evaluation. The leases
have initial lease terms varying from 3 to 5 years, during which period the
venture must either commence drilling operations or lose the leases. To date,
wells have been drilled on two of the joint venture projects, the Aurora and
Polaris Prospects. Hydrocarbons were encountered in both wells, but were of
insufficient quantities to justify completion attempts. A third party drilled
one of these wells under a farmout for which Fortune received $66,000 in fees.
Fortune incurred approximately $832,000 in costs on the other well. 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, and the
exploration wells may not be drilled or be successful.
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.
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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 has 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 recorded in 1997.
Rio Arriba County, New Mexico - San Juan Basin
On June 24, 1994, Fortune concluded the purchase of a 25% interest in
EnRe-1, LLC, a newly formed Texas limited liability company, which owned three
Jicarilla Apache Minerals Development Agreements covering 60,000 producing,
development and exploratory acres in Rio Arriba County, New Mexico and
associated tangible property, and an approximately 22% working interest in
certain mineral, oil and gas leasehold interests in an additional 10,000
exploratory acres in that county. 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 reverted to the lessors pursuant to the terms of the development
agreements.
Of the seven wells drilled on these properties during 1994 and 1995, two
were completed as producing wells. Fortune did not participate in the drilling
of any additional wells in 1996 or 1997. Production revenues from the properties
have not exceeded the total cost of acquiring and conducting drilling operations
on the properties. Fortune's reserve engineers have not assigned 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 were unable to determine whether the future production
would be economic and, therefore, were unable to conclude that any proved
reserves should be assigned to the producing wells. There are no immediate plans
to conduct further evaluations of the wells that are temporarily shut in or to
drill additional wells in this field. 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. On August 26, 1998 Fortune sold
its entire interest in these properties and in EnRe-1, LLC to the operator in
exchange for an assumption of all existing liabilities.
Webb County, Texas - Belle Pepper and Belle Jeffers Fields
On October 5, 1993, Fortune completed the acquisition of certain mineral,
oil and gas leasehold interests and associated tangible property from Michael
Petroleum Corporation, Brazos Resources, Inc., Pioneer Drilling Company and
Endowment Energy Partners. The mineral, oil and gas leasehold interests include
working interests in producing and non-producing oil and gas properties located
in Webb County, Texas, known as the Belle Pepper and Belle Jeffers Fields.
Fortune acquired interests in approximately 2,300 acres of mineral leases,
including 10 producing gas wells. The Lobo sand in this area has very low
permeability, under one millidarce, which has qualified all the acquired
production as a "tight" gas sand. As a tight gas sand, the production from the
nine wells drilled before January 1, 1993 is exempt from Texas state severance
tax. Fortune participated in the drilling of a 10,000 foot exploratory test well
to the Lobo sand in 1994 which was determined to be non-commercial. Fortune had
a 25% working interest in this well; dry hole costs to Fortune were $115,000.
Fortune has a 20% interest in a proved undeveloped in-fill location within the
Belle Pepper Field.
Fortune paid an adjusted price of $6.5 million in cash and 195,000
three-year common stock purchase warrants which were either exercised or expired
in 1996. Aggregate production from the producing wells acquired by Fortune has
not yet returned Fortune's investment in this area.
25
<PAGE>
McMullen County, Texas - AWP Field
In 1992, Fortune acquired a 10% working interest in the AWP Field, McMullen
County, Texas 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 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 was resumed with the commencement of drilling the Bracken Ranch #47
well location 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. The operator is currently attempting to reduce
the landowners' royalty from 35% to 25% before proceeding with further drilling
in the field.
Divestiture 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 Fortune's leases, facilities and
interests in the East Bayou Sorrel area of mutual interest, as such area is
defined in the East Bayou Sorrel operating agreement. The sale was effective
April 1, 1998. The sale closed on March 31, 1998, whereupon Fortune received
$4,535,000, which is net of ordinary closing adjustments.
Fortune's interest in the two productive wells at East Bayou Sorrel were
pledged to secure Fortune's credit facility with Credit Lyonnais. The total
balance outstanding under the credit facility prior to this sale was $550,000.
Concurrently with closing the sale of the East Bayou Sorrel field, Fortune paid
down the outstanding balance of the credit facility by $540,000. Fortune plans
to reinvest the remaining proceeds from the sale of East Bayou Sorrel into its
exploration, development and property acquisition activities, including, for
example, future anticipated exploration and development wells at its Espiritu
Santo Bay and LaRosa 3D seismic exploration projects.
The Schwing #1 and #2 wells began producing from permanent production
facilities in January 1997 and June 1997, respectively. Although both wells were
shut-in from March 13, 1998 through the date of the sale to repair production
facilities, they accounted for a significant portion of 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 pending further evaluation of the well's
potential. During 1997 and 1998, Fortune incurred approximately $1 million in
connection with drilling and attempting to complete this well as a result of
difficult drilling conditions and mechanical problems.
Divestiture of California Properties
At December 31, 1995, Fortune owned and operated 39 gross and 29.92 net
wells located 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.
The Sespe property comprised approximately 26% of Fortune's net proved oil
reserves and 1% of Fortune's net proved gas reserves as of December 31, 1995.
Despite the high percentage of Fortune's oil production represented by
these properties, the costs of operating the wells in California was, in the
view of management, disproportionately high in relation to the revenues
generated. The high cost of production in California on Fortune's properties 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 sold 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. In connection with the sale, Fortune
paid commissions and expenses of approximately $75,000. Fortune sold its
remaining California property, the Sespe Field, Ventura County, California, to
Seneca Resources for approximately $300,000 net of closing adjustments in April
1996. Fortune recorded a loss on sale of $3.6 million in 1995 as a result of
these divestitures.
26
<PAGE>
All of Fortune's California properties were pledged to secure Fortune's
bank debt. Concurrently with the closing of 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 the California properties and the relocation of Fortune's
headquarters to Houston completed Fortune's strategic move to focus its efforts
on exploration in the Gulf Coast.
Prior to 1994, Fortune made various other acquisitions, primarily of
producing properties located in California, which have since been sold.
Drilling Activities
The following table sets forth information regarding development and
exploratory wells drilled by Fortune in the years ended December 31, 1997, 1996
and 1995:
WELL DRILLING ACTIVITY
<TABLE>
<CAPTION>
Year Ended December 31,
------------------------------------------------------------
1997 1996 1995
----------------- ------------------ ------------------
Gross Net Gross Net Gross Net
------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C>
Exploratory Wells
Productive - - 1.0 .11 - -
Dry 1.0 .13 3.0 1.21 - -
------- ------- ------- ------- ------- -------
1.0 .13 4.0 1.32 - -
======= ======= ======= ======= ======= =======
Development Wells
Productive 1.0 .13 2.0 .20 1.0 .20
Dry - - - - - -
------- ------- ------- ------- ------- -------
1.0 .13 2.0 .20 1.0 .20
======= ======= ======= ======= ======= =======
</TABLE>
Oil and Gas Reserves
Fortune's reserves are located in Texas and onshore and offshore 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, 1997, 1996 and 1995 were
determined by Huddleston & Co., Inc., Houston, Texas, independent petroleum
engineers. Such estimates are subject to numerous uncertainties inherent in the
estimation of quantities of proved reserves and in the projection of future
rates of production, prices and the timing of development expenditures. 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 attributable to any particular
group of properties, classifications of such reserves based on risk of recovery
and estimates of future net cash flows expected therefrom, prepared by different
engineers or by the same engineers at different times, may vary substantially.
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, and the present values thereof 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 the
reserve estimates presented herein are believed to be reasonable, they should be
viewed with the understanding that subsequent production of oil and gas from
each reservoir, the timing and success of future development drilling and
changes in pricing structure or market demand will affect the reserve estimate.
27
<PAGE>
The following sets forth information with respect to 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,
1997, 1996 and 1995. 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 6 to the September 30, 1998 Financial Statements.
These estimates of oil and gas reserves 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 slight decrease in equivalent proved reserves in 1997 versus
1996 was primarily attributable to production, which was almost offset by
reserve extensions and discoveries. The decrease in proved reserves in 1996
versus 1995 was primarily attributable to the sale of 25% of Fortune's interest
in South Timbalier Block 76 in March 1996, the sale of its one remaining
California property and a West Texas property in 1996, and natural depletion,
offset by the reserve addition at East Bayou Sorrel. Oil is converted to natural
gas equivalents at the ratio of one barrel of oil to six Mcf of gas.
ESTIMATED NET RESERVE QUANTITIES
<TABLE>
<CAPTION>
December 31,
----------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Total Proved Reserves (1)
Oil (Bbls)......................... 257,000 249,000 347,000
Gas (Mcf).......................... 3,217,000 3,481,000 5,938,000
Equivalent Mcf (MCFE) (2).............. 4,759,000 4,975,000 8,020,000
Total Proved Developed Reserves:
Oil (Bbls)......................... 198,000 160,000 324,000
Gas (Mcf).......................... 1,548,000 1,749,000 4,686,000
Equivalent Mcf (MCFE) (2).............. 2,736,000 2,709,000 6,630,000
</TABLE>
Discounted Present Value of Future Net Revenues
The following table represents the estimated future net revenues using
unescalated prices and the present value of the estimated future net revenues
from the proved reserves at December 31, 1997, 1996 and 1995. The decrease in
the estimated discounted and undiscounted future net revenues in 1997 versus
1996 is primarily attributable to the significant decrease in prices to $2.60
per Mcf and $16.90 per Bbl at December 31, 1997. The increase in the discounted
present value of the reserves in 1996 versus 1995 is primarily attributable to
the higher prices at year end 1996 of $4.04 per Mcf and $22.79 per Bbl vs. $2.32
per Mcf and $16.10 per Bbl at December 31, 1995. The Standardized Measure of
Discounted Future Net Cash Flow represents the present value of future net
revenues after income taxes, discounted at 10%.
FUTURE NET REVENUES
<TABLE>
<CAPTION>
December 31,
---------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Estimated Future Net Revenue
Undiscounted..................... $ 8,410,000 $14,112,000 $12,600,000
----------- ----------- -----------
Standardized Measure of Discounted
Future Net Cash Flows.......... $ 6,503,000 $10,820,000 $ 8,942,000
----------- ----------- -----------
</TABLE>
28
<PAGE>
Production
The approximate net production data related to Fortune's properties for the
years ended December 31, 1997, 1996 and 1995 are set forth below:
NET PRODUCTION DATA
<TABLE>
<CAPTION>
December 31,
---------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Oil (Bbls).................. 87,000 57,000 92,000
Gas (Mcf)................... 821,000 1,038,000 909,000
</TABLE>
Prices and Production Costs
The following table sets forth the approximate average sales prices and
production costs per Bbl of oil and per Mcf of gas produced and sold in the
United States from Fortune's oil and gas properties for the years ended December
31, 1997, 1996 and 1995:
AVERAGE SALES PRICES AND PRODUCTION COSTS
<TABLE>
<CAPTION>
December 31,
---------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Average Sales Price Received:
Oil (per Bbl).................................... $ 19.04 $ 20.24 $ 14.66
Gas (per Mcf).................................... 2.66 2.56 1.77
Average Production and Operating Cost per MCFE... 0.81 0.85 1.04
</TABLE>
29
<PAGE>
Producing Wells
The following table lists the total gross and net producing oil and gas
wells in which Fortune had an interest at December 31, 1997.
PRODUCING WELLS
<TABLE>
<CAPTION>
Gross Net
------------------ -----------------
Oil Gas Oil Gas
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Texas................................. 39.0 43.0 3.90 11.15
Louisiana............................. 2.0 - .26 -
Federal waters - Gulf of Mexico....... - 1.0 - .13
-------- -------- -------- --------
Total............................... 41.0 44.0 4.16 11.28
======== ======== ======== ========
</TABLE>
Principal Customers
During 1997, 63% of Fortune's oil production was sold to Plains Marketing
and Transportation, Inc. and 25% to Scurlock Permian Corporation; of Fortune's
gas production, 41% was sold to CNG Energy Services Corporation, 16% to Pinnacle
Natural Gas Company and 16% to Valero Industrial Gas, L.P. During 1996, 54% of
Fortune's oil production was sold to Scurlock Permian Corporation; of Fortune's
gas production, 26% was sold to CNG Energy Services Corporation, 23% to Fina
Natural Gas Company, 20% to Texana Pipeline Joint Venture and 17% to Michael Gas
Marketing. During 1995, 56% of Fortune's oil production was sold to Texaco
Trading and Transportation and 10% to Laroco, LLP; of Fortune's gas production,
29% was sold to Laroco LLP, 26% to Michael Gas Marketing and 16% to AWP.
Fortune believes that the loss of any of these customers should not have
any material adverse effect on Fortune, since there are a large number of
companies which purchase oil and gas in the areas in which Fortune operates.
Properties
Leasehold Acreage
Fortune's holdings of developed and undeveloped leasehold acreage as of
December 31, 1997 were approximately as follows:
LEASEHOLD ACREAGE
<TABLE>
<CAPTION>
Developed Undeveloped
------------------ ------------------
Gross Net Gross Net
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Louisiana............................ 160 21 5,347 1,297
Federal waters - Gulf of Mexico...... 500 63 21,095 5,607
Texas ............................ 11,270 1,677 18,306 3,113
New Mexico........................... 1,320 285 27,180 5,882
Oklahoma ............................ - - 80 5
-------- -------- -------- --------
Total.............................. 13,250 2,046 72,008 15,904
======== ======== ======== ========
</TABLE>
30
<PAGE>
Title to Properties
Detailed title examinations were performed for many of Fortune's properties
in 1997 in conjunction with the establishment of Fortune's bank credit facility,
and title opinions were issued. 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 the commencement of drilling operations, 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
In February 1996, Fortune relocated its headquarters to Houston, Texas.
Prior to that, Fortune leased office space in Agoura Hills, California. The
lease in Agoura Hills, California expires in January 1999. 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. 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, 1997 Financial Statements.
Competition
The principal resources necessary for the exploration for, and the
acquisition, development, production and sale of, oil and gas are: leasehold
prospects under which oil and gas reserves may be discovered; drilling and other
service contractors to evaluate and explore for such reserves; and 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 the companies with which Fortune competes are still
better equipped to acquire them. There is no assurance that Fortune will be able
to acquire any portion of these resources in a timely and economical manner.
Employees
As of December 31, 1998, Fortune employed seven persons, all in management
and administration. In addition, Fortune utilizes the services of outside
consultants in certain technical aspects of Fortune's business. Fortune utilizes
these consultants to aid in the evaluation of company projects and to evaluate
oil and gas assets for potential acquisitions.
Governmental Regulation
Environmental laws and regulations are having an increasing impact on
Fortune's operations in nearly all the jurisdictions where it has production.
Drilling activities and the production of oil and gas 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 a property
in which Fortune has an interest 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 oil spills providing $11,000,000 of coverage with a
$5,000 deductible for such hazards.
31
<PAGE>
The operations of oil and gas properties covered by leases in which Fortune
has or may acquire an interest will require compliance with spacing and other
conservation rules of various state commissions and of the United States
Geological Survey and the Bureau of Land Management with respect to federal oil
and gas acreage. 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. Rulings in unitization proceedings 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 all
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 exploration for or production and marketing of oil and gas.
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 received leave of court to add third-party defendants
whose actions furthered this market manipulation. Fortune intends to continue to
vigorously defend plaintiffs' actions and prosecute its own counterclaims.
Discovery has been stayed pending a ruling by the court on a motion filed by one
of these third-party defendants.
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.
32
<PAGE>
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 as follows:
<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(1).......... 51 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(2)......... 41 1992 Director
Barry Feiner(1)............. 64 1995 Director
Gary Gelman(2).............. 33 1995 Director
Daniel Shaughnessy(2)....... 48 1997 Director
Dewey A. Stringer, III(1)... 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.
34
<PAGE>
Gary Gelman has served as president of GAR-COR Holding Corporation, a real
estate management and brokerage firm, since 1989. Mr. Gelman is a principal of
and serves as a loan consultant for National Bank of New York City and is a
member of the Audit Committee.
Daniel R. Shaughnessy is a geologist and geophysicist. He is the founder
and president of Interpretation3, a company that specializes in interpretation
of 2D and 3D seismic data. His firm provides consultation services to Fortune.
Prior to organizing Interpretation3, Mr. Shaughnessy served as a consultant with
Interactive Exploration Solutions, Inc. for approximately one year. For most of
the period from 1980 through 1993, he worked for Mobil Oil, most recently as
Exploration Supervisor in Louisiana. See "Business and Properties - Strategy."
Mr. Shaughnessy is a member of the Audit Committee.
Dewey A. Stringer has been the president of Petro-Guard Company, Inc. since
1982. Petro-Guard specializes in acquiring operated and non-operated oil and gas
properties, exploration utilizing 3D seismic technology and organizing large
exploration projects. Petro-Guard currently operates the Espiritu Santo Bay
project in which Fortune is a participant. Mr. Stringer received his B.S. degree
from the University of Houston in 1966 and serves on the Compensation Committee.
Executive Compensation
The following table lists the total compensation paid by Fortune to persons
who served in the capacity of chief executive officer during the periods
indicated and to the other executive officers whose combined 1997 salary and
bonus exceeded $100,000:
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
Long Term Compensation
------------------------------------
Annual Compensation Awards Payouts
----------------------------- -------------------------- --------
Restricted Securities
Stock Underlying LTIP All Other
Name and Principal Salary Bonus Other Awards Options/Warrants Payouts Compensation
Position Year ($) ($) ($) ($) (No.) ($) ($)
- ---------------------------- ---- -------- -------- -------- -------- ---------------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks......... 1997 155,833 17,500 35,309 - 120,000 - 4,748
President and CEO 1996 150,000 - 20,934 - 80,000 - 3,000
1995 125,000 25,000 - - 105,599 - -
Dean W. Drulias............. 1997 125,000 3,000 - - 75,000 - 4,750
Executive Vice President 1996 26,291 250 - - 56,0002 - 1,643
J. Michael Urban............ 1997 120,000 5,000 - - 100,000 - 4,750
Chief Financial Officer 1996 97,308 - - - 55,0003 - 4,750
</TABLE>
Amounts referred to as "other" annual compensation include automobile
expenses and loan forgiveness, but are shown only if such amounts exceed 10% of
the total annual salary and bonus.
The following table lists the outstanding options under Fortune's stock
option plans held on December 31, 1997 by Fortune's executive officers listed in
the Summary Compensation Table:
AGGREGATE OPTION EXERCISES IN 1997 AND YEAR-END OPTION VALUES
<TABLE>
<CAPTION>
Number of Value of Unexercised
Unexercised Options/ in the Money Options
Warrants at FY-End at FY-End
Shares Acquired Exercisable/ Exercisable/
Name on Exercise Value Realized ($) Unexercisable Unexercisable
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Tyrone J. Fairbanks - - 406,999 / 0 -
Dean W. Drulias 6,400 - 151,000 / 0 -
J. Michael Urban - - 155,000 / 0 -
</TABLE>
35
<PAGE>
Employment Agreements
Fortune has entered into 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 for cause, death or
disability within two years following a change in control, which for purposes of
the employment agreement means a change in more than one-third of the board of
directors following certain special events, 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. 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 $160,000, annual salary increases, 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."
Fortune also entered into an employment agreement with Dean W. Drulias, its
Executive Vice President and General Counsel. The agreement provided that if
employment is terminated for any reason other than for cause, death or
disability within two years following a change in control, which for purposes of
this Agreement means a change in the majority of the board of directors
following certain special events, Mr. Drulias 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. The agreement provided for an annual salary of $125,000. The term of
Mr. Drulias' employment contract expired December 31, 1998.
Stock Options
Fortune has two Stock Option Plans. Both plans cover directors, officers
and employees of Fortune. Awards are made by the board of directors upon
recommendations of its Compensation Committee. There is no performance formula
or measure. Options granted under both plans must be exercised within five years
of the date of grant or they are forfeited.
Options have been granted as follows: (1) under the 1993 plan, options for
75,000 shares at $5.00 per share granted in 1993, options for 263,000 shares at
$5.48 per share granted in 1994, options for 264,000 shares at $6.03 per share
granted in 1995, options for 450,000 shares at $3.125 per share granted in 1996,
and options for 595,000 shares at $3.00 per share granted in 1997 and (2)
727,500 shares at $1.5625 per share granted under the 1998 plan. The exercise
prices of all options granted prior to January 12, 1995 were reduced to $2.75 on
that date.
The following table shows the grants of stock options during 1997 to each
of the executives named in the Summary Compensation Table.
OPTION GRANTS IN 1997
<TABLE>
<CAPTION>
Individual Grants
------------------------------------------------------------
Number of % of Total Potential Realizable Value At
Securities Options Assumed Annual Rates Of
Underlying Granted to Exercise or Stock Price Appreciation
Options Employees in Base Price Expiration For Option Term
Name Granted Fiscal Year ($/Share) Date 5% 10%
- ------------------- ---------- ----------- ----------- ----------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Tyrone J. Fairbanks 120,000 20.2 3.00 February 13, 2002 $ 99,461 $219,784
Dean W. Drulias 75,000 12.6 3.00 February 13, 2002 62,163 137,365
J. Michael Urban 100,000 16.8 3.00 February 13, 2002 82,884 183,153
</TABLE>
In addition to the grants shown, Mr. Fairbanks was granted options to
purchase 100,000 shares and Messrs. Drulias and Urban were each granted options
to purchase 150,000 shares on March 5, 1998.
In the event of a change in control of Fortune, the shares of common stock
subject to options granted to all option holders under Fortune's stock option
plans will be issued to them without further action on their part or the payment
of the exercise price for such shares.
36
<PAGE>
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 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 1997 plan year, Fortune's matching contribution obligation was
$24,000, all of which was paid in shares of common stock. The amounts
contributed to the plan as matching contributions for executives of Fortune are
shown in the Summary Compensation Table set forth above.
Director Compensation
Fortune pays outside directors fees of $2,500 per quarter. Inside directors
do not receive any compensation for serving as directors.
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 a
placement agreement with J. Robbins Securities, L.L.C. 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, is
managing director for the placement agent 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 to be 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, and Mr. Blank's mother 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 company 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, provided Mr. Fairbanks is still employed by Fortune or has
not been terminated by Fortune with cause. The $70,000 loan also bears interest
at the rate of 6% per annum, payable interest only for two years with a $35,000
principal payment due on the second anniversary of the loan and all remaining
principal and interest due on the third anniversary of the loan. See "Management
- - Employment Agreements."
On April 24, 1995, Fortune obtained a $300,000 "bridge" loan to enable it
to pay certain expenses, including $100,000 on its credit facility. The loan was
obtained from Lagniappe Exploration, Inc., which in turn had borrowed the funds
from several individuals. Upon the consummation of Fortune's acquisition of
Lagniappe, it became liable on such loans. The loans were repaid out of the
proceeds of Fortune's public offering of common stock in 1995. Among the
individuals who loaned funds to Lagniappe were Mrs. William H. Forster, mother
of William D. Forster, a principal of Lagniappe and former director of Fortune,
and John E. McConnaughy, Jr., formerly a principal stockholder of Fortune. Each
of Mrs. Forster and Mr. McConnaughy loaned Lagniappe $100,000 and received from
Lagniappe, as an inducement to make the loan, 33,333 shares of common stock and
33,333 stock purchase warrants out of 170,000 shares and 170,000 warrants issued
to Lagniappe prior to the closing of the acquisition. W. Forster & Co., Inc., a
corporation wholly owned by William D. Forster, received a $30,000 placement fee
from Fortune for assistance in arranging the $300,000 bridge loan. As a result
of its acquisition of
37
<PAGE>
Lagniappe, Fortune was required, at the time the bridge loan was repaid, to
accelerate the amortization of the value of the shares paid by Lagniappe to the
lenders in connection with the bridge loan in the amount of $150,000.
In order to provide additional capital for development activities, in
December 1994, Fortune borrowed an aggregate of $750,000 from certain principal
stockholders and from each of its directors then serving, including Messrs.
Champion, Drulias, Fairbanks, Folsom and Walker. Fortune borrowed an aggregate
of $175,000 from the directors, $375,000 from Klein Ventures, Inc., and $200,000
from Jack Farber. See "Principal Stockholders". The notes were unsecured, bore
interest at 11% per annum, or 1.5% above the Bank One, Texas, prime rate,
payable monthly, and were due six months from their respective dates of issue.
The loans from each of the directors were repaid in full on December 21, 1995.
Both the Klein Ventures, Inc. and Farber notes permitted the holder to elect to
exchange their notes for shares of common stock at the price on the date the
notes were issued, $2.00 and $1.875 per share, respectively, and Fortune
reserved 294,166 shares of common stock for such purpose. Klein Ventures, Inc.
and the Estate of Jack Farber exercised the option contained in their note
agreements to convert the note to Fortune common stock. This option was not
available to the directors.
As additional consideration for making these loans, Klein Ventures, Inc.
received 10,000 common stock purchase warrants with an exercise price of $2.40
per share, and Mr. Farber received 35,000 common stock purchase warrants with an
exercise price of $1.875 per share. Klein Ventures, Inc. and the successors to
Mr. Farber each exercised the warrants issued in connection with this
transaction.
During 1996 and 1995, the law firm of which Dean W. Drulias was formerly a
shareholder billed Fortune a total of $152,000 and $183,000, respectively, for
legal fees and costs. See "Management - Directors and Executive Officers."
During 1997 and 1996, Fortune paid $182,000 and $45,000, respectively, and
$367,000 for the nine months ended September 30, 1998 for consulting services to
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."
All of the foregoing transactions between Fortune and members of management
or principal stockholders were, and any future transactions will be, on terms no
less favorable to Fortune than those which could be obtained from unaffiliated
third parties. In addition, no future transaction will be entered into between
Fortune and members of management or principal stockholders unless such
transactions 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.
38
<PAGE>
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.
PRINCIPAL STOCKHOLDERS
The following table contains information at December 31, 1998, as to all
persons who, to the knowledge of Fortune, were the beneficial owners of five
percent or more of the outstanding shares of the common stock of Fortune, and of
all officers and directors.
<TABLE>
<CAPTION>
Amount and Nature Percent
Name Of Beneficial Ownership Of Class
--------------------------------------------------- ----------------------- --------
<S> <C> <C>
Barry Blank
5353 N. 16th St., Phoenix, AZ(1) 1,132,604 8.6%
William D. Forster
237 Park Ave, New York, NY(2) 681,000 5.4%
Tyrone J. Fairbanks (Director, President and CEO)
515 W. Greens Rd., Houston, TX(3) 533,521 4.2%
John L. Collins (Vice President)
515 W. Greens Rd., Houston TX(3) 410,267 3.3%
Dean W. Drulias (Director, Executive Vice President,
General Counsel and Corporate Secretary)
515 W. Greens Rd., Houston, TX(3) 333,641 2.7%
J. Michael Urban (Vice President and CFO)
515 W. Greens Rd., Houston, TX(3) 323,701 2.6%
Graham S. Folsom (Director)
515 W. Greens Rd., Houston, TX(3)(4) 172,251 1.4%
Gary Gelman (Director)
515 W. Greens Rd., Houston, TX(3) 131,583 1.1%
Barry Feiner (Director)
515 W. Greens Rd., Houston, TX(3)(5) 127,993 1.0%
Daniel R. Shaughnessy (Director)
515 W. Greens Rd., Houston, TX(3) 77,500 *
Dewey A. Stringer, III (Director)
515 W. Greens Rd., Houston, TX(3) 15,000 *
All Officers and Directors
as a group of nine (9) persons 2,125,457 15.2%
========= =====
</TABLE>
- ----------
* indicates less than 1%.
(1) Includes 137,000 shares of common stock and 17,917 shares of common
stock which underlie an equal number of private stock purchase
warrants, exercisable at $3.60 per warrant, issued in connection with
Fortune's note offering; 777,687 shares of common stock which underlie
541,000 publicly-traded stock purchase warrants held by Mr. Blank and
exercisable at $3.75 per warrant; and 200,000 shares of common stock
underlying 200,000 stock purchase warrants, exercisable at $2.40 per
share, issued to the underwriters of Fortune's 1995 equity offering,
which Mr. Blank acquired from Coleman & Company Securities, Inc. Mr.
Blank was a former employee of J. Robbins Securities, LLC., the
underwriter for Fortune's note offering.
(2) Includes 515,000 shares of common stock underlying stock purchase warrants
exercisable at $4.75 per share and expiring April 2000.
39
<PAGE>
(3) 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 506,999 $2.63
J. Michael Urban 305,000 2.25
Dean W. Drulias 299,800 2.27
John L. Collins 272,000 2.57
Graham S. Folsom 148,475 2.61
Gary Gelman 111,750 2.56
Barry Feiner 111,750 2.56
Daniel R. Shaughnessy 47,500 1.87
Dewey A. Stringer, III 10,000 1.50
(4) Includes 7,187 shares issuable upon exercise of 5,000 stock purchase
warrants at $3.75 per warrant.
(5) All shares shown, except those which underlie stock purchase options
granted to Mr. Feiner by virtue of his service as a director, are owned by
Janet Portelly, wife of Barry Feiner; Mr. Feiner disclaims beneficial
ownership of all such shares owned by Mrs. Portelly. The number shown
includes 14,375 shares issuable upon exercise of 10,000 stock purchase
warrants at $3.75 per warrant.
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 $3.00 and the shares underlying the placement agent's warrants issued in
connection with the sale of the notes. The actual number of shares may differ
substantially from those shown, if the conversion price is based on recent
trading prices. See "Risk Factors - The number of shares eligible for future
sale will potentially dilute the price of Fortune stock." 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 (1)
- -------------------------------------- --------------------------------- --------------------
<S> <C> <C>
Sherrill M. Baird $ 150,000 50,000
Violet M. Blank Trust 50,000 16,666
William N. Jones 50,000 16,666
Robert A. Mignatti 50,000 16,666
Janet M. Portelly 50,000 16,666
Richard J. Cranmer 50,000 16,666
Joseph Roselle 150,000 50,000
Harlan W. Smith 150,000 50,000
Dwight and Judith Haight 100,000 33,333
Ben Branch 30,000 10,000
Tenaire Profit Sharing Trust 20,000 6,666
Suzanne Bader 50,000 16,666
Richard Maser 50,000 16,666
JoAnn Timbanard Trust 50,000 16,666
Compass Bank, Custodian FBO Renaissance
Capital Growth and Income Fund III, Inc. 350,000 116,666
Compass Bank, Custodian FBO Renaissance
US Growth and Income Trust PLC 350,000 116,666
George P. Haight 100,000 33,333
J. E. McConnaughy, Jr. 500,000 166,666
Barry A. Friedman 50,000 16,666
Stuart D. Wechsler 50,000 16,666
Kenneth W. Moore IRA 50,000 16,666
Sam A. and Barbara C. Phillips 50,000 16,666
John L. and Sharon L. Kiser 50,000 16,666
Willard J. Kiser Living Trust 100,000 33,333
Alec G. Land 75,000 25,000
J. Robbins Securities, LLC (1) - 71,666
Barry W. Blank (2) 500,000 184,582
----------
Total $3,225,000
==========
</TABLE>
(1) The number of shares of common stock shown are the number of whole shares
into which the placement agent's warrants held by J. Robbins Securities,
LLC are convertible at their initial exercise price. The warrants are not
registered or listed for trading.
(2) Mr. Blank is the beneficiary of a trust which owns $500,000 in principal
amount of the notes, convertible into 166,666 shares, and separately holds
a warrant to purchase 17,916 shares at $3.60 per share paid to him as a
representative for the placement agent in the offering of the notes.
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 $3,225,000
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, shall be the lower of $3.00 per share or 5% above the average closing
prices of the common stock for the 60 calendar day period immediately preceding
May 1, 1999. The closing price of the stock on February 12, 1999 was $0.31 per
share.
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
------------------------ multiplied by
Total shares outstanding Less: Price of stock issued
after issuance
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
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- 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,
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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 December 31, 1998. An additional
6,604,827 shares of common stock were issuable upon exercise of options and
private warrants outstanding as of that date. No preferred stock is currently
outstanding.
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.
Warrants
Fortune has issued various common stock private purchase warrants from time
to time.
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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, 1997 and 1996 and
for each of the years in the three year period ended December 31, 1997, 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, 1995, 1996 and 1997, 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, 1997, filed on
March 3, 1998.
2. Current report on Form 8-K filed on March 31, 1998.
3. Current report on Form 10-Q for the quarterly period ended March 31, 1998,
filed on May 8, 1998.
4. Current report on Form 10-Q for the quarterly period ended June 30, 1998,
filed on August 3, 1998.
5. Current report on Form 10-Q for the quarterly period ended September 30,
1998, filed on November 12 , 1998
53
<PAGE>
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.
54
<PAGE>
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.
55
<PAGE>
INDEX TO FINANCIAL STATEMENTS
Page
Independent Auditors' Report - KPMG LLP........................... F-2
Balance Sheets - December 31, 1997 and 1996....................... F-3
Statements of Operations for the years ended
December 31, 1997, 1996 and 1995............................... F-4
Statements of Stockholders' Equity for the years ended
December 31, 1997, 1996 and 1995................................ F-5
Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995................................ F-6
Notes to Financial Statements..................................... F-7
Balance Sheets - September 30, 1998 (unaudited)
and December 31, 1997 (audited)................................... F-22
Statement of Operations for the nine months ended
September 30, 1998 and 1997 (unaudited)......................... F-23
Statement of Stockholders' Equity for the year ended
December 31, 1997 and nine months ended
September 30, 1998 (unaudited).................................. F-24
Statement of Cash flows for the nine months ended
September 30, 1998 (unaudited).................................... F-25
Notes to Financial Statements (unaudited)......................... F-26
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Fortune Natural Resources Corporation:
We have audited the financial statements of Fortune Natural Resources
Corporation as listed in the accompanying index. 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, 1997 and 1996, and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 1997, in conformity with generally accepted accounting principles.
/s/ KPMG LLP
Houston, Texas
February 20, 1998
F-2
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
December 31,
---------------------------
1997 1996
------------ ------------
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ............................. $ 1,667,000 $ 2,174,000
Accounts receivable ................................... 507,000 695,000
Prepaid expenses ...................................... -- 25,000
------------ ------------
Total Current Assets .................................. 2,174,000 2,894,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method .......................... 27,822,000 23,079,000
Office and other ...................................... 383,000 375,000
------------ ------------
28,205,000 23,454,000
Less--accumulated depletion, depreciation
and amortization .................................... (18,403,000) (12,545,000)
------------ ------------
9,802,000 10,909,000
------------ ------------
OTHER ASSETS:
Deposits and other .................................... 124,000 188,000
Debt issuance costs (net of accumulated amortization of
$93,000 and $238,000 at December 31, 1997
and 1996, respectively) ............................. 526,000 51,000
Restricted cash ....................................... -- 2,293,000
------------ ------------
650,000 2,532,000
------------ ------------
TOTAL ASSETS ................................................. $ 12,626,000 $ 16,335,000
============ ============
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt ..................... $ -- $ 2,253,000
Accounts payable ...................................... 279,000 84,000
Accrued expenses ...................................... 407,000 77,000
Royalties payable ..................................... 36,000 103,000
Accrued interest ...................................... 76,000 101,000
------------ ------------
Total Current Liabilities ............................. 798,000 2,618,000
------------ ------------
LONG-TERM DEBT, net of current portion ....................... 3,775,000 680,000
------------ ------------
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--12,118,982 and 11,853,663
shares at December 31, 1997 and 1996,
respectively ...................................... 121,000 119,000
Capital in excess of par value ........................ 30,283,000 29,273,000
Treasury stock, at cost (9,769 and -0- shares,
respectively)...................................... (38,000) --
Accumulated deficit ................................... (22,313,000) (16,355,000)
------------ ------------
NET STOCKHOLDERS' EQUITY ..................................... 8,053,000 13,037,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................... $ 12,626,000 $ 16,335,000
============ ============
</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,
------------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
REVENUES
Sales of oil and gas, net of royalties $ 3,851,000 $ 3,825,000 $ 2,959,000
Other income ......................... 154,000 215,000 184,000
------------ ------------ ------------
4,005,000 4,040,000 3,143,000
------------ ------------ ------------
EXPENSES
Production and operating ............. 1,094,000 1,172,000 1,514,000
Provision for depletion, depreciation
and amortization ................... 2,219,000 1,623,000 1,816,000
General and administrative ........... 1,965,000 1,924,000 1,212,000
Corporate relocation ................. -- 216,000 --
Debt conversion expense .............. 316,000 -- --
Stock offering cost .................. 323,000 -- --
Interest ............................. 396,000 435,000 870,000
Loss on sale of oil and gas properties -- -- 3,607,000
Impairments to oil and gas properties 3,650,000 -- --
------------ ------------ ------------
9,963,000 5,370,000 9,019,000
------------ ------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES ...... (5,958,000) (1,330,000) (5,876,000)
PROVISION FOR INCOME TAXES .................. -- -- --
NET LOSS .................................... $ (5,958,000) $ (1,330,000) $ (5,876,000)
============ ============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING ................. 12,086,219 11,351,211 6,555,875
============ ============ ============
NET LOSS PER COMMON SHARE ................... $ (0.49) $ (0.12) $ (0.90)
============ ============ ============
</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, 1994............. 2,644,032 $ 26,000 $ 11,253,000 $ - $ (9,149,000) $ 2,130,000
Common stock returned
to treasury.......................... (12) - - - -
Common stock issued for
exercise of stock options............ 202,481 2,000 500,000 - - 502,000
Common stock issued for
directors' fees...................... 14,445 - 39,000 - - 39,000
Common stock issued for
stock offerings ..................... 6,569,117 65,000 11,729,000 - - 11,794,000
Common stock issued for
merger .............................. 1,200,000 12,000 2,480,000 - - 2,492,000
Common stock and warrants issued
for payment of investment
banking services..................... 100,000 2,000 263,000 - - 265,000
Common stock issued for
warrant conversion................... 115,479 1,000 392,000 - - 393,000
Common stock issued for
note conversion...................... 294,167 3,000 572,000 - - 575,000
Net loss............................... - - - - (5,876,000) (5,876,000)
---------- ---------- ------------ --------- ------------ ------------
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
Company 401(k) Plan.................. 4,835 - 14,000 - - 14,000
Common stock repurchased in
odd-lot buyback...................... (9,769) - - (38,000) - (38,000)
Common stock returned to treasury...... (5) - - - - -
Net loss............................... - - - - (5,958,000) (5,958,000)
---------- ---------- ------------ --------- ------------ -------------
BALANCE, December 31, 1997............. 12,118,982 $ 121,000 $ 30,283,000 $ (38,000) $(22,313,000) $ 8,053,000
========== ========== ============ ========= ============ =============
</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,
----------------------------------------
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.......................................................... $ (5,958,000) $ (1,330,000) $ (5,876,000)
Adjustments to reconcile net loss
to net cash provided by (used in) operating activities:
Common stock issued for directors' fees,
compensation and consulting fees .............................. -- 4,000 39,000
Depletion, depreciation and amortization ........................ 2,219,000 1,623,000 1,816,000
Amortization of deferred financing cost ......................... 147,000 74,000 172,000
Debt conversion expense ......................................... 316,000 -- --
Stock offering cost ............................................. 323,000 -- --
Impairments to oil and gas properties ........................... 3,650,000 -- --
Loss on sale of oil and gas properties .......................... -- -- 3,607,000
Provision for executive severance ............................... -- -- (17,000)
Non-cash compensation expense ................................... 58,000 20,000 --
Changes in assets and liabilities:
Accounts receivable ............................................. 188,000 340,000 (485,000)
Prepaids and oil inventory ...................................... 25,000 102,000 (13,000)
Accounts payable and accrued expenses ........................... 525,000 (215,000) (95,000)
Payment of executive severance .................................. -- -- (111,000)
Royalties and working interest payable .......................... (67,000) 9,000 41,000
Accrued interest ................................................ (25,000) (18,000) (11,000)
Deposits and other .............................................. (22,000) (2,000) 189,000
------------ ------------ ------------
Net cash provided by (used in) operating activities ............... 1,379,000 607,000 (744,000)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties ........................... (4,946,000) (3,232,000) (5,654,000)
(Increase) decrease in restricted cash ............................ 2,293,000 937,000 (3,230,000)
Proceeds from sale of properties and equipment .................... 203,000 2,197,000 --
Expenditures for other property and equipment ..................... (27,000) (297,000) 16,000
------------ ------------ ------------
Net cash used in investing activities ............................. (2,477,000) (395,000) (8,868,000)
------------ ------------ ------------
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 ....................................... (1,793,000) (1,979,000) (1,651,000)
Gross proceeds from issuance of common stock ...................... 103,000 2,168,000 15,220,000
Debt and equity offering costs .................................... (971,000) (115,000) (2,467,000)
Common stock repurchase ........................................... (38,000) -- --
------------ ----------- ------------
Net cash provided by financing activities ......................... 591,000 74,000 11,102,000
------------ ----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ................... (507,000) 286,000 1,490,000
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR ........................... 2,174,000 1,888,000 398,000
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, END OF YEAR ................................. $ 1,667,000 $ 2,174,000 $ 1,888,000
============ =========== ============
Supplemental information:
Interest paid in cash .............................................. $ 249,000 $ 361,000 $ 692,000
Common stock issued or issuable as directors' fees ................. -- 4,000 39,000
Common stock issued for payment of executive severance ............. -- -- 43,000
Common stock issued to acquire LEX ................................. -- -- 2,492,000
Common stock and warrants issued for payment of
investment banking fees .......................................... -- -- 265,000
Common stock issued for conversion of debt ......................... 975,000 -- 575,000
Value of California assets transferred to oil and gas
properties held for sale.......................................... -- -- 1,180,000
Common stock issued for 401(k) Plan contribution ................... 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 (Fortune or the Company), formerly
Fortune Petroleum Corporation, is an independent energy company engaged in the
acquisition, production and exploration of oil and gas, primarily offshore
Louisiana and the Texas and Louisiana Gulf Coast.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates, judgments
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the financial statements and revenues and expenses during the
reported period. Actual results could differ from those estimates.
Cash Equivalents
The Company considers all highly liquid instruments with original
maturities of three months or less to be cash equivalents.
Property and Equipment
The Company 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, 1997.
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 the Company's
properties are located in the United States. Estimated future development and
abandonment costs are included in the amortization base. Depreciation, depletion
and amortization expense per equivalent Mcf was $1.62, $1.14, and $1.22 for the
years ended December 31, 1997, 1996, and 1995, 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. See note 3 regarding the disposition of the California Properties.
The unamortized cost of oil and gas properties less 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 the
Company'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 1997, the Company recorded
$3.7 million of impairments to oil and gas properties. See note 2 regarding
these 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.
F-7
<PAGE>
Income Taxes
The Company utilizes the asset and liability method for recognition of
deferred tax assets and liabilities. Deferred taxes are recognized for future
tax consequences attributable to differences between financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. The effect on deferred
taxes of a change in tax rates is recognized in income in the period the change
occurs.
Debt Issuance Costs
Debt issuance costs are being amortized using the straight line method over
the life of the related debt, or in the case of convertible debt outstanding at
December 31, 1997, over the period that such debt is not convertible.
Stock Option Plans
Prior to January 1, 1996, the Company 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, and related interpretations.
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, the Company adopted SFAS No. 123, Accounting for Stock-Based Compensation,
which permits entities to recognize as expense over the vesting period the fair
value of all stock-based awards on the date of grant. Alternatively, SFAS No.
123 also allows entities to continue to apply the provisions of APB Opinion No.
25 and provide pro forma net income and pro forma earnings per share disclosures
to employee stock option grants made in 1995 and future years as if the
fair-value-based method defined in SFAS No. 123 had been applied. The Company
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
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 anti-dilutive effect.
In 1997, the Company adopted SFAS No. 128 Earnings Per Share. SFAS No. 128,
under certain circumstances, changes the calculation and financial statement
presentation of earnings per share and requires the restatement of prior period
earnings per share amounts. The adoption of SFAS No. 128 by the Company did not
result in a change to the net loss per share information presented herein.
(2) RESTRICTED CASH AND IMPAIRMENTS TO OIL AND GAS PROPERTIES
Under the terms of the Company's exploration venture agreement with Zydeco
Exploration, Inc. ("Zydeco"), 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 AMI. Prior to
June 1997, the remaining unspent contribution had been recorded as restricted
cash on Fortune's balance sheet. On June 4, 1997, the Company 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, the Company's 50%
working interest in each project which has not already been farmed out is
subject to a proportionate reduction in the event that Zydeco expends additional
funds on such project.
In connection with requesting the return of unspent funds from its
exploration venture with Zydeco, the Company reviewed its $4.3 million remaining
unevaluated investment in the Zydeco exploration venture properties (see note
3). The $4.3 million investment includes 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 review in the second quarter of 1997
and subsequent reviews in the third and fourth quarters of 1997, Fortune has
transferred all of its investment in the Zydeco exploration venture projects to
the evaluated property account during 1997. As a result, the Company has
recorded impairments to oil and gas properties during 1997 of $3.7 million.
F-8
<PAGE>
(3) ACQUISITIONS AND DISPOSITION OF ASSETS
South Timbalier Block 76
On December 11, 1995, Fortune acquired, for $2.2 million, a 16.67% working
interest (12.5% net revenue interest) in a 5,000 acre producing oil and gas
property offshore Louisiana from Petrofina, Inc. The property, South Timbalier
Block 76 (and referred to herein as the "South Timbalier Block"), includes a
producing well, drilling and production platform and transmission line. In
connection with the acquisition, Fortune granted a third party the option,
exercisable until March 11, 1996, to acquire a 4.167% working interest in the
South Timbalier Block for $790,000 and the retention by Fortune of the option
holder's deposit of $150,000. The option was exercised on March 8, 1996 for the
$940,000 consideration discussed above, reducing the Company's interest in the
block to a 12.5% working interest. The proceeds received on this sale were
credited to oil and gas properties in 1996.
The following pro forma unaudited results reflect the year ended December
31, 1995 as if the South Timbalier Block 76 acquisition had occurred, the option
had been exercised, and the common stock issued in the acquisition of Langniappe
Exploration, Inc. was issued (see below and note 9), as of January 1, 1995:
For the Year
Ended
December 31, 1995
-----------------
Revenues................................... $ 4,451,000
=============
Net Loss................................... $ (5,316,000)
=============
Net Loss Per Common Share.................. $ (0.59)
=============
Disposition of California Properties
In December 1995, the Company entered into a purchase and sale agreement to
sell all but one of its California properties to a private group for a price of
$840,000. The sale closed in February 1996, with an effective date of December
31, 1995. The sale of the Company's remaining California property closed in
April 1996, with an effective date of December 1, 1995. The Company received net
proceeds in this transaction of $300,000 after deducting closing adjustments,
primarily consisting of net cash flow received by the Company between the
effective date and the closing date. The sale of these properties significantly
altered the relationship between capitalized costs and proved reserves because
the properties sold comprised approximately 53% of the Company's proved reserves
at the time of the sales. Accordingly, the Company recognized a loss in 1995 of
$3.6 million, which represents the excess of 53% of the oil and gas property
balance subject to depreciation, depletion and amortization over the $1.2
million net sales proceeds received from the sale of the properties. During 1996
and 1995, the operation of these properties did not have a significant impact on
net income.
Lagniappe Exploration, Inc./Zydeco Exploration
On May 12, 1995, Fortune acquired Lagniappe Exploration, Inc. ("LEX") which
had previously entered into an exploration agreement with Zydeco. The Company
acquired 100% of LEX in exchange for 1.2 million shares of Fortune Common Stock
and 1.2 million warrants. The acquisition has been recorded using the purchase
method of accounting, effective May 12, 1995. The market value of the shares,
when issued, was $2,572,000. At the time of the acquisition, the only material
asset owned by LEX was its right to participate in the Zydeco exploration
agreement in exchange for funding a budget of $4.8 million for leasehold
acquisition and seismic costs. Subsequent to closing the acquisition, LEX was
liquidated and its assets were merged into Fortune. Under the exploration
agreement, Fortune acquired a 50% interest in certain seismically defined oil
and gas projects. (See notes 2 and 9).
F-9
<PAGE>
(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, 1997, 1996
and 1995 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Capitalized costs of oil
and gas properties............... $27,822,000 $23,079,000 $20,864,000
Less accumulated depletion,
depreciation and amortization....... (18,137,000) (12,308,000) (10,730,000)
----------- ----------- -----------
$ 9,685,000 $10,771,000 $10,134,000
=========== =========== ===========
</TABLE>
Of the above capitalized costs, the amount representing unproved properties
was $3.2 million, $4.9 million, and $5.9 million in 1997, 1996 and 1995,
respectively.
Costs incurred in oil and gas producing activities were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ----------- -----------
<S> <C> <C> <C>
Property acquisition
Unproved.......................... $ 333,000 $ 77,000 $ 4,596,000
Proved............................ 368,000 - 2,192,000
Exploration............................ 2,285,000 2,317,000 576,000
Development............................ 1,960,000 838,000 498,000
------------ ----------- -----------
$ 4,946,000 $ 3,232,000 $ 7,862,000
============ =========== ===========
</TABLE>
F-10
<PAGE>
The results of operations from oil and gas producing activities for the
years ended December 31, 1997, 1996 and 1995, are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------ ------------ ------------
<S> <C> <C> <C>
Revenues from oil and gas producing activities:
Sales to unaffiliated parties.............................. $ 3,851,000 $ 3,825,000 $ 2,959,000
Production and other taxes................................... 1,094,000 1,172,000 1,514,000
Depreciation, depletion and amortization...................... 2,179,000 1,576,000 1,781,000
Loss on sale of oil and gas properties........................ - - 3,607,000
Impairments to oil and gas properties......................... 3,650,000 - -
----------- ------------ ------------
Total expenses............................................... 6,923,000 2,748,000 6,902,000
----------- ------------ ------------
Pretax income (loss) from producing activities................ (3,072,000) 1,077,000 (3,943,000)
Income tax (expense) benefit.................................. - - -
Results of oil and gas producing activities
(excluding corporate overhead and interest costs)........... $ (3,072,000) $ 1,077,000 $ (3,943,000)
=========== ============ ============
</TABLE>
(5) LONG-TERM DEBT
A summary of long-term debt follows:
<TABLE>
<CAPTION>
December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
Convertible Subordinated Notes due December 31, 2007........................... $ 3,225,000 $ -
Credit Lyonnais credit facility due July 11, 1999,
including interest at 1-1/4 over the bank's base rate....................... 550,000 -
Convertible Subordinated Debentures converted or repaid in 1997................ - 1,683,000
Bank One credit facility repaid July 11, 1997.................................. - 1,250,000
------------ ------------
Total long-term debt........................................................... 3,775,000 2,933,000
Less current installments...................................................... - 2,253,000
------------ ------------
Long-term debt, excluding current installments................................. $ 3,775,000 $ 680,000
============ ============
</TABLE>
During November and December of 1997, Fortune closed a private placement of
12% Convertible Subordinated Notes due December 31, 2007 (the "Notes"). An
aggregate of $3,225,000 principal amount of Notes was sold, and the Company
received $2,815,000 of proceeds, net of offering expenses and commissions.
The Notes are currently convertible into the Company's Common Stock at a
conversion price of $3.00 per share, subject to adjustment. The Notes are
convertible by the holders after May 1, 1999, subject to a one-time option by
the holders to convert at a lower conversion price prior to that date in the
event that the Company sells shares of its Common Stock at a price below the
conversion price. The Notes are redeemable by the Company after May 1, 1999, at
a premium that reduces monthly from 10% to zero over an 18-month period. Any
such premium on redemption is waived in the event that the Company's Common
Stock price averages at least $4.50 per share for 30 consecutive trading days.
The holders of the Notes will be entitled to receive additional shares upon
conversion in the event that the Company's Common Stock price averages less than
the conversion price for a certain period prior to May 1, 1999. The Company has
determined that the value of the potential adjustments to the conversion price
is not material. The Notes are subordinate to all of the Company's secured debt,
including the credit facility with Credit Lyonnais. The Notes bear interest at a
rate of 12% per year, payable quarterly. The costs incurred to issue the Notes
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 private placement was used to
refinance existing debt. On December 5, 1997, the Company redeemed the remaining
outstanding balance of $1,028,000 of the Company's Debentures due December 31,
1997. In addition, $315,000 of net proceeds was used to reduce the borrowings
under the Company's credit facility with Credit Lyonnais.
F-11
<PAGE>
As discussed in the proceeding paragraph, the remaining balance on the 10
1/2% Convertible Subordinated Debentures (the "Debentures") was repaid on
December 5, 1997. The Debentures bore an effective interest rate of 12.13% and
were convertible into shares of the Company's Common Stock at a conversion price
of $6.32 per share (158 shares of Common Stock per Debenture). On February 26,
1997, the Company closed an Exchange Offer for these Debentures which resulted
in $697,000 ($680,000 net of discount) principal amount of Debentures being
converted to 218,858 shares of Common Stock. The Company also issued 174,250
Common Stock Warrants to the Debentureholders who exchanged their Debentures in
connection with the Exchange Offer. 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, the Company recorded a non-cash debt conversion expense
of $316,000 during the first quarter of 1997. The $316,000 non-cash expense
represents 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 prior to the Exchange Offer. For purposes
of calculating the non-cash debt conversion expense, the Company valued the
218,858 shares of Common Stock issued in connection with the Exchange Offer at
$547,502 ($2.625 per share) based on the closing price of the Common Stock on
the American Stock Exchange on February 26, 1997. The Company estimated the
value of the Common Stock Warrants issued to the Debentureholders at $8,713
($0.05 per warrant). As of December 31, 1996, the Company classified as
long-term liabilities the portion, net of discount, of the Debentures that were
converted to Common Stock in the Exchange Offer.
On July 11, 1997, the Company refinanced its bank debt by entering into 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. Under the new credit facility, the Company 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 borrowing base, currently set at $2.0 million, was
calculated based upon the Company's July 1, 1997 oil and gas reserves and is
subject to semi-annual review. The Credit Lyonnais facility is secured by a
mortgage on all of the Company's existing proved oil and gas properties. The
Company is also required to pay a commitment fee of 0.5% on the unused portion
of the borrowing base. The Company previously had a credit facility in place
with Bank One, Texas, N.A. which was due October 1, 1997, bore interest at 1.5%
over Bank One's prime rate and required monthly principal payments of
$75,000.
The Company's maturities of long-term debt over the next five years are as
follows:
Year Debt
---- ----
1998 $ 0
1999 550,000
2000 0
2001 0
2002 0
--------
$550,000
========
F-12
<PAGE>
(6) INCOME TAXES
No provision for income taxes was required for the years ended December 31,
1997, 1996 and 1995. Deferred taxes consist of the following:
<TABLE>
<CAPTION>
1997 1996
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards................ $ 4,990,000 $ 4,354,000
Oil and gas properties difference
in accumulated depletion...................... 1,517,000 586,000
----------- -----------
6,507,000 4,940,000
Less valuation allowance (100%)............... 6,507,000 4,940,000
----------- -----------
Net deferred taxes.............................. $ - $ -
=========== ===========
</TABLE>
At December 31, 1997, the Company estimates it had cumulative net operating
loss carryforwards for federal income tax purposes of approximately $15 million
which, subject to significant restrictions under I.R.C. 382, is available to
offset future federal taxable income, if any, with various expirations through
2012. The Company is uncertain as to the recoverability of the above deferred
tax assets and has therefore applied a 100% valuation allowance.
The Company has available IRC Section 29 Tax Credits that may be used to
reduce or eliminate federal income tax through the year 2001. It is uncertain at
this time to what extent the Company will be able to utilize these federal tax
credits, as their utilization is dependent upon the amount, if any, of future
federal income tax incurred, after application of the Company's net operating
loss carryforwards.
(7) STOCK OFFERINGS
In December 1996, the Company 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, the Company issued to the acquiring shareholders
one Common Stock Warrant for every two Common Stock shares acquired. The 206,000
warrants are exercisable for a period of two years at a price of $3.50 per
share.
On December 15, 1995, the Company received approximately $3.3 million of
net proceeds in a private placement of 1,321,117 shares of Common Stock at a
price of $3.22 per share. 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 below the purchase price during
certain calculation periods. The Company's Common Stock price did fall to a
level that would have required the Company to issue approximately 1,266,000
additional Common Stock shares to the purchasers; however, the Company alleges
certain irregularities occurred in the trading in its Common Stock and is
uncertain whether it will be required to issue additional shares. (See note 8.)
In June and July 1995, the Company received net proceeds of $8.1 million
for the sale of 4.6 million shares of the Company's Common Stock at $2.00 per
share in a public offering. In February 1995, the Company closed a previous
private placement of 648,000 shares of Common Stock. The proceeds were used to
fund the initial contribution to the Zydeco venture.
(8) COMMITMENTS AND CONTINGENCIES
The Company has an employment agreement with its President and Chief
Executive Officer (the "CEO") that provides for an annual salary of $160,000
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 for 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 the Company's Common Stock.
The Company also has an employment agreement with its Executive Vice President
and General Counsel that provides for an annual salary of $125,000 through
December 31, 1998. In the event of a termination of employment after a change of
control, the Executive Vice President and General Counsel is also entitled to 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
thereof.
F-13
<PAGE>
The Company leases certain office space under non-cancelable operating
leases. Rental expense under the office lease for the years ended December 31,
1997, 1996 and 1995 was $86,000, $75,000 and $53,000, respectively.
Minimum future lease payments under the non-cancelable operating leases are
as follows:
Year ending December 31,
1998........................................ $ 87,000
1999........................................ 87,000
2000........................................ 87,000
2001........................................ 36,000
----------
$ 297,000
==========
On March 26, 1996, Fortune was served with a lawsuit that 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 of 1933. The terms of the subscription agreement pursuant to
which the plaintiff acquired his shares entitled him 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 contested this lawsuit, 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 it 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 Common Stock occurred immediately prior
to and during the time period in which the additional-share allocation was
computed. Fortune believes that it has discovered evidence of active market
manipulation in the Common Stock by these plaintiffs; accordingly, it has
commenced a countersuit for damages suffered by the Company and its shareholders
as a result of these acts and has also received leave of court to add
third-party defendants whose actions furthered this market manipulation. Fortune
intends to continue to vigorously defend plaintiffs' actions and prosecute its
own counterclaims. Discovery is continuing in these cases and a consolidated
trial is expected in 1998.
(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 the
Company's Common Stock, is managing director for the Placement Agent and
marketed substantially the entire private placement. As such, Mr. Blank earned
approximately 50% of the fees and commissions paid to the Placement Agent and
20% of the warrants to be 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 and Mr. Blank's mother acquired $50,000 of Notes. Mr. Blank
disclaims beneficial ownership of the Notes purchased by his mother. Barry
Feiner, a director of the Company, 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 Company board of director matters associated with the private
placement.
As part of the relocation of Fortune's headquarters to Houston, Texas, the
Company 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 the Company 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, provided Mr. Fairbanks is still employed by the Company or
has not been terminated by the Company with cause. The $70,000 loan also bears
interest at the rate of 6% per annum, payable interest only for two years, with
a $35,000 principal payment due on the second anniversary of the loan and all
remaining principal and interest due on the third anniversary of the loan.
F-14
<PAGE>
On April 24, 1995, the Company obtained a $300,000 "bridge" loan to enable
it to pay certain expenses, including $100,000 on its credit facility. The loan
was obtained from LEX, which in turn had borrowed the funds from several
individuals. Upon the consummation of the Company's acquisition of LEX, it
became liable on such loans. (See note 3.) The loans were repaid out of the
proceeds of the Company's June 1995 Common Stock offering. The individuals who
loaned funds to LEX included Mrs. William H. Forster, mother of William D.
Forster, (a principal of LEX and principal stockholder and formerly a director
of Fortune), and John E. McConnaughy, Jr., formerly a principal stockholder of
the Company. Each of Mrs. Forster and Mr. McConnaughy loaned LEX $100,000 and
received from LEX, as an inducement to make the loan, 33,333 shares of Common
Stock and 33,333 stock purchase warrants out of 1,200,000 shares and 1,200,000
warrants issued to LEX in conjunction with the acquisition. W. Forster & Co.,
Inc., a corporation wholly owned by William D. Forster, received a $30,000
placement fee from the Company for assistance in arranging the $300,000 bridge
loan.
In order to provide additional capital for development activities, on
December 19 and 20, 1994, the Company borrowed an aggregate of $750,000 from
certain principal stockholders and from each of its directors then serving
(Messrs. Champion, Drulias, Fairbanks, Folsom and Walker). The directors loaned
$175,000 to the Company in the aggregate; $375,000 was obtained from Klein
Ventures, Inc.; and $200,000 was obtained from Jack Farber. The notes were
unsecured, bearing interest at 11% per annum (1.5% above the Bank One, Texas,
prime rate), payable monthly, and were due six months from their respective
dates of issue.
Both the Klein Ventures, Inc. and Farber notes permitted the holder to
elect to exchange their notes for shares of Common Stock at the price on the
date the notes were issued ($2.00 and $1.875 per share, respectively), and
Fortune reserved 294,166 shares of Common Stock for such purpose. On or about
June 30, 1995, the estate of Mr. Farber converted its note into 106,667 shares
of Common Stock. As additional consideration for making the loan, Klein
Ventures, Inc. received 10,000 Common Stock purchase warrants with an exercise
price of $2.40 per share, and Mr. Farber received 35,000 Common Stock purchase
warrants with an exercise price of $1.875 per share. The Company also agreed to
name two individuals nominated by Mr. Farber to fill vacancies on the board of
directors. Barry Feiner, Esq., who served as counsel to Mr. Farber prior to the
latter's death on May 5, 1995 and to Barry Blank, another principal stockholder
of the Company, and Mr. Gary Gelman, Mr. Farber's grandson, were appointed to
the board of directors in January 1995 pursuant to this agreement. Both Mr.
Feiner and Mr. Gelman were subsequently re-elected to the board by the Company's
stockholders.
At maturity, on December 21, 1995, Klein Ventures, Inc. opted for
conversion of its notes to Fortune Common Stock. The balance of the notes to the
directors was repaid in full.
No future transaction will be entered into between the Company and members
of management or principal stockholders unless such transactions are approved by
a majority of the directors who are not members of management or principal
stockholders.
In January 1995, Daniel E. Pasquini, the former president of the Company,
agreed to a modification of a previous severance package. He accepted $85,000 in
cash, the exercise price of 45,000 Common Stock options held by him was reduced
to $.575 per share and the Company issued him warrants to purchase 45,000 shares
of Common Stock at $2.75 per share. Compensation expense related to this
severance package was recognized in 1994.
Until his employment by the Company 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 the Company since its incorporation in May 1987. Mr. Drulias has
served as a director since 1990 and as Secretary since July 1994. During 1996
and 1995, his firm billed the Company a total of $152,000 and $183,000,
respectively, for legal fees and costs.
On January 22, 1997, the Company's board of directors appointed Daniel R.
Shaughnessy as a director of the Company. 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 the Company. During 1997, 1996 and 1995, Mr.
Shaughnessy's firm billed the Company a total of $182,000, $45,000 and $1,500,
respectively, for geological and geophysical consulting.
As compensation to outside directors, the Company pays directors' fees of
$2,500 per quarter. Inside directors do not receive such compensation.
F-15
<PAGE>
(10) STOCKHOLDERS' EQUITY
On September 30, 1997 the Company completed an odd-lot shareholder stock
buy back wherein the Company offered to buy for $3.00 per share the Common Stock
owned by shareholders who held fewer than 100 shares of the Company's Common
Stock. The Company initiated the odd-lot buy back in an effort to reduce the
cost of administering odd-lot shareholders. In connection with the buy back,
9,769 shares of the Company's Common Stock were acquired as treasury stock.
Fortune has three Stock Option Plans. The plans cover all officers and
employees of the Company. Two plans also provide for options for directors of
the Company. The board of directors grants awards upon recommendations of its
Compensation Committee. There is no performance formula or measure. Options
granted under the 1988 plan must be exercised within ten years of the date of
grant or are forfeited. Options granted under the 1993 and 1998 plans must be
exercised within five years of the date of grant or they are forfeited.
The Company follows the intrinsic value method for stock options granted to
employees. In October 1995, the FASB issued Statement of Financial Accounting
Standard No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). The
Company 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 the Company's stock option plans been determined based
upon the methodology prescribed under FAS 123, the impact on the Company's
reported net loss and loss per share would have been:
Year ended December 31,
-----------------------------------
1997 1996 1995
-------- -------- ---------
Impact on net loss:
Increase in net loss (millions) $ 0.6 $ 0.5 $ 0.1
Increase in net loss per share $ 0.05 $ 0.05 $ 0.02
The fair value on the date of grant of the options granted during 1997 is
estimated as $1.23 per Common Stock option using the Black-Scholes
option-pricing model. Following are the assumptions used by the Company 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,
--------------------------------
1997 1996 1995
-------- -------- --------
Assumptions:
Dividend yield 0% 0% 0%
Volatility 65% 65% 65%
Risk-free interest rate 6.3% 6.14% 7.8%
Forfeiture rate 5% 5% 5%
Expected life (years) 2.5 2.5 2.5
F-16
<PAGE>
Common Stock option transactions were:
<TABLE>
<CAPTION>
Weighted Average
Common Stock of Exercise Price of
Options Exercisable(a) Shares Under Plans
------------------- ------------------
<S> <C> <C>
Balance, December 31, 1994.......... 405,750 $ 2.71
Granted............................. 289,000 2.46
Exercised........................... (202,481) 2.26
Forfeited........................... - -
--------- --------
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 3.00
Exercised........................... (6,400) 2.75
Forfeited........................... (20,411) 2.74
--------- --------
Balance, December 31, 1997.......... 1,502,898 $ 2.96
========= ========
</TABLE>
(a) 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, 1997,
the Company had 623,243 and 2,000,000 Common Stock options available for grant
during 1998 under the 1993 and 1998 Stock Option Plans, respectively. All
options under the 1988 Plan have been granted. In January 1995, the Company
reduced the exercise price on 45,000 Common Stock options held by Daniel E.
Pasquini, the former president of the Company, from $2.75 per share to $0.575
per share. (See note 9) On January 12, 1995, the prices of the options granted
in 1991, 1993, 1994, and 1995 were reduced from $6.00, $5.00, $5.48 and $6.03
per share, respectively, to $2.75 per share for all optionholders who were
employees of the Company on that date. Such price reduction is reflected in the
year the options were originally granted in the above table.
The following table summarizes information concerning currently outstanding
and exercisable options and warrants issued in lieu of options:
Options Outstanding and Exercisable
---------------------------------------------
Weighted
Average Weighted
Range of Remaining Average
Exercise Number Contractual Exercise
Price Outstanding Life Price
-------------- ----------- -------------- --------
$2.38 to $3.25 1,502,898 3.20 years $2.96
F-17
<PAGE>
At December 31, 1997 the Company's outstanding Common Stock purchase
warrants consisted of (d):
Number of Warrants Exercise Price Expiration Date
------------------ -------------- ---------------
45,000 $ 3.00 2/15/98
75,000 $ 2.68 8/29/98
138,888 $ 3.89 9/28/98
64,015 (a) $ 4.41 9/28/98
1,982,750 (b) (e) $ 3.75 9/28/98
31,500 (c) (e) $ 11.14 10/05/98
168,500 $ 3.50 12/3/98
37,500 $ 3.50 12/5/98
100,000 $ 3.50 3/31/99
50,000 $ 4.0 5/19/99
87,125 $ 4.00 12/2/99
87,125 $ 5.00 12/2/99
35,000 $ 2.75 1/06/00
27,600 $ 3.19 2/25/00
1,200,000 $ 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
20,000 $ 2.44 8/29/01
10,000 $ 2.44 9/06/01
---------
4,720,003
=========
(a) Warrants permit the holder to purchase 88,289 total shares of Common Stock.
(b) Warrants permit the holders to purchase 2,841,610 total shares of Common
Stock.
(c) Represents units that permit each unitholder to purchase 3.3097 shares of
Common Stock plus two stock purchase warrants. Each stock purchase warrant,
which expires September 28, 1998, permits the holder to purchase 1.4375
additional shares of Common Stock at an exercise price of $3.75.
(d) Table excludes warrants that have been issued to employees in lieu of stock
options.
(e) See note 14 regarding offer to exchange certain warrants for new warrants.
(11) MAJOR CUSTOMERS
The Company sold oil representing 88% of its oil production to two
customers (63% and 25%, respectively) for the year ended December 31, 1997. The
Company sold gas representing 73% of its gas production to three customers (41%,
16% and 16%, respectively) for the year ended December 31, 1997.
The Company sold oil representing 54% of its oil production under contracts
to one customer for the year ended December 31, 1996. The Company's sold gas
representing 86% of its gas production to four customers (26%, 23%, 20% and 17%,
respectively) for the year ended December 31, 1996.
The Company sold oil representing 56% of its oil production under contracts
to one customer for the year ended December 31, 1995. The Company sold gas
representing 71% of its gas production to three customers (29%, 26% and 16%,
respectively) for the year ended December 31, 1995.
(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.
F-18
<PAGE>
(13) RETIREMENT PLAN
During 1996, the Company 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 the Company, subject to IRS limitations, and
are 100% vested after two years of service with the Company. Salary deferrals
are 100% vested at all times. The Company does not make profit sharing
contributions to the plan. For the 1997 and 1996 plan years, the Company's
matching contribution was $24,000 and $14,000, respectively, all of which was
paid in shares of Common Stock.
(14) SUBSEQUENT EVENTS
On February 12, 1997, the Company commenced a voluntary exchange offer of
its outstanding publicly traded Common Stock purchase warrants and certain
private warrants (collectively referred to herein as the old warrants) for new
private warrants. The old warrants include 1,917,000 publicly traded warrants
and 63,000 private warrants currently held by unitholders, all of which expire
September 28, 1998. (See note 10.) Under the terms of the exchange offer,
holders of the old warrants will have until March 31, 1998, subject to extension
at the Company's sole discretion, to exchange their old warrants for an equal
number of new private warrants that expire September 28, 1999. The new private
warrants 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 generally contain the same terms and conditions as the old
warrants. The Company will not receive any proceeds as a result of this exchange
offer.
(15) UNAUDITED OIL AND GAS PRODUCING ACTIVITIES AND
OIL AND GAS COST INFORMATION
All of the Company'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, 1997, 1996 and 1995, the oil and gas
reserve estimates were determined by Huddleston & Co., Inc., ("Huddleston")
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 quantities of
proved reserves and in the projection of future rates of production, prices and
the timing of development expenditures. 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, and
the present values thereof should not be construed to be the current market
values of the Company's oil and gas reserves or the costs that would be incurred
to obtain equivalent reserves.
Changes in Estimated Reserve Quantities
The Company's net interests in estimated quantities of proved developed and
undeveloped reserves of oil and gas at December 31, 1997, 1996, and 1995, and
changes in such quantities during the years then ended were as follows:
<TABLE>
<CAPTION>
Oil (MBbls)
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
BEGINNING OF PERIOD......................... 249 347 1,647
Revisions of previous estimates.......... (1) 6 (160)
Extensions and discoveries............... 88 106 -
Production............................... (87) (57) (92)
Purchase of minerals in place............ 13 - 174
Sales of minerals in place*.............. (5) (153) (1,222)
---------- ---------- ----------
END OF PERIOD............................... 257 249 347
========== ========== ==========
Proved developed reserves
Beginning of period.................... 160 324 675
========== ========== ==========
End of period.......................... 198 160 324
========== ========== ==========
</TABLE>
F-19
<PAGE>
<TABLE>
<CAPTION>
Gas (Mmcf)
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
BEGINNING OF PERIOD......................... 3,481 5,938 5,911
Revisions of previous estimates........ 431 (753) (388)
Extensions and discoveries............. 187 85 -
Production ......................... (821) (1,038) (909)
Purchase of minerals in place.......... 11 - 2,934
Sales of minerals in place*............ (72) (751) (1,601)
---------- ---------- ----------
END OF PERIOD............................... 3,217 3,481 5,938
========== ========== ==========
Proved developed reserves
Beginning of period.................. 1,749 4,686 3,317
========== ========== ==========
End of period ....................... 1,548 1,749 4,686
========== ========== ==========
</TABLE>
- -----------
* During 1995, the Company's interests in its California properties that were
sold in February 1996 were transferred to oil and gas properties held for
sale.
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" ("FAS 69") and based on oil and gas
reserve and production volumes determined by the Company's reserve engineers. It
may be useful for certain comparative purposes, but should not be solely relied
upon in evaluating the Company 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 the Company.
The Company believes that the following factors should be taken into
account in reviewing the following information: (1) future costs and selling
prices will probably differ from those required to be used in these
calculations; (2) due to future market conditions and governmental regulations,
actual rates of production achieved in future years may vary significantly from
the rate of production assumed in the calculations; (3) 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 (4)
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. FAS
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.
F-20
<PAGE>
The standardized measure of discounted future net cash flows relating to
proved oil and gas reserves is as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Future cash inflows.................... $ 12,717 $ 19,751 $ 19,531
Future costs:
Production............................ (3,346) (4,026) (6,050)
Development........................... (961) (1,613) (881)
-------- -------- --------
Future net inflows before income taxes.. 8,410 14,112 12,600
Future income taxes..................... - - -
-------- -------- --------
Future net cash flows................... 8,410 14,112 12,600
10% discount factor..................... (1,907) (3,292) (3,658)
-------- -------- --------
Standardized measure of
discounted net cash flows............. $ 6,503 $ 10,820 $ 8,942
======== ======== ========
</TABLE>
The average gas prices received by the Company were approximately $2.60,
$4.04 and $2.32 per Mcf at year end 1997, 1996 and 1995, respectively. The
average oil prices received by the Company were approximately $16.90, $22.79 and
$16.10 per Bbl at year end 1997, 1996 and 1995, respectively. As of February
1998, the Company was receiving an average of approximately $2.10 per Mcf for
its gas production and $14.70 per Bbl for its oil production. These current
prices represent declines from December 1997 prices and the Company expects
further price declines through the spring and summer of 1997.
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>
1997 1996 1995
-------- -------- --------
(in thousands)
<S> <C> <C> <C>
Standardized Measure:
Beginning of period.................................. $ 10,820 $ 8,942 $ 8,148
Increases (decreases):
Sales and transfers, net of production costs......... (2,757) (2,653) (1,445)
Extensions and discoveries........................... 1,571 1,532 -
Net change in sales and transfer prices,
net of production costs............................ (4,643) 5,233 460
Changes in estimated future development costs........ 245 (332) 500
Development costs incurred during the period......... 400 - -
Revisions of quantity estimates...................... 630 (1,473) (871)
Accretion of discount................................ 1,082 894 814
Purchases of reserves in place....................... 191 - 5,329
Sales of reserves in place*.......................... (199) (1,612) (3,024)
Changes in production rates (timing) and other....... (837) 289 (969)
-------- -------- --------
Standardized Measure:
End of period........................................ $ 6,503 $ 10,820 $ 8,942
======== ======== ========
</TABLE>
* During 1995, the Company's interests in its California properties that were
sold in February 1996 were transferred to oil and gas properties held for
sale.
F-21
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
September 30, December 31,
1998 1997
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents....................... $ 2,385,000 $ 1,667,000
Accounts receivable............................. 266,000 507,000
Prepaid expenses................................ 86,000 --
------------ ------------
Total Current Assets......................... 2,737,000 2,174,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method.................... 26,159,000 27,822,000
Office and other................................ 384,000 383,000
------------ ------------
26,543,000 28,205,000
Less--accumulated depletion, depreciation
and amortization (20,383,000) (18,403,000)
------------ ------------
6,160,000 9,802,000
------------ ------------
OTHER ASSETS:
Materials, supplies and other .................. 86,000 124,000
Debt issuance costs (net of accumulated
amortization of $446,000 and $93,000 at
September 30, 1998 and December 31, 1997,
respectively)................................. 173,000 526,000
------------ ------------
259,000 650,000
------------ ------------
TOTAL ASSETS....................................... $ 9,156,000 $ 12,626,000
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
September 30, December 31,
1998 1997
------------ ------------
CURRENT LIABILITIES:
Current portion of long-term debt............... $ 10,000 $ --
Accounts payable................................ 183,000 279,000
Accrued expenses................................ 378,000 407,000
Royalties and working interests payable......... 10,000 36,000
Accrued interest................................ -- 76,000
------------ ------------
Total Current Liabilities.................... 581,000 798,000
------------ ------------
LONG-TERM DEBT..................................... 3,225,000 3,775,000
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value:
Authorized--2,000,000 shares
Issued and outstanding--None.................. -- --
Common stock, $.01 par value :
Authorized--40,000,000 shares
Issued and outstanding 12,134,678 and
12,118,982 at September 30, 1998 and
December 31, 1997, respectively 121,000 121,000
Capital in excess of par value.................. 30,171,000 30,283,000
Accumulated deficit............................. (24,942,000) (22,313,000)
Treasury Stock, at cost (9,769 shares at
December 31, 1997) -- (38,000)
------------ ------------
NET STOCKHOLDERS' EQUITY........................... 5,350,000 8,053,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY......... $ 9,156,000 $ 12,626,000
============ ============
</TABLE>
See accompanying notes to financial statements.
F-22
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
For the Nine Months Ended
---------------------------
September 30, September 30,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties ............... $ 1,511,000 $ 2,870,000
Other income ......................................... 118,000 137,000
------------ ------------
1,629,000 3,007,000
COSTS AND EXPENSES
Production and operating ............................. 477,000 940,000
Provision for depletion, depreciation and amortization 1,120,000
1,609,000
Impairment to oil and gas properties ................. 860,000 3,200,000
General and administrative ........................... 1,142,000 1,481,000
Debt conversion expense .............................. -- 316,000
Stock offering cost .................................. -- 323,000
Interest paid in cash ................................ 306,000 160,000
Interest - amortization of deferred financing cost ... 353,000 62,000
------------ ------------
4,258,000 8,091,000
------------ ------------
LOSS BEFORE PROVISION FOR INCOME TAXES .................. (2,629,000) (5,084,000)
PROVISION FOR INCOME TAXES .............................. -- --
------------ ------------
NET LOSS ................................................ $ (2,629,000) $ (5,084,000)
============ ============
WEIGHTED AVERAGE NUMBER OF
COMMON SHARES OUTSTANDING ............................. 12,130,015 12,074,959
============ ============
NET LOSS PER COMMON SHARE (BASIC AND DILUTED) ........... $ (0.22) $ (0.42)
============ ============
</TABLE>
See accompanying notes to financial statements.
F-23
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1997
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1998
Capital in Stock-
Common Stock Excess of Accumulated Treasury holders'
Shares Amount Par Value Deficit stock Equity
---------- -------- ------------ ------------ ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1996.......... 11,853,663 $119,000 $ 29,273,000 $(16,355,000) $ -- $13,037,000
Common stock issued for
exercise of stock options......... 6,400 -- 18,000 -- -- 18,000
Common stock issued for
exercise of warrants.............. 45,000 -- 89,000 -- -- 89,000
Common stock issued in exchange
for debentures, net of
offering costs.................... 218,858 2,000 889,000 -- -- 891,000
Common stock contributed to
Company 401(k) Plan............... 4,835 -- 14,000 -- -- 14,000
Common stock repurchased in
odd-lot buyback................... (9,769) -- -- -- (38,000) (38,000)
Common stock returned to treasury... (5) -- -- -- -- --
Net loss............................ -- -- -- (5,958,000) -- (5,958,000)
---------- -------- ----------- ------------ ---------- -----------
BALANCE, December 31, 1997.......... 12,118,982 $121,000 30,283,000 $(22,313,000) $ (38,000) $ 8,053,000
Common stock issued for
exercise of warrants and options.. 5,512 -- 13,000 -- -- 13,000
Common stock contributed to
Company 401(k) Plan............... 10,185 -- 24,000 -- -- 24,000
Cancellation of treasury stock..... -- -- (38,000) -- 38,000 --
Voluntary exchange of public
warrants for private warrants..... -- -- (59,000) -- -- (59,000)
Repurchase of outstanding
private warrants.................. -- -- (52,000) -- -- (52,000)
Common stock returned to treasury... (1) -- -- -- -- --
Net loss............................ -- -- -- (2,629,000) -- (2,629,000)
---------- -------- ------------ ------------ ---------- -----------
BALANCE, September 30, 1998
(Unaudited)....................... 12,134,678 $121,000 $ 30,171,000 $(24,942,000) $ -- $ 5,350,000
========== ======== ============ ============ ========== ===========
</TABLE>
See accompanying notes to financial statements.
F-24
<PAGE>
<TABLE>
<CAPTION>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
For the Nine Months Ended
---------------------------
September 30, September 30,
1998 1997
------------ ------------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ................................................... $ (2,629,000) $ (5,084,000)
Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
Depletion, depreciation and amortization ................ 1,120,000 1,609,000
Non-cash compensation expense ........................... 20,000 57,000
Amortization of deferred financing cost ................. 353,000 62,000
Impairment of oil and gas assets ........................ 860,000 3,200,000
Debt conversion expense ................................. -- 316,000
Stock offering cost ..................................... -- 323,000
Changes in assets and liabilities:
Accounts receivable ..................................... 241,000 (300,000)
Prepaids ................................................ (86,000) 18,000
Accounts payable and accrued expenses ................... (125,000) 713,000
Royalties and working interest payable .................. (26,000) (52,000)
Accrued interest ........................................ (76,000) (46,000)
Other assets ............................................ 24,000 --
------------ ------------
Net cash (used in) provided by operating activities ........ (324,000) 816,000
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties .................... (3,032,000) (3,414,000)
Restricted cash used ....................................... -- 138,000
Return of exploration venture restricted cash .............. -- 2,154,000
Proceeds from sale of properties and equipment ............. 4,695,000 203,000
Net changes in other property and equipment and other assets 17,000 (26,000)
------------ ------------
Net cash provided by (used in) investing activities ........ 1,680,000 (945,000)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt ................... -- 65,000
Repayment of long term debt ................................ (540,000) (450,000)
Proceeds from issuance of common stock ..................... 13,000 103,000
Expenditures for debenture exchange and other offerings .... (59,000) (353,000)
Expenditures for debt refinancing .......................... -- (171,000)
Repurchase of private warrants ............................. (52,000) --
------------ ------------
Net cash used in financing activities ...................... (638,000) (806,000)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS .......... 718,000 (935,000)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................ 1,667,000 2,174,000
------------ -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ...................... $ 2,385,000 $ 1,239,000
============ ============
Supplemental information:
Interest paid in cash ...................................... $ 382,000 $ 160,000
Non-cash transactions
Common stock issued for conversion of debt ................. -- 975,000
Common stock issued for 401(k) Plan contribution ........... 24,000 14,000
</TABLE>
See accompanying notes to financial statements
F-25
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
September 30, 1998
(1) Line of Business and Summary of Significant Accounting Policies and
Procedures
The condensed financial statements at September 30, 1998, and for the three
months and nine months ended September 30, 1998 and 1997 included herein have
been prepared by Fortune Natural Resources Corporation ("Fortune" or the
"Company"), without audit, pursuant to the Rules and Regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to such
Rules and Regulations, although the Company believes that the disclosures are
adequate to make the information presented not misleading. These condensed
financial statements should be read in conjunction with the financial statements
and the notes thereto included in the Company's latest annual report on Form
10-K. Certain reclassifications have been made to prior period amounts to
conform to presentation in the current period. In the opinion of the Company,
the financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly the financial position of the
Company as of September 30, 1998 and December 31, 1997, the results of its
operations for the three months and nine months ended September 30, 1998 and
1997, and cash flows for the nine months ended September 30, 1998 and 1997. The
results of the operations for such interim periods are not necessarily
indicative of the results for the full year.
(2) Long-Term Debt
At September 30, 1998, a summary of long-term debt is as follows:
September 30, December 31,
1998 1997
---------- ----------
Convertible Subordinated Notes
due December 31, 2007.................. $3,225,000 $3,225,000
Credit Lyonnais credit facility
due July 11, 1999...................... 10,000 550,000
---------- ----------
Total long-term debt..................... 3,235,000 3,775,000
Less current installments................ 10,000 -
---------- ----------
Long-term debt, excluding current
installments........................... $3,225,000 $3,775,000
========== ==========
The Convertible Subordinated Notes (the "Notes)" are currently convertible
into the Company's Common Stock at a conversion price of $3.00 per share,
subject to adjustment. The Notes are convertible by the holders after May 1,
1999, subject to a one-time option by the holders to convert at a lower
conversion price prior to that date in the event that the Company issues shares
of its Common Stock at a price below the conversion price. (See note 7 regarding
transactions that may trigger this option.) The Notes are redeemable by the
Company after May 1, 1999, at a premium that reduces monthly from 10% to zero
over an 18-month period. Any such premium on redemption is waived in the event
that the Company's Common Stock price averages at least $4.50 per share for 30
consecutive trading days. The holders of the Notes will be entitled to receive
additional shares upon conversion in the event that the Company's Common Stock
price averages less than the conversion price for a certain period prior to May
1, 1999. The Company determined at the time of issuance of the Notes that the
value of the potential adjustments to the conversion price was not material. The
Notes are subordinate to all of the Company's secured debt, including the credit
facility with Credit Lyonnais. The Notes bear interest at a rate of 12% per
year, payable quarterly. The costs incurred to issue the Notes are being
amortized as additional interest expense over the 18-month period ending May 1,
1999, the first date that the Notes are convertible. As a result of this
amortization of issuance costs, the effective interest rate of the Notes over
this 18-month period is 21.2%. If the Notes were held to maturity, the effective
interest rate over the life of the Notes would be 13.4%.
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, the
Company repaid all but $10,000 of the outstanding balance of the credit facility
with a portion of the proceeds from the sale of East Bayou Sorrel. (See note 6).
Prior to the Company's sale of its interest in the East Bayou Sorrel field, the
Company's borrowing base was $2 million. The bank has not completed its
redetermination of the borrowing base subsequent to this sale; consequently,
F-26
<PAGE>
the Company does not know how much, if any, is currently available for borrowing
under this credit facility. Once the borrowing base is redetermined, the Company
may borrow up to such pre-determined borrowing base, for acquisitions and
development projects approved by Credit Lyonnais at either 1.25% above Credit
Lyonnais' base rate or 4% above LIBOR. The Credit Lyonnais facility is secured
by a mortgage on all of the Company's existing proved oil and gas properties.
The Company is also required to pay a commitment fee of 0.5% on the unused
portion of the borrowing base. Primarily as a result of lower oil and gas prices
and lower production after the sale of East Bayou Sorrel, the Company was unable
to meet the 3 to 1 coverage ratio of cash flow to fixed-charges which is
required by the credit facility for the twelve-month period ended September 30,
1998. The Company has received a waiver of this covenant from the bank for the
period ended September 30, 1998.
Fortune's maturities of long-term debt over the next two years are as
follows:
Year Debt
---- --------
1998 $ --
1999 10,000
--------
$ 10,000
========
(3) Income Tax Expense
No provision for income taxes was required for the three months and nine
months ended September 30, 1998.
At September 30, 1998, the Company estimates it had cumulative net
operating loss carryforwards for federal income tax purposes of $14 million
which are significantly restricted under IRC Section 382. These carryforwards
are available to offset future federal taxable income, if any, with various
expirations through 2013. The Company is uncertain as to the recoverability of
the above deferred tax assets and has therefore applied a 100% valuation
allowance.
The Company has available IRC Section 29 Tax Credits that may be used to
reduce or eliminate any corporate taxable income in future years. It is
uncertain at this time to what extent the Company will be able to utilize these
federal tax credits, as their utilization is dependent upon the amount, if any,
of future federal income tax incurred, after application of the Company's net
operating loss carryforwards.
F-27
<PAGE>
(4) Legal Proceedings
There are no material pending legal proceedings involving any of the
Company's properties or which involve a claim for damages which exceed 10% of
the Company's current assets.
On April 16, 1996, Fortune was served with two lawsuits which had been
filed in the Federal District Court in New York by purchasers of its Common
Stock in an offering in December 1995 under Regulation S. Under the terms of the
subscription agreement pursuant to which the plaintiffs acquired their shares,
each was entitled to receive additional shares of Common Stock if the market
price fell below a stated level during a specified period following the 40-day
holding period prescribed by Regulation S. Fortune responded to the suits,
admitting that the stock price declined but alleged that suspicious trading
activity in its Common Stock occurred immediately prior to and during the time
period in which the additional-share allocation was computed. Fortune believes
that it has discovered evidence of active market manipulation in the Common
Stock by these plaintiffs. Accordingly, it has commenced a countersuit for
damages suffered by the Company and its shareholders as a result of these acts
and has also received leave of court to add third-party defendants whose actions
furthered this market manipulation. Discovery has been stayed pending a
determination of objections filed by one of these third-party defendants.
Fortune intends to resume both the defense of plaintiffs' claims and the
aggressive prosecution of its own counterclaims as soon as it is entitled to do
so.
(5) Computation of Loss Per Share
Net loss per common share is computed by dividing net loss by the weighted
average number of common shares outstanding. Diluted earnings per common share
are not presented because the issuance or conversion of additional securities
would have an anti-dilutive effect.
(6) Sale of East Bayou Sorrel
On March 31, 1998, the Company sold its interest in the East Bayou Sorrel
field, Iberville Parish, Louisiana to National Energy Group, Inc. for cash in
the amount of $4,695,000. The properties sold consisted of the Company's
interest in the Schwing #1 and #2 wells and all of the Company's leases,
facilities and interests in the East Bayou Sorrel area of mutual interest, as
such area is defined in the East Bayou Sorrel operating agreement. The sale was
effective April 1, 1998. The sale closed on March 31, 1998, whereupon the
Company received $4,535,000, which is net of ordinary closing adjustments.
Fortune's interest in the two productive wells at East Bayou Sorrel were
pledged to secure the Company's Credit Facility with Credit Lyonnais. The total
balance outstanding under the Credit Facility prior to this sale was $550,000.
Concurrently with closing the sale of the East Bayou Sorrel field, the Company
paid down the outstanding balance of the Credit Facility by $540,000.
The Schwing #1 and #2 wells began producing from permanent production
facilities in January 1997 and June 1997, respectively. Although both wells were
shut-in from March 13, 1998 through the date of the sale to repair production
facilities, they accounted for a significant portion of the Company's oil and
gas revenues during 1997 and proved reserves as of December 31, 1997. A third
well in the field, the Schwing #3, which was spudded October 9, 1997, was
temporarily plugged and abandoned on March 5, 1998 pending further evaluation of
the well's potential. During 1997 and 1998, the Company incurred approximately
$1 million in connection with drilling and attempting to complete this well as a
result of difficult drilling conditions and mechanical problems. Selected
financial information attributable to the Fortune's interest in the East Bayou
Sorrel field as reported in its 1997 and year-to-date operating and financial
results is as follows:
F-28
<PAGE>
Year Ended Nine Months Ended
December 31, 1997 September 30, 1998 **
----------------- -----------------
Production
Oil (Bbls) 55,000 12,000
Gas (Mcf) 78,000 18,000
Oil and Gas Revenues $1,241,000 $231,000
Production and Operating Expense 205,000 60,000
Provision for Depletion, Depreciation
and Amortization* 430,000 54,000
As of
December 31, 1997
-----------------
Estimated Net Reserve Quantities
of Total Proved Reserves
Oil (Bbls) 152,000
Gas (Mcf) 204,000
- ----------
* Represents the estimated reduction in depreciation, depletion and
amortization expense reported by the Company in 1997 and 1998 that
would have resulted from excluding the East Bayou Sorrel production
and proved reserves.
** Amounts in this column represent 1998 production, revenues and related
expenses through March 31, 1998, the date of sale of the East Bayou
Sorrel interests.
This represents 32% and 30% of the Company's oil and gas revenues and
equivalent oil production and 23% of the Company's estimated quantities of
equivalent proved oil reserves as of December 31, 1997. Consequently, the
Company's revenues and cash flow from operations have decreased significantly
since the sale.
Under the full cost method of accounting for oil and gas operations,
dispositions of oil and gas properties are recorded as adjustments to
capitalized costs, with no gain or loss recognized unless such adjustment would
significantly alter the relationship between capitalized costs and proved
reserves. A significant alteration would not ordinarily be expected to occur for
sales involving less than 25 percent of the reserve quantities in a given cost
center. Because the sale of East Bayou Sorrel represents less than 25% of the
Company's reserve quantities, the entire proceeds of $4,695,000 was credited to
capitalized oil and gas properties as of March 31, 1998. Subsequent to charging
these proceeds against capitalized oil and gas property costs, the Company
recorded impairments to oil and gas properties. Consequently, if the Company had
reported a gain on the sale of this property, it would have been completely
offset by additional impairments to oil and gas properties.
(7) Subsequent Events
On November 2, 1998, Fortune executed a letter of intent with 3DX
Technologies Inc., a NASDAQ-traded exploration and production company that uses
state-of-the-art geophysical interpretation and processing technology in its oil
and gas activities. On November 4, 1998, Fortune executed a second letter of
intent with Petro-Guard Company, Inc. and Petro-Guard Production LLC, two
privately-held operating and production companies that operate producing
properties and exploratory projects along the Gulf Coast. The boards of
directors of each of the four entities have approved the letters of intent,
which provide for the merger of both 3DX and the Petro-Guard group into Fortune.
Each of the transactions is conditioned upon, among other things, the
preparation and approval of definitive merger agreements and the approval of the
shareholders of each of the companies.
Petro-Guard Company, Inc. and Petro-Guard Production LLC (collectively,
Petro-Guard) are both privately owned companies held principally by Dewey A.
Stringer, III, a director of Fortune. Petro-Guard also operates and participates
in Fortune's Espiritu Santo Bay project in Calhoun County, Texas.
F-29
<PAGE>
The terms of the 3DX acquisition provide for the issuance initially of up
to 6,965,431 shares of Fortune stock. 3DX shareholders could also receive up to
3,862,605 additional Fortune stock on or about two years after closing if
additional reserves attributable to the exploration properties acquired from 3DX
contribute disproportionately to the total of all reserves added by Fortune from
all exploration properties. No such additional shares will be issued, however,
if Fortune's closing common stock price averages at least $3.50 per share for a
thirty-day consecutive period any time prior to December 31, 2000. The letter of
intent with Petro-Guard provides for Fortune to issue three million shares of
its common stock to the Petro-Guard shareholders in exchange for the assets of
those companies. The Company expects to mail proxies by February 1, 1999 seeking
shareholder approval of these transactions. The Company expects to close the
transactions before the end of the first quarter of 1999. Fortune has also
obtained a conditional commitment from a private investor for an additional $5
million dollars in capital, on terms to be agreed upon, to facilitate the
additional exploration capital requirements of the combined companies. The terms
of this conditional commitment will be reported when they are finalized.
3DX reported total revenues for the six months ended June 30, 1998, of $2.1
million and a net loss for the same period of $6.4 million. The Petro-Guard
companies report their financial results on a tax basis; consequently,
accounting information prepared on a generally accepted accounting basis is not
currently available.
In the event that Fortune issues common stock at a price below $3.00 per
share prior to May 1, 1999, the holders of the Convertible Subordinated Notes
discussed in note 2 have a one-time option to convert the Notes at a conversion
price lower than $3.00 per share. At the holders option, the current $3.00 per
share conversion price is reduced by an amount obtained by multiplying the
difference between $3.00 and the price at which new shares are issued by the
ratio of total new shares issued over total shares outstanding after the new
issuance. If these proposed acquisition transactions are consummated prior to
May 1, 1999, this one-time conversion option may be triggered.
F-30
<PAGE>
================================================================================
UNTIL MAY 17, 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 AND WITH RESPECT TO THEIR UNSOLD
ALLOTMENT OR SUBSCRIPTIONS.
TABLE OF CONTENTS
Page
Prospectus Summary 2
Risk Factors 5
Dividend Policy 11
Use of Proceeds 11
Price Range of Securities 12
Selected Financial and Operating Data 13
Management's Discussion and
Analysis of Financial Condition
And Results of Operations 14
Business and Properties 21
Management 34
Certain Relationships and Related
Transactions 37
Principal Stockholders 39
The Selling Holders 41
Description of the Notes 42
Description of Securities 47
Certain Federal Income Tax Considerations 49
Plan of Distribution 52
Legal Matters 52
Experts 52
Available Information 53
Glossary of Oil and Gas Terms 54
Index to Financial Statements F-1
$3,325,000
12% CONVERTIBLE
SUBORDINATED NOTES
DUE
DECEMBER 31, 2007
FORTUNE NATURAL
RESOURCES CORPORATION
-----------------------
P R O S P E C T U S
-----------------------
FEBRUARY 16, 1999
================================================================================
<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 $ 986
Accountants' Fees and Expenses $ 5,000
Legal Fees and Expenses $ 20,000
American Stock Exchange fees $ 17,500
Printing and Engraving Expenses $ 0
Miscellaneous $ 514
-----------
$ 44,000
===========
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 Form of Note between Registrant and holders of 12% Convertible
Subordinated Notes due December 31, 2007 (incorporated by
reference to Registrant's quarterly report on Form 10-Q filed on
November 14, 1997.
4.2 Form of Warrant Certificate representing Common Stock
(incorporated by reference to Registrant's Registration
Statement on Form S-2/A filed on February 11, 1998.
4.3 Rights Agreement dated March 21, 1997 between the Company and
U.S. Stock Transfer Corporation, including the form of rights
certificate (incorporated by reference to Registrant's quarterly
report on Form 10-Q filed on July 29, 1997.
4.4 Credit Agreement dated as of July 11, 1997 among Registrant,
Credit Lyonnais New York Branch, as agent for itself and the
other lenders now or hereafter party thereto (incorporated by
reference to Registrant's quarterly report on Form 10-Q filed on
July 29, 1997.
4.5 Amendment dated November 3, 1997 to Credit Agreement among
Registrant, Credit Lyonnais New York Branch, as agent for
itself and the other lenders now or hereafter party thereto
(incorporated by reference to Registrant's quarterly report
on Form 10-Q filed on November 14, 1997.
5.1 * Opinion of Mr. Dean W. Drulias, General Counsel of the
Registrant, regarding legality of securities.
18.1 Letter from KPMG Peat Marwick LLP regarding change in accounting
method (incorporated by reference to Fortune's Registration
Statement on Form S-2, Registration No. 333-22599 filed on
February 28, 1997)
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 as exhibits to Registrant's Registration Statement on Form S-2 filed
on October 19, 1998 (File No. 333-65847).
** Filed herewith.
II-1
<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-2
<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 Pre-Effective
Amendment No. 2 to the Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Houston, State of Texas,
on February 16, 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 February 16, 1999
/s/ Dean W. Drulias
- ----------------------------
Dean W. Drulias Executive Vice President,
General Counsel,
Corporate Secretary
and Director February 16, 1999
/s/ Graham S. Folsom*
- ----------------------------
Graham S. Folsom Director February 16, 1999
/s/ Barry Feiner*
- ----------------------------
Barry Feiner Director February 16, 1999
/s/ Gary Gelman*
- ----------------------------
Gary Gelman Director February 16, 1999
/s/ D. R. Shaughnessy*
- ----------------------------
D. R. Shaughnessy Director February 16, 1999
/s/ Dewey A. Stringer, III*
- ----------------------------
Dewey A. Stringer, III Director February 16, 1999
By: /s/ Tyrone J. Fairbanks
-----------------------
Tyrone J. Fairbanks, Attorney-In-Fact
* A power of attorney authorizing Mr. Fairbanks to execute amendments to this
Registration Statement on behalf of the above named directors was included
in the registration Statement originally filed by the Registrant on October
19, 1998.
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
February 17, 1999
