SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NO. 1-12334
FORTUNE NATURAL RESOURCES CORPORATION
(Exact Name of Registrant as specified in its charter)
Delaware 95-4114732
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Commerce Green, 515 W. Greens Rd.,
Suite 720, Houston, Texas 77067
(Address of Principal Executive Offices) (Zip Code)
281-872-1170
-------------------------
Issuer's telephone number
N/A
--------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes X No ___
Applicable only to corporate issuers:
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
12,259,846 as of October 29, 1999
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT ASSETS:
Cash and cash equivalents ................................ $ 556,000 $ 1,452,000
Accounts receivable ...................................... 306,000 361,000
Prepaid expenses ......................................... 34,000 74,000
------------ ------------
Total Current Assets .................................. 896,000 1,887,000
------------ ------------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method ............................. 27,102,000 26,800,000
Office and other ......................................... 384,000 384,000
------------ ------------
27,486,000 27,184,000
Less--accumulated depletion, depreciation and
amortization............................................ (21,417,000) (20,728,000)
------------ ------------
6,069,000 6,456,000
------------ ------------
OTHER ASSETS:
Deposits and other ....................................... 51,000 51,000
Debt issuance costs (net of accumulated amortization of
$347,000 at December 31, 1998) ......................... - 98,000
------------ ------------
51,000 149,000
------------ ------------
TOTAL ASSETS ................................................ $ 7,016,000 $ 8,492,000
============ ============
</TABLE>
LIABILITIES AND STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
------------ ------------
(Unaudited) (Audited)
<S> <C> <C>
CURRENT LIABILITIES:
Current portion of long-term debt ........................ $ 10,000 $ 10,000
Accounts payable ......................................... 31,000 93,000
Accrued expenses ......................................... 82,000 351,000
Royalties and working interests payable .................. 4,000 12,000
Accrued interest ......................................... 97,000 97,000
------------ ------------
Total Current Liabilities ............................. 224,000 563,000
------------ ------------
LONG-TERM DEBT .............................................. 3,225,000 3,225,000
------------ ------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value:
Authorized--2,000,000 shares
Issued and outstanding--None .......................... - -
Common stock, $.01 par value:
Authorized--40,000,000 shares
Issued and outstanding 12,259,667 and 12,134,675 at
September 30, 1999 and December 31, 1998, respectively. 123,000 121,000
Capital in excess of par value ........................... 30,293,000 30,171,000
Accumulated deficit ...................................... (26,849,000) (25,588,000)
------------ ------------
NET STOCKHOLDERS' EQUITY .................................... 3,567,000 4,704,000
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .................. $ 7,016,000 $ 8,492,000
============ ============
</TABLE>
See accompanying notes to financial statements .
2
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Nine Months Ended
---------------------------
September 30, September 30,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties ............... $ 1,136,000 $ 1,511,000
Other income ......................................... 33,000 118,000
------------ ------------
1,169,000 1,629,000
------------ ------------
COSTS AND EXPENSES
Production and operating ............................. 330,000 477,000
Provision for depletion, depreciation
and amortization.................................... 689,000 1,120,000
Impairment to oil and gas properties ................. - 860,000
General and administrative ........................... 960,000 1,142,000
Notes restructuring cost ............................. 61,000 -
Interest paid in cash ................................ 291,000 306,000
Interest - amortization of deferred financing cost ... 99,000 353,000
------------ ------------
2,430,000 4,258,000
------------ ------------
LOSS BEFORE INCOME TAXES ................................ (1,261,000) (2,629,000)
PROVISION FOR INCOME TAXES .............................. - -
------------ ------------
NET LOSS ................................................ $ (1,261,000) $ (2,629,000)
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING ............. 12,188,875 12,130,015
============ ============
NET LOSS PER COMMON SHARE (BASIC AND DILUTED) ........... $ (0.10) $ (0.22)
============ ============
</TABLE>
See accompanying notes to financial statements.
3
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
For the Three Months Ended
---------------------------
September 30, September 30,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
REVENUES
Sales of oil and gas, net of royalties ............... $ 460,000 $ 388,000
Other income ......................................... 9,000 42,000
------------ ------------
469,000 430,000
------------ ------------
COSTS AND EXPENSES
Production and operating ............................. 128,000 118,000
Provision for depletion, depreciation
and amortization.................................... 249,000 290,000
Impairment to oil and gas properties ................. - 600,000
General and administrative ........................... 311,000 328,000
Interest paid in cash ................................ 97,000 97,000
Interest - amortization of deferred financing cost ... - 162,000
------------ ------------
785,000 1,595,000
------------ ------------
LOSS BEFORE INCOME TAXES ................................ (316,000) (1,165,000)
PROVISION FOR INCOME TAXES .............................. - -
------------ ------------
NET LOSS ................................................ $ (316,000) $ (1,165,000)
============ ============
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING ............. 12,234,202 12,134,222
============ ============
NET LOSS PER COMMON SHARE (BASIC AND DILUTED) ........... $ (0.03) $ (0.10)
============ ============
</TABLE>
See accompanying notes to financial statements.
4
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEAR ENDED DECEMBER 31, 1998
AND THE NINE MONTHS ENDED SEPTEMBER 30, 1999
<TABLE>
<CAPTION>
Capital in Stock-
Common Stock Excess of Treasury Accumulated holders'
Shares Amount Par Value Stock Deficit Equity
---------- --------- ----------- -------- ------------ -----------
<S> 0 <C> <C> <C> <C> <C>
BALANCE, December 31, 1997......... 12,118,982 $ 121,000 $30,283,000 $(38,000) $(22,313,000) $ 8,053,000
Common stock issued for
exercise of warrants............ 5,512 - 13,000 - - 13,000
Common stock contributed to
401(k) Plan..................... 10,185 - 24,000 - - 24,000
Cancellation of treasury stock..... - - (38,000) 38,000 - -
Voluntary exchange of public
warrants for private warrants... - - (59,000) - - (59,000)
Repurchase of outstanding
private warrants................ - - (52,000) - - (52,000)
Common stock returned to treasury (4) - - - - -
Net loss........................... - - - - (3,275,000) (3,275,000)
---------- --------- ----------- -------- ------------ -----------
BALANCE, December 31, 1998......... 12,134,675 $ 121,000 $30,171,000 $ - $(25,588,000) $ 4,704,000
========== ========= =========== ======== ============ ===========
Common stock contributed to
401(k) Plan..................... 22,137 - 29,000 - - 29,000
Warrants issued for
note restructuring.............. - - 61,000 - - 61,000
Common stock issued for
directors' fees................. 102,856 2,000 32,000 - - 34,000
Common stock returned to treasury.. (1) - - - - -
Net loss........................... - - - - (1,261,000) (1,261,000)
---------- --------- ----------- -------- ------------ -----------
BALANCE, September 30, 1999
(Unaudited)..................... 12,259,667 $ 123,000 $ 30,293,000 $ - $(26,849,000) $ 3,567,000
========== ========= =========== ======== ============ ===========
</TABLE>
See accompanying notes to financial statements.
5
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
For the Nine Months Ended
--------------------------
September 30, September 30,
1999 1998
------------ ------------
(Unaudited)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ..................................................... $ (1,261,000) $ (2,629,000)
Adjustments to reconcile net loss to net
cash used in operating activities:
Depletion, depreciation and amortization .................. 689,000 1,120,000
Non-cash compensation expense ............................. 20,000 20,000
Common stock issued for directors' fees ................... 34,000 -
Amortization of deferred financing cost ................... 99,000 353,000
Impairment of oil and gas assets .......................... - 860,000
Notes restructuring cost .................................. 61,000 -
Changes in assets and liabilities:
Accounts receivable ....................................... 55,000 241,000
Prepaids .................................................. 40,000 (86,000)
Accounts payable and accrued expenses ..................... (331,000) (125,000)
Royalties and working interest payable .................... (8,000) (26,000)
Accrued interest .......................................... - (76,000)
Other ..................................................... 8,000 24,000
------------ ------------
Net cash used in operating activities ........................ (594,000) (324,000)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Expenditures for oil and gas properties ...................... (302,000) (3,032,000)
Proceeds from sale of properties and equipment ............... - 4,695,000
Expenditures for other property and equipment
and other assets............................................ - 17,000
----------- ------------
Net cash provided by (used in) investing activities .......... (302,000) 1,680,000
----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of long term debt .................................. - (540,000)
Proceeds from issuance of common stock ....................... - 13,000
Expenditures for debenture exchange and other offerings....... - (59,000)
Repurchase of private warrants ............................... - (52,000)
------------ ------------
Net cash used in financing activities ........................ - (638,000)
------------ ------------
NET INCREASE (DECREASE) IN CASH
AND CASH EQUIVALENTS .......................................... (896,000) 718,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .................. 1,452,000 1,667,000
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ........................ $ 556,000 $ 2,385,000
============ ============
Supplemental information:
Interest paid in cash ........................................ $ 291,000 $ 382,000
Non-cash transactions
Common stock issued for 401(k) Plan contribution ............. 29,000 24,000
Common stock issued for directors' fees ...................... 34,000 -
Notes restructuring cost ..................................... 61,000 -
</TABLE>
See accompanying notes to financial statements.
6
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
September 30, 1999
(1) LINE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
AND PROCEDURES
The condensed financial statements at September 30, 1999, and for the
periods then ended included herein have been prepared by Fortune Natural
Resources Corporation, without audit, pursuant to the rules and regulations of
the Securities and Exchange Commission. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations. However, Fortune believes that the
disclosures are adequate to make the information presented not misleading. These
condensed financial statements should be read in conjunction with the financial
statements and the notes thereto included in Fortune's latest annual report on
Form 10-K. Certain reclassifications have been made to prior period amounts to
conform to presentation in the current period. In Fortune's opinion, the
financial statements reflect all adjustments, consisting only of normal
recurring adjustments, necessary to present fairly its financial position and
the results of its operations and its cash flows for the dates and periods
presented. The results of the operations for these interim periods are not
necessarily indicative of the results for the full year.
(2) LONG-TERM DEBT
At September 30, 1999, a summary of long-term debt is as follows:
<TABLE>
<CAPTION>
September 30, December 31,
1999 1998
---------- ----------
<S> <C> <C>
Convertible Subordinated Notes due December 31, 2007..... $3,225,000 $3,225,000
Credit Lyonnais credit facility due January 11, 2000..... 10,000 10,000
---------- ----------
Total long-term debt..................................... 3,235,000 3,235,000
Less current installments................................ (10,000) (10,000)
---------- ----------
Long-term debt, excluding current installments........... $3,225,000 $3,225,000
========== ==========
</TABLE>
In March 1999, noteholders representing $2,295,000 principle amount of the
Convertible Subordinated Notes agreed to amend the conversion price of their
notes. As a result, these amended notes are convertible into Fortune's common
stock at a conversion price of $0.75 per share, subject to adjustment for
certain recapitalizations or dividends of Fortune. The remaining $930,000
principal amount of notes are convertible into Fortune's common stock at a
conversion price of approximately $0.33 per share, subject to adjustment for
certain recapitalizations or dividends of Fortune. All notes are convertible by
the holders and/or redeemable by Fortune. The notes are redeemable by Fortune at
a premium that reduces monthly from 10% to zero from May 1999 to November 2000.
As of October 1, 1999, the premium on redemption was 7.2% of par. Any such
premium on redemption is waived if Fortune's common stock price averages at
least $4.50 per share for 30 consecutive trading days. The notes are subordinate
to all of Fortune's secured debt, including the credit facility with Credit
Lyonnais. The notes bear interest at a rate of 12% per year, payable quarterly.
The cost incurred to issue the
7
<PAGE>
original notes has been amortized as additional interest expense over the
18-month period ended May 1, 1999, the first date that the notes were
convertible. As a result of this amortization of issuance costs, the effective
interest rate of the notes over this 18-month period was 21.2%. If the notes are
held to maturity, the effective interest rate to maturity will be 13.4%.
For agreeing to amend their conversion price, the amending noteholders
received one three-year warrant, exercisable at $1 each, for each share into
which each of their notes is now convertible. Fortune valued this warrant at
$0.02 per warrant and expensed the value of all such warrants during the first
quarter of 1999 as note restructuring cost.
Fortune's $20 million credit facility with Credit Lyonnais New York Branch
was to expire July 11, 1999; however, it has been extended to January 11, 2000.
Upon mutual consent, it is extendable through July 11, 2000. On March 31, 1998,
Fortune repaid all but $10,000 of the outstanding balance of the credit facility
with a portion of the proceeds from the sale of East Bayou Sorrel. (See note 6).
Prior to its sale of the East Bayou Sorrel field, Fortune's borrowing base was
$2 million. The bank has not redetermined the borrowing base subsequent to this
sale; consequently Fortune does not know how much, if any, is currently
available for borrowing under this credit facility. Once the borrowing base is
redetermined, Fortune may borrow up to that amount for acquisitions and
development projects approved by Credit Lyonnais at either 1.25% above Credit
Lyonnais' base rate or 4% above LIBOR. The credit facility is secured by a
mortgage on all of Fortune's existing proved oil and gas properties. Fortune is
also required to pay a commitment fee of 0.5% on the unused portion, if any, of
the borrowing base.
Primarily as a result of the lower revenues after the sale of East Bayou
Sorrel, Fortune was unable to meet the 3 to 1 coverage ratio of cash flow to
fixed-charges which is required by the credit facility for the twelve-months
period ended September 30, 1999. Fortune has requested a waiver of this covenant
from the bank for the period ended September 30, 1999.
The $10,000 balance on the credit facility matures January 11, 2000.
(3) INCOME TAX EXPENSE
No provision for income taxes was required for the three and nine months
ended September 30, 1999.
At September 30, 1999, Fortune estimates it had cumulative net operating
loss carryforwards for federal income tax purposes of approximately $20 million
which are significantly restricted under IRC Section 382. These carryforwards
are available to offset future federal taxable income, if any, with various
expirations through 2014. Fortune also has net operating loss carryforwards in
certain states, including California, New Mexico and Texas, with various
expiration dates and restrictions. Fortune is uncertain as to the recoverability
of these deferred tax assets and has therefore applied a 100% valuation
allowance.
Fortune has available IRC Section 29 Tax Credits that may be used to
reduce or eliminate any corporate taxable income in future years. It is
uncertain at this time to what extent Fortune will be able to utilize these
federal tax credits, as their utilization is dependent upon the amount, if any,
of future federal income tax incurred, after exhausting Fortune's net operating
loss carryforwards.
(4) LEGAL PROCEEDINGS
There are no material pending legal proceedings involving any of Fortune's
properties or which involve a claim for damages which exceed 10% of Fortune's
current assets.
8
<PAGE>
On April 16, 1996, Fortune was served with two lawsuits which had been
filed in the Federal District Court in New York by purchasers of Fortune common
stock in an offering in December 1995 under Regulation S. Under the terms of the
subscription agreement pursuant to which the plaintiffs acquired their shares,
each was entitled to receive additional shares of Fortune common stock if the
market price fell below a stated level during a specified period following the
40-day holding period prescribed by Regulation S. Fortune responded to the
suits, admitting that the stock price declined but alleged that suspicious
trading activity in Fortune stock occurred immediately prior to and during the
time period in which the additional-share allocation was computed. Fortune
believes that it has discovered evidence of active market manipulation in the
common stock by these plaintiffs; accordingly, it has commenced a countersuit
for damages suffered by Fortune and its shareholders as a result of these acts
and has also added certain third-party defendants whose actions furthered this
market manipulation. Fortune intends to continue to vigorously defend
plaintiffs' actions and prosecute its own counterclaims. Discovery is proceeding
on this matter.
(5) COMPUTATION OF LOSS PER SHARE
Basic net loss per common share is computed by dividing net loss by the
weighted average number of common shares outstanding. Diluted earnings per
common share are not presented because the issuance or conversion of additional
securities would have an antidilutive effect.
(6) SALE OF EAST BAYOU SORREL
On March 31, 1998, Fortune sold its interest in the East Bayou Sorrel
field, Iberville Parish, Louisiana to National Energy Group, Inc. for cash in
the amount of $4,695,000. The properties sold consisted of Fortune's interest in
the Schwing #1 and #2 wells and associated leases, facilities and interests.
The Schwing #1 and #2 wells began producing in January 1997 and June 1997,
respectively. Although both wells were shut-in from March 13, 1998 through the
date of the sale to repair production facilities, they accounted for a
significant portion of Fortune's oil and gas production through that date.
Selected unaudited financial information attributable to Fortune's interest in
the East Bayou Sorrel field as reported in its 1998 financial results is as
follows:
Nine Months Ended
September 30, 1998
------------------
(unaudited)
Production
Oil (Bbls) 12,000
Gas (Mcf) 18,000
Oil and gas revenues $231,000
Production and operating expense 60,000
Provision for depletion, depreciation
and amortization 54,000
This represented 15% and 13% of Fortune's oil and gas revenues and
production for the first nine months of 1998. Consequently, Fortune's revenues
and cash flow from operations have decreased significantly since the sale.
Because the sale of East Bayou Sorrel represented less than 25% of
Fortune's proved reserve quantities, all of the proceeds of $4,695,000 were
credited to capitalized oil and gas properties as of March 31, 1998.
9
<PAGE>
FORTUNE NATURAL RESOURCES CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
COMPARISON OF 1999 OPERATING RESULTS TO 1998
QUARTER ENDED SEPTEMBER 30, 1999 AND 1998
Fortune's oil and gas revenues continue to improve as a result of higher
oil and gas prices. Furthermore, successful drilling results are partially
offsetting production declines from depletion. New production from two
successful year-end 1998 drilling projects, at South Timbalier Block 86 and
Espiritu Santo Bay, began contributing revenues during the quarter ended June
30, 1999. Revenues from Bay Marchand Block 5 and the Bacon prospect began
contributing revenues during the third quarter of 1999. Increases in oil and gas
prices offset lower oil and gas production. Consequently, Fortune's revenues
from sales of oil and gas for the quarter ended September 30, 1999 of $460,000
increased 19% over the $388,000 reported during the third quarter of 1998. This
represents the highest quarterly oil and gas revenues reported by Fortune since
our sale of East Bayou Sorrel on March 31, 1998. As a result, Fortune's net loss
improved to $316,000 during the third quarter of 1999 compared to a net loss of
$1,165,000 for the same 1998 period. The lower 1999 loss is due to a combination
of the higher oil and gas prices, absence in 1999 of a writedown for impairment
to oil and gas properties and a reduction in most costs as a result of our cost
reduction plan implemented in January 1999. This $316,000 loss is the lowest
quarterly loss reported by Fortune since the fourth quarter of 1996 and is the
fourth consecutive quarter in which our reported loss has declined.
Gas production decreased 4% during the third quarter of 1999 versus 1998.
New production from primarily gas discoveries almost fully offset depletion on
existing properties. Fortune's oil production decreased 28% during the third
quarter of 1999 versus 1998. Depletion was the primary contributor to the oil
decrease.
Gas prices on Fortune's production averaged $2.60 per Mcf for the third
quarter of 1999 as compared to $2.09 per Mcf for the same 1998 period (a 24%
increase). Oil prices averaged $18.98 per barrel for the third quarter of 1999
compared to $11.75 per barrel for the same 1998 period (a 62% increase).
Production and operating expense increased by $10,000 (8%) for the third
quarter of 1999 versus 1998 because of higher production taxes and more
producing properties in 1999.
Non-cash amortization of debt financing costs has declined because all
such costs were fully amortized by the end of April 1999.
Fortune's provision for depletion, depreciation and amortization (DD&A)
decreased by $41,000 (14%) in the third quarter of 1999 as compared to 1998
primarily because of lower production and past ceiling test impairments. Fortune
recorded an impairment to oil and gas properties of $600,000 during the third
quarter of 1998. Primarily as a result of higher oil and gas prices and the
effect of past impairments, no impairment was recorded in the third quarter of
1999.
10
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1999 VS. 1998
During the first nine months of 1999, Fortune's net loss improved to
$1,261,000 compared to a net loss of $2,629,000 for the same 1998 period. Lower
expenses in almost all categories in 1999 more than offset a decline in
revenues. Significantly lower oil and gas production resulted in net oil and gas
revenues decreasing by $375,000 (25%) in the first nine months of 1999, compared
to the same 1998 period. The East Bayou Sorrel field, which accounted for 15%
and 13% of first nine months 1998 revenues and production, respectively, was
sold on March 31, 1998 for $4.7 million. See note 6 to the financial statements
for a discussion of this sale and its impact on Fortune's operating results.
Fortune's oil production decreased 64% during the first nine months of
1999 versus 1998. Gas production decreased 11% during the first nine months of
1999 versus 1998. The sale of East Bayou Sorrel and depletion were the primary
contributors to these decreases.
Gas prices on Fortune's production averaged $2.25 per Mcf for the first
nine months of 1999 as compared to $2.23 per Mcf for the same 1998 period (a 1%
increase). Oil prices averaged $16.27 per barrel for the first nine months of
1999 compared to $13.38 per barrel for the same 1998 period (a 22% increase).
Production and operating expense decreased by $147,000 (31%) for the first
nine months of 1999 versus 1998 because of the lower production discussed above
and the absence of workovers and operating problems during 1999.
General and administrative expense decreased by $182,000 (16%) primarily
because of reductions which have been made in response to lower oil and gas
prices. In connection with Fortune's efforts to reduce cash outlays, the board
of directors voted, effective January 1, 1999, to begin paying the quarterly
$2,500 per outside director fee in Fortune common stock instead of cash.
Interest expense paid in cash decreased by $15,000 (5%) for the first nine
months of 1999 over 1998 due to a lower debt balance. The lower debt balance
resulted from Fortune paying off substantially all of its credit facility at
March 31, 1998 with a portion of the proceeds of the sale of East Bayou Sorrel.
Non-cash amortization of debt financing costs has declined because all such
costs were fully amortized at the end of April 1999.
Fortune's provision for depletion, depreciation and amortization (DD&A)
decreased by $431,000 (38%) in the first nine months of 1999 as compared to 1998
primarily because of lower production and a lower property balance as a result
of the sale of the East Bayou Sorrel property and past ceiling test impairments.
LIQUIDITY AND CAPITAL RESOURCES
CASH BALANCE, WORKING CAPITAL AND CASH FLOWS FROM OPERATING ACTIVITIES
Fortune used $594,000 of cash in its operating activities during the first
nine months of 1999 compared to $324,000 during the same 1998 period. Before
considering the effect of changes in non-cash working capital accounts,
operating cash flow used was $(347,000) during 1999 compared to $(276,000)
during 1998. Lower oil and gas production, as discussed above, accounts for this
decrease in cash flow. Working capital at September 30, 1999 decreased from
December 31,1998 because of the negative cash flow from operating activities and
the capital expenditures discussed below. Cash flow increased in the third
quarter of 1999 compared to the prior quarters ended March 31, 1999 and June 30,
1999 as the production from two recently completed wells at Espiritu Santo Bay,
the recently completed farmout wells at South Timbalier 86 and Bay Marchand
Block 5 and the recently completed well in Mississippi commenced production.
Also, oil and gas prices have increased since March 31, 1999.
11
<PAGE>
CASH USED IN INVESTING ACTIVITIES - CAPITAL EXPENDITURES
Expenditures for oil and gas properties for the first nine months of 1999
were $302,000 compared to $3,032,000 for 1998. The 1999 expenditures include
primarily:
- additional leases at Espiritu Santo Bay;
- seismic interpretation at Espiritu Santo Bay and LaRosa;
- completion expenditures for two wells at Espiritu Santo Bay,
ST 216 #16 and ST 210 #5;
- completion expenditures for the Bacon prospect well drilled in
Mississippi;
- expenditures for the Espiritu Santo Bay ST 164 #4 well which was
plugged and abandoned in May 1999; and
- drilling expenditures for a La Rosa well that was plugged and
abandoned in August 1999.
Fortune did not incur any expenditures on the South Timbalier 86 and Bay
Marchand Block 5 wells because Fortune farmed out these properties retaining
overrides of 3.17% and .5%, respectively. The South Timbalier 86 override
converts to 4% after payout. The Bay Marchand Block 5 farmout acreage was
unitized with acreage containing another producing well. This unitization
resulted in Fortune's revenue interest decreasing to 0.24% over the
newly-combined acreage block.
The 1998 expenditures include primarily:
- drilling and completion expenditures for the third well at East
Bayou Sorrel, which was plugged on March 5, 1998;
- drilling and completion operations at LaRosa;
- drilling costs for a dry hole at the S.W. Segno prospect;
- land, seismic and well costs for the dry holes at Whiskey Pass
and Sea Serpent; and
- land, seismic and drilling costs for Espiritu Santo Bay.
During the third quarter of 1999, Fortune and substantially all of the
working interest owners at Espiritu Santo Bay farmed out their interest in the
first deep Espiritu Santo Bay prospect delineated from the proprietary 3-D
seismic to McMoRan Oil and Gas, LLC, a wholly-owned subsidiary of McMoRan
Exploration Company.
Under the terms of the farmout agreement, McMoRan and its exploration
program partners will pay 100% of all drilling, completion, testing and
facilities costs for the farmout well in exchange for 50% of Fortune's working
interest in the prospect. McMoRan will retain 100% of Fortune's interest and pay
100% of all costs until it recovers all of its costs out of production revenues.
Upon such payout, Fortune will back in for 50% of its original interest in the
prospect. McMoRan has agreed to limit the recovery of its costs of the drilling
of the well in the event of any significant drilling cost overruns. The farmout
well, which McMoRan spud the weekend of October 30, 1999, is currently drilling.
The farmout agreement establishes a 22 square mile area of mutual interest
(AMI) around the prospect, grants McMoRan a license to approximately 22 square
miles of Fortune's 135 square miles of 3-D seismic data and grants McMoRan an
option to acquire 50% of Fortune's interest in the AMI by paying Fortune 50% of
certain of its costs in the AMI. The agreement also provides that Fortune will
bear its "after-payout" share of drilling and completion costs for subsequent
wells on the acreage subject to the farmout. Fortune's working interest in the
AMI prior to the farmout ranged from 7.3% to 12.5%.
12
<PAGE>
Fortune believes that it has sufficient capital to pursue additional
drilling at Espiritu Santo Bay. However, if early wells are unsuccessful or
encounter significant drilling problems or delays, Fortune may need to make
additional significant reductions in overhead or raise additional capital to
pursue its business strategy.
OIL AND GAS PRICES
Conditions outside of our control influence the prices we receive for oil
and gas. As of October 27, 1999, Fortune was receiving an average of
approximately $21.00 per barrel for its oil production and $2.70 per Mcf for its
gas production.
"YEAR 2000" COMPLIANCE
Fortune is aware of the issues associated with the inability of many
computer systems worldwide to recognize dates beyond December 31, 1999 and that
a failure to correct this problem could result in significant disruption to
those systems. Fortune has reviewed its internal and accounting systems and
believes that they are "year 2000 compliant." Fortune currently does not operate
any of its producing properties; accordingly it does not use any operating
systems internally that must be evaluated for compliance. Fortune's concerns
regarding year 2000 compliance rest almost solely with its third party business
associates. Fortune has been assessing the readiness of the third parties that
it believes are important to its business, such as: operators of its properties,
its oil and gas product purchasers, its accounting system providers,
consultants, communication systems providers, etc. The third parties contacted
thus far have represented either to be in compliance or have communicated their
plans and timetables for compliance. This process is ongoing. Fortune has begun
making contingency plans in the event that its third parties are unable to
achieve compliance. With respect to oil and gas product purchasers, systems
providers, consultants, its bank, and its stock transfer agent, for example,
Fortune does not have any contracts that extend beyond 1999. Accordingly,
Fortune can change to goods and service providers who are year 2000 compliant,
if necessary. With respect to operators of its properties, Fortune believes that
a failure to comply by the operator or its critical suppliers would generally
not be material except at South Timbalier Block 76. CNG Producing Company
operates South Timbalier Block 76 and Fortune is monitoring CNG's compliance
efforts. Fortune does not believe that the direct, out-of-pocket cost of its
year 2000 compliance requirements will be significant. There are, however,
numerous parties who Fortune has no direct contact with but who nonetheless
could have a significant impact on Fortune's business activities if they do not
achieve compliance. These indirect third parties include oil and gas refiners,
gas and oil transmission companies, third party banking institutions, suppliers
of suppliers, etc. Although Fortune has no practical way of assessing the
viability of these companies, Fortune believes that its risks are no greater in
this regard than businesses and the public in general. Fortune will continue to
monitor the status of year 2000 compliance issues to determine the impact, if
any, on its operations.
RECENTLY ISSUED FINANCIAL ACCOUNTING STANDARDS
In June 1998, the FASB issued Statement of Financial Accounting Standards
No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS
133 establishes accounting and reporting standards for derivative instruments,
including derivative instruments embedded in other contracts and for hedging
activities. SFAS 133, as amended, is effective for all fiscal years beginning
after June 15, 2000. Fortune has not historically utilized derivative
instruments; accordingly, the impact upon Fortune of SFAS 133 is not expected to
have an effect on the reporting of future operating results.
13
<PAGE>
FORWARD LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements. Forward-looking
statements include statements regarding future oil and gas production and
prices, future exploration and development spending, future drilling and
operating plans, reserve and production potential of Fortune's properties and
prospects, Fortune's business strategy, "Year 2000" compliance expectations and
management's plans and expectations. Actual events or results could differ
materially from those discussed in the forward-looking statements as a result of
various risk factors including the factors described below.
FORTUNE'S RELIANCE ON EXPLORATORY PROJECTS INCREASES THE RISKS INHERENT IN
THE OIL AND GAS INDUSTRY. Our current investments are primarily in exploration
projects, where the risks are substantially greater than projects involving
already producing formations. We anticipate that one or more of our next wells
will be designed to test formations that are deeper than known production in
Espiritu Santo Bay. These formations have not been extensively tested to date.
The exploration risks, therefore, are higher on this project than they might be
where a greater number of underground references exist. Fortune has realized
less success than originally anticipated in drilling some of its recent
prospects and we expect that a substantial number of our future projects could
experience similar results.
FORTUNE HAS INCURRED NET LOSSES FOR EACH OF THE LAST SEVERAL YEARS.
Fortune has incurred substantial net losses for several years. Although we have
made significant budget cuts in 1999, oil and gas prices continue to fluctuate
significantly. This makes it likely that losses will continue. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
FORTUNE IS NOT CURRENTLY REPLACING ALL OF ITS EXISTING RESERVES. We are
not adding reserves at present at the same pace at which they are being
produced. Therefore, without adding additional reserves in the future, our oil
and gas reserves and production will decline.
OUR REVENUE IS DEPENDENT UPON A LIMITED NUMBER OF PRODUCING WELLS. Over
30% of our oil and gas revenues, cash flow, and proved oil and gas reserves are
currently accounted for by a single well at South Timbalier Block 76. This well
was shut-in for repairs for one month in 1997 and for over two months during
1996 as the result of mechanical failures. A significant curtailment or loss of
production for a prolonged period before we could replace the reserves would
have a material adverse effect on our projected operating results and financial
condition.
OUR NEED FOR WORKING CAPITAL MAY AFFECT OUR LEVEL OF PARTICIPATION IN
VARIOUS PROJECTS. Investment in oil and gas exploration requires the commitment
of substantial amounts of capital over significant periods of time. We may not
have sufficient liquid capital resources to participate at our existing working
interest level if the operators of any of our properties accelerate the drilling
and development schedule or if we incur unexpected significant expenditures or
reduced production. If we do not participate in the capital expenditures for any
project, our interest in that project will be substantially reduced or lost
entirely.
FORTUNE IS DEPENDENT ON OPERATORS, CONSULTANTS AND PARTNERS OVER WHOM IT
HAS LITTLE CONTROL. Since we do not operate our projects, we are dependent on
other oil and gas companies to conduct operations in a prudent, competent, and
timely manner.
14
<PAGE>
ACCOUNTING METHOD MAY RESULT IN ADDITIONAL WRITE-DOWNS OF OIL AND GAS
PROPERTY COSTS. We report our operations using the full-cost method of
accounting for oil and gas properties. Under these rules, the net capitalized
costs of properties may not exceed a "ceiling" limit of the tax-effected,
discounted present value of estimated future net revenues from proved reserves,
plus the lower of cost or fair market value of unproved properties. The risk
that we will be required to write down the carrying value of our properties
increases when oil and gas prices are depressed or unusually volatile or when
previously unevaluated properties are determined to be worth less than their
cost. Fortune has recognized significant impairments in past periods. As a
result of continued fluctuating oil and gas prices, it is likely that we will
incur further impairments in future periods.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DISCLOSURE ABOUT MARKET RISK
Fortune is exposed to market risk, including adverse changes in oil and
gas prices and interest rates as discussed below. Fortune does not currently use
derivative financial instruments to mitigate fluctuations in oil and gas prices
or interest rates.
OIL AND GAS PRICE RISK. Fortune's oil and gas revenues can be
significantly affected as oil and gas prices fluctuate widely in response to
changing market forces. These fluctuations can be reduced through the proper use
of oil and gas price hedging tools. We currently do not use oil and gas price
hedges because we do not believe that Fortune has sufficient production volumes
to offset the risks inherent in their use. Consequently, our oil and gas
revenues will continue to fluctuate as prices fluctuate.
INTEREST RATE RISK. Fortune's exposure to changes in interest rates
primarily results from its short-term and long-term debt with both fixed and
floating interest rates.
Fortune's debt structure is comprised of:
Stated Balance
Interest Rate September 30, 1999 Matures
------------- ------------------ -------
12% Fixed $3,225,000 2007
Variable at banks
Base rate + 1 1/4% or
LIBOR + 4% $10,000 2000
Changes in interest rates will not currently have a significant impact on
Fortune's interest expense.
15
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
See note 4 of the footnotes to the financial statements in Part I herein
for a description of legal proceedings.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
Exhibit No. Description
----------- -----------
27.1* Financial Data Schedule.
(B) REPORTS ON FORM 8-K / 8K-A
A report on Form 8-K was filed with the Securities and Exchange Commission
on September 15, 1999 to report Fortune's press releases announcing farmout of
first deep prospect at Espiritu Santo Bay.
A report on Form 8-K was filed with the Securities and Exchange Commission
on November 2, 1999 to report Fortune's press release of its third quarter 1999
financial results.
*Filed herewith.
16
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FORTUNE NATURAL RESOURCES CORPORATION
By: /s/ TYRONE J. FAIRBANKS
---------------------------------
Tyrone J. Fairbanks
President and Chief Executive Officer
By: /s/ J. MICHAEL URBAN
---------------------------------
J. Michael Urban
Vice President and Chief Financial
and Accounting Officer
Date: November 2, 1999
17
<PAGE>
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