SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
[ ] 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.
16,684,892 as of July 31, 2002
Transition small business disclosure format (check one) Yes ____ No X
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements
FORTUNE NATURAL RESOURCES CORPORATION
BALANCE SHEETS
ASSETS
June 30, December 31,
2002 2001
----------- -----------
(Unaudited) (Audited)
CURRENT ASSETS:
Cash and cash equivalents........................ $ 115,000 $ 507,000
Restricted joint venture cash account............ 51,000 -
Accounts receivable.............................. 152,000 173,000
Prepaid expenses................................. 73,000 66,000
----------- -----------
Total Current Assets.......................... 391,000 746,000
----------- -----------
PROPERTY AND EQUIPMENT:
Oil and gas properties, accounted for
using the full cost method..................... 29,042,000 28,546,000
Office and other................................. 82,000 396,000
----------- -----------
29,124,000 28,942,000
Less--accumulated depletion, depreciation
and amortization............................. (25,157,000) (25,261,000)
----------- -----------
3,967,000 3,681,000
----------- -----------
Deferred stock offering and debt financing costs 69,000 -
----------- -----------
TOTAL ASSETS........................................ $ 4,427,000 $ 4,427,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
June 30, December 31,
2002 2001
----------- -----------
(Unaudited) (Audited)
CURRENT LIABILITIES:
Accounts payable................................. $ 89,000 $ 134,000
Accrued expenses................................. 144,000 94,000
Royalties and working interests payable.......... 50,000 52,000
Accrued interest................................. 134,000 69,000
Bridge loans payable............................. 460,000 -
----------- -----------
Total Current Liabilities..................... 877,000 349,000
----------- -----------
LONG-TERM DEBT...................................... 2,295,000 2,295,000
----------- -----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $1.00 par value:
Authorized--2,000,000 shares
Issued and outstanding--26,000 shares of
Series A at liquidation preference.......... 260,000 -
Common stock, $.01 par value:
Authorized--40,000,000 shares
Issued and outstanding 16,639,060 and
16,485,474 at June 30, 2002 and
December 31, 2001 .......................... 166,000 165,000
Capital in excess of par value................... 32,184,000 32,171,000
Accumulated deficit.............................. (31,355,000) (30,553,000)
----------- -----------
NET STOCKHOLDERS' EQUITY............................ 1,255,000 1,783,000
----------- -----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY.......... $ 4,427,000 $ 4,427,000
=========== ===========
See accompanying notes to financial statements.
2
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
For the Six Months Ended
June 30, June 30,
2002 2001
----------- -----------
(Unaudited)
REVENUES
Sales of oil and gas, net of royalties........... $ 465,000 $ 1,315,000
Other income..................................... 30,000 25,000
----------- -----------
495,000 1,340,000
----------- -----------
COSTS AND EXPENSE
Production and operating......................... 224,000 323,000
Provision for depletion, depreciation
and amortization............................... 212,000 309,000
General and administrative....................... 596,000 673,000
Stock option variable accounting charge.......... 82,000 -
Interest......................................... 180,000 139,000
----------- -----------
1,294,000 1,444,000
----------- -----------
NET LOSS............................................ (799,000) (104,000)
Dividends - Series A Preferred Stock................ (3,000) -
----------- -----------
NET LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS........ $ (802,000) $ (104,000)
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING.......... 16,612,274 16,454,226
=========== ===========
NET LOSS PER COMMON SHARE (BASIC AND DILUTED)...... $ (0.05) $ (0.01)
=========== ===========
See accompanying notes to financial statements.
3
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF OPERATIONS
For the Three Months Ended
June 30, June 30,
2002 2001
----------- -----------
(Unaudited)
REVENUES
Sales of oil and gas, net of royalties........... $ 260,000 $ 471,000
Other income..................................... 1,000 11,000
----------- -----------
261,000 482,000
----------- -----------
COSTS AND EXPENSES
Production and operating......................... 105,000 155,000
Provision for depletion, depreciation
and amortization............................... 112,000 142,000
General and administrative....................... 292,000 315,000
Stock option variable accounting income.......... (268,000) -
Interest......................................... 99,000 69,000
----------- -----------
340,000 681,000
----------- -----------
NET LOSS............................................ (79,000) (199,000)
Dividends - Series A preferred stock................ (3,000) -
----------- -----------
NET LOSS TO COMMON STOCKHOLDERS..................... $ (82,000) $ (199,000)
=========== ===========
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING.......... 16,636,254 16,462,579
=========== ===========
NET LOSS PER COMMON SHARE
(BASIC AND DILUTED).............................. $ (0.00) $ (0.01)
=========== ===========
See accompanying notes to financial statements.
4
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2002
Preferred Stock Common Stock Capital in Stock-
------------------- -------------------- Excess of Accumulated holders'
Shares Amount Shares Amount Par Value Deficit Equity
-------- --------- ---------- -------- ----------- ------------ ----------
BALANCE, December 31, 2001......... - $ - 16,485,474 $165,000 $32,171,000 $(30,553,000) $1,783,000
Common stock contributed to
401(k) Plan...................... - - 51,462 - 20,000 - 20,000
Common stock issued for
directors' fees.................. - - 92,154 1,000 21,000 - 22,000
Common stock issued for
employee compensation............ - - 10,000 - 2,000 - 2,000
Common stock returned to treasury.. - - (30) - - - -
Common stock warrants issued
for professional services........ - - - - 14,000 - 14,000
Stock option variable
accounting charge................ - - - - 82,000 - 82,000
Series A preferred stock issued for
stock offering................... 26,000 260,000 - - (133,000) - 127,000
Deferral of interest on 12%
Convertible Subordinated Notes... - - - - 7,000 - 7,000
Dividends - Series A preferred
stock............................ - - - - - (3,000) (3,000)
Net loss........................... - - - - - (799,000) (799,000)
-------- --------- ---------- -------- ----------- ------------ ----------
BALANCE, June 30, 2002
(unaudited)..................... 26,000 $ 260,000 16,639,060 $166,000 $32,184,000 $(31,355,000) $1,255,000
======== ========= ========== ======== =========== ============ ==========
See accompanying notes to financial statements.
5
FORTUNE NATURAL RESOURCES CORPORATION
STATEMENTS OF CASH FLOWS
For the Six Months Ended
------------------------
June 30, June 30,
2002 2001
----------- -----------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss to common shareholders............................ $ (802,000) $ (104,000)
Adjustments to reconcile net loss to net
cash (used in) provided by operating activities:
Depletion, depreciation and amortization................ 212,000 309,000
Stock option variable accounting charge................. 82,000 -
Common stock issued for employee compensation........... 2,000 -
Common stock warrants issued for professional services.. 14,000 -
Common stock issued for directors' fees................. 22,000 -
Common stock issued for 401(k) Plan contribution........ - 24,000
Amortization of financing costs......................... 26,000 -
----------- -----------
Cash flow before changes in operating
assets and liabilities.............................. (444,000) 229,000
Changes in operating assets and liabilities:
Accounts receivable..................................... 21,000 279,000
Prepaids................................................ (7,000) 40,000
Accounts payable and accrued expenses................... 26,000 (7,000)
Royalties and working interests payable................. (2,000) (4,000)
Accrued interest........................................ 65,000 -
----------- -----------
Net cash (used in) provided by operating activities....... (341,000) 537,000
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Funding of restricted joint venture cash account, net..... (51,000) -
Expenditures for oil and gas properties................... (496,000) (440,000)
Expenditures for other property and equipment............. (3,000) (3,000)
----------- -----------
Net cash used in investing activities..................... (550,000) (443,000)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from bridge financing............................ 700,000 -
Repayment of long-term debt............................... - (10,000)
Redemption of Series B preferred stock bridge financing... (240,000) -
Gross proceeds from preferred stock Series A offering..... 260,000 -
Expenditure for Series A and C preferred
stock offering costs.................................... (197,000) -
Bridge financing offering costs........................... (24,000) -
----------- -----------
Net cash provided by (used in) financing activities....... 499,000 (10,000)
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS......... (392,000) 84,000
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD............... 507,000 1,028,000
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD..................... $ 115,000 $ 1,112,000
=========== ===========
Supplemental information:
Interest paid in cash..................................... $ 89,000 $ 139,000
Non-cash transactions
Common stock issued for 401(k) Plan contribution.......... 20,000 -
See accompanying notes to financial statements.
6
FORTUNE NATURAL RESOURCES CORPORATION
NOTES TO FINANCIAL STATEMENTS
June 30, 2002
(1) Line of Business and Summary of Significant Accounting
Policies and Procedures
The condensed financial statements at June 30, 2002, 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 accounting
principles generally accepted in the United States of America 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-KSB. 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) Liquidity
The accompanying financial statements have been prepared on a going
concern basis, which contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The financial statements do not
include any adjustments relating to the recoverability and classification of
liabilities that might be necessary should Fortune be unable to continue as a
going concern.
Fortune incurred a loss during the first six months of 2002 and has
incurred substantial losses in earlier years resulting in an accumulated deficit
at June 30, 2002 of approximately $31 million. Fortune incurred negative cash
flow before changes in operating assets and liabilities of $444,000 and $325,000
during the first six months of 2002 and the year ended December 31, 2001.
Fortune also reported a working capital deficit at June 30, 2002 of $486,000.
This deficit includes $125,000 and $335,000 of bridge financing loans that are
due August 19, 2002 and October 2, 2002, respectively. Furthermore, Fortune
expects to report negative cash flow and a net loss during the third quarter of
2002. Fortune believes that this negative cash flow and earnings trend may
continue and could cause the company to be unable to service its obligations
when they become due. To improve its viability as a going concern, Fortune has
recently taken the following steps:
o Acquired a working interest in a new exploration program in an effort to
increase the quality of the drilling projects available to Fortune and the
opportunity to have greater control over the exploration process by
serving as operator on 50% of the prospects delineated in the program;
o Hired a new President and Chief Operating Officer in an effort to enhance
the quality of the technical review applied to Fortune's drilling projects
and to better manage oil and gas operations;
o Reduced overhead expenses by reducing staff and cutting
other expenditures;
o Obtained the short-term bridge financing discussed herein to
finance the initial expenditures of its new exploration
program;
7
o Began private placement offerings to fund its operations and repay the
bridge financing. On May 15, 2002, Fortune closed the first such
offering; and
o Reached agreements with most of Fortune's subordinated noteholders to
defer their first quarter and second quarter 2002 interest payments for 12
months and 3 months, respectively.
In July and August 2002, bridge lenders holding an aggregate of $335,000
in loans agreed to extend the due date from August 19, 2002 until October 2,
2002. As of August 14, 2002, Fortune's cash balance of $22,000 is not sufficient
to repay the one remaining lender in the amount of $125,000 that is due August
19, 2002. Fortune is still in discussions with the lender who did not extend the
due date of its note to attempt to get an extension beyond August 19. Fortune is
also in discussions with other parties to raise other funds to repay the bridge
lender if it does not agree to an extension. If an extension is not granted or
other funds are not raised for repayment, the bridge lender may begin
foreclosure proceedings on the Cadiz Field, the collateral for its loan. If
foreclosure proceedings commence, Fortune may attempt to sell the property on
its own and repay the loan. The Cadiz Field represented 26% and 8% of Fortune's
discounted present value of future net revenues from total proved developed
producing reserves and total proved reserves, respectively, as of December 31,
2001. The field also accounted for $22,000 (14%) of Fortune's revenues net of
operating costs during the second quarter of 2002.
There is no assurance that Fortune will be successful in its efforts to
maintain its viability as a going concern. If Fortune is successful raising
sufficient capital or if the initial drilling in the new exploration program is
sufficiently successful, Fortune believes that it will have the capital to fund
its operations during the short term. However, drilling success, improved
commodity prices and/or additional financings will be necessary to fund
long-term growth.
(3) Series B Preferred Stock and Bridge Loans Payable
In February 2002, Fortune acquired a 25% working interest in an onshore
oil and gas exploration program. To finance its initial participation in this
program, Fortune obtained short-term bridge financing in February 2002 of
$500,000. This bridge financing consisted of $240,000 in Series B Preferred
Stock and loans of $260,000. On May 14, 002, Fortune obtained $200,000 of
additional short-term bridge financing from Barry Blank, a principal shareholder
of Fortune, in the form of a loan with generally the same terms as the earlier
bridge loans. Mr. Blank is not entitled to receive any of the bridge financing
warrants that are discussed below for this $200,000 portion of the bridge. This
latest bridge loan was used, along with Fortune cash, to redeem the $240,000 in
Series B Preferred Stock. The $260,000 loans are secured by Fortune's Cadiz
property and the $200,000 of new bridge indebtedness is secured by the balance
of Fortune's producing properties.
The $240,000 in Series B Preferred Stock was issued to Renaissance Capital
Growth & Income Fund and Renaissance US Growth & Income Trust, PLC, which are
principal shareholders of Fortune. The Series B Preferred Stock had a 10%
quarterly dividend. On May 20, 2002, Fortune completed the redemption of the
Series B Preferred Stock.
The $460,000 of loans have been provided by members of Fortune's board of
directors (Mssrs. Fairbanks, Drulias and Lacoff), by Mr. Blank, by C. K. Cooper
& Company, Inc., the managing dealer in Fortune's Series A preferred stock
private placement offering discussed below, and certain other third parties. The
loans bear interest at the rate of 10% per annum. Interest is payable quarterly
commencing April 1, 2002.
Fortune has also agreed to pay the holders of the initial bridge
financing, three-year Fortune common stock purchase warrants. In July and August
2002, all but one of the bridge lenders agreed to extend the due date of
$335,000 of the bridge loans from August 19, 2002 until October 2, 2002. In
exchange for the extension, Fortune agreed to grant the lenders a total of
13,500 additional warrants and reduce their warrant exercise price by
approximately $0.018 per share if the loans are redeemed after August 18, 2002.
Fortune estimated the value of the consideration it gave the lenders for this
extension to be immaterial based upon the small number of incremental warrants
and the minimal reduction in exercise price that may be earned by the lenders.
The number of warrants issuable and the exercise price will be determined by the
date on which the financing is redeemable according to the following schedule:
8
Number of warrants to be issued Exercise price as
Redemption expressed as percentage of dollar percentage of market
date of financing value of amount due hereunder price of common stock
- -------------------------- --------------------------------- ---------------------
Prior to 5/6/02 20% 150%
From 5/6/02 to 6/5/02 30% 140%
From 6/6/02 to 7/10/02 40% 130%
From 7/11/02 to 8/9/02 50% 120%
From 8/10/02 to 8/18/02 60% 110%
After 8/18/02, if extended 70% 100%
The market price of Fortune's common stock used to make the foregoing
calculation is calculated based upon Fortune's average closing price prior to
the date the bridge financing was obtained. In connection with redeeming their
stock, the Series B Preferred Stockholders received 72,000 warrants exercisable
at approximately $0.25 per share.
(4) Joint Venture Cash Account
In connection with the new onshore exploration program, the co-operators
of the program, Fortune and PrimeEnergy Management Corporation, each deposited
$287,500 into a joint venture bank account styled the PrimeFortune Onshore
Exploration Account. The bank account funds are being used to fund the initial
program expenditures. Both PrimeEnergy and Fortune have signature authority over
the bank account and each owns one-half of the funds in the account. Fortune has
recorded its 50% share of the bank account on its books as well as its share of
all expenditures incurred in the account.
(5) Long-Term Debt
At June 30, 2002, a summary of long-term debt is as follows:
June 30, December 31,
2002 2001
------------ ------------
Convertible Subordinated Notes
due December 31, 2007................ $ 2,295,000 $ 2,295,000
Less current installments............. - -
------------ ------------
Long-term debt, excluding
current installments................. $ 2,295,000 $ 2,295,000
============ ============
Fortune's subordinated notes are convertible by the holders into common
stock at from $0.65 to $0.75 per share or redeemable by Fortune at par. The
notes are unsecured and can be subordinated to any secured debt. The notes bear
interest at a rate of 12% per year, payable quarterly. The cost incurred to
issue the original notes has been amortized as additional interest expense over
the 18-month period ended May 1, 1999, the first date that the notes were
convertible. As a result of this amortization of issuance costs, the effective
interest rate of the notes over this 18-month period was 21.2%. If any notes are
held to maturity, the effective interest rate to maturity on those notes will be
13.4%.
9
In March 2002, Fortune offered to extend until March 31, 2003 the
expiration date of the Fortune common stock purchase warrants owned by holders
of Fortune's 12% notes in exchange for the noteholders consent to defer for one
year their interest payment that was due April 1, 2002. Included among these
holders are Barry Blank, a principal shareholder of Fortune, who owns 666,667
such warrants, and John McConnaughy, a member of Fortune's board of directors,
who owns 333,333 such warrants. Also, 66,667 of such warrants are owned by the
wife of another member of Fortune's board of directors. Eighteen of 22 note
holders representing $56,850 of the $68,850 interest payment due April 1, 2002
agreed to the extension. In April 2002, Fortune paid the interest due to the
note holders who declined this offer.
In June 2002, Fortune requested an extension until October 1, 2002 of the
interest payment due July 1, 2002 in exchange for an additional one year
extension of the expiration date of the noteholder warrants and a reduction in
the conversion price of the notes from $0.75 per share to $0.65 per share.
Eighteen of 22 note holders representing $56,850 of the $68,850 interest payment
due July 1, 2002 agreed to the extension. In July 2002, Fortune paid the
interest due to the note holders who declined this offer.
Fortune estimated the value of each extension to be approximately $7,000.
These amounts were estimated by Fortune based upon the amount of the interest
payments that have been extended, the extension period and the interest rate on
the notes. These amounts will be amortized as additional interest expense over
the extension periods.
Fortune's credit facility with Credit Lyonnais New York Branch expired
January 11, 2001. The $10,000 outstanding balance of this credit facility was
repaid in the first quarter of 2001. The interest rate on the facility was 1.25%
above Credit Lyonnais' base rate.
(6) Private Placement
On May 15, 2002, Fortune closed on the sale of 26,000 Units of a private
placement offering and received $201,600, net of underwriter's commission and
certain underwriter's accountable offering expenses. Each Unit was priced at $10
each and consisted of one share of Fortune Series A Convertible Participating
Preferred Stock and one three-year common stock purchase warrant. The preferred
shares have a liquidity preference of $10.00 per share. Each warrant converts
into one share of Fortune common stock at an exercise price of $0.90 per share.
Fortune incurred $74,704 of additional costs associated with this offering, all
of which were charged to capital in excess of par value upon closing the
offering.
The preferred shares will pay both a fixed and a contingent cash dividend
quarterly. The fixed dividend is payable at 8% per year. The contingent dividend
will be 0.1875% of Fortune's net oil and gas revenue from the new onshore
exploration program discussed above.
Fortune will be restricted from issuing certain securities while the
preferred shares are outstanding. Each preferred share was originally
convertible into shares of Fortune common stock at $0.45 per common stock share.
In June 2002, the conversion price was reduced to $0.35 per share in exchange
for the preferred stockholders consent to Fortune's contingent issuance of
additional preferred stock on parity with the Series A Preferred stock in a new
private placement.
The Series A preferred stock will convert automatically if Fortune's
common stock price reaches $0.90 per share for a 10-day trading period. Fortune
may redeem the shares for $25 per share of preferred stock. The preferred
shareholders will have certain other rights if Fortune fails to pay the
preferred stock dividends.
The managing dealer of the Series A offering also received 13,888 Fortune
three-year common stock purchase warrants exercisable at $0.90 per share.
10
In June 2002, Fortune began discussions with an underwriter concerning
another private placement offering of securities. Barry Blank, a principal
shareholder of Fortune, is employed by this underwriter and is participating in
marketing the offering. Mr. Blank, through a trust, also loaned Fortune $225,000
of the bridge financing that Fortune plans to repay if this offering closes. Mr.
Feiner, one of Fortune's directors, has served as counsel to Mr. Blank for
approximately 15 years. Mr. Feiner has refrained from voting on all Fortune
board of director matters associated with this offering.
(7) Stock Option Variable Accounting
Since 1995, Fortune's stock option plans have provided that the exercise
price per share of its stock options issued to employees and directors would be
reduced to par value ($0.01 per share) in the event of a change in control of
Fortune that is not approved by its board of directors. This change of control
provision requires Fortune to follow variable accounting for its stock options
while they are outstanding. Under variable accounting, increases in Fortune's
stock price above the option exercise price as of the end of each quarter will
result in an expense equal to the excess of the stock price over the exercise
price multiplied by the number of such options. Subsequent decreases, if any, in
Fortune's stock price will result in a reversal of all or part of this expense.
During the first quarter of 2002, Fortune recorded non-cash expense of $350,000
attributable to variable accounting based upon Fortune's March 28, 2002 common
stock closing price of $0.47 per share. Fortune's June 28, 2002 common stock
closing price of $0.24 per share resulted in a non-cash income of $268,000 for
the second quarter of 2002.
(8) Income Tax Expense
No provision for income taxes was required for the six months ended June
30, 2002 and 2001.
At June 30, 2002, Fortune estimates it had cumulative net operating loss
carryforwards for federal income tax purposes of approximately $25 million, of
which approximately $7 million is subject to restrictions under I.R.C. 382.
These loss carryforwards are available to offset future federal taxable income,
if any. The net operating losses expire from 2002 through 2021. Fortune is
uncertain as to the recoverability of the above deferred tax assets and has
therefore applied a 100% valuation allowance.
(9) 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.
(10) Computation of Loss Per Share
Basic net loss per common share is computed by dividing net loss to common
stockholders by the weighted average number of common shares outstanding.
Diluted loss per common share does not differ from basic loss per common share
because the issuance or conversion of additional securities would have an
antidilutive effect.
(11) New Accounting Pronouncements
The Financial Accounting Standards Board ("FASB") has recently issued
Statement of Financial Accounting Standards ("SFAS") No. 141, `Business
Combinations," SFAS No. 142, "Goodwill and Other Intangible Assets," SFAS No.
143, "Accounting for Asset Retirement Obligations" and SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets."
11
SFAS No. 141, "Business Combinations," requires the use of the purchase
method of accounting for all business combinations initiated after June 30,
2001, SFAS No. 142, "Goodwill and Other Intangible Assets", addresses accounting
for the acquisition of intangible assets and accounting for goodwill and other
intangible assets after they have been initially recognized in the financial
statements. Fortune does not currently have goodwill or other similar intangible
assets; therefore, the adoption of the new standard on January 1, 2002, has not
had a material effect on Fortune's financial statements.
SFAS No. 143, "Accounting for Asset Retirement Obligations," addresses
accounting and reporting for obligations associated with the retirement of
tangible long-lived assets and the associated asset retirement costs. SFAS No.
143 will be effective for Fortune January 1, 2003 and early adoption is
encouraged. SFAS No. 143 requires that the fair value of a liability for an
asset's retirement obligation be recorded in the period in which it is incurred
and the corresponding cost capitalized by increasing the carrying amount of the
related long-lived asset. The liability is accreted to its then present value
each period, and the capitalized cost is depreciated over the useful life of the
related asset. If the liability is settled for an amount other than the recorded
amount, a gain or loss is recognized. Currently, Fortune does accrue for certain
dismantlement costs through depletion and is therefore evaluating the impact the
new standard will have on its financial statements.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets," is effective for Fortune January 1, 2002, and addresses accounting and
reporting for the impairment or disposal of long-lived assets. SFAS No. 144
supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed Of" and APB Opinion No. 30, "Reporting the
Results of Operations-Reporting the Effects of Disposal of a Segment of a
Business." SFAS No. 144 retains the fundamental provisions of SFAS No. 121 and
expands the reporting of discontinued operations to include all components of an
entity with operations that can be distinguished from the rest of the entity and
that will be eliminated from the ongoing operations of the entity in a disposal
transaction. The new standard has not had a material impact on Fortune's
financial statements.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FAS Statement No. 13, and Technical Corrections
("SFAS 145"). This statement rescinds the requirement in SFAS No. 4, Reporting
Gains and Losses from Extinguishment of Debt, that material gains and losses on
the extinguishment of debt be treated as extraordinary items. The statement also
amends SFAS No. 13, Accounting for Leases, to eliminate an inconsistency between
the accounting for sale-leaseback transactions and the accounting for certain
lease modifications that have economic effects that are similar to
sale-leaseback transactions. Finally the standard makes a number of
consequential and other technical corrections to other standards. The provisions
of the statement relating to the rescission of SFAS 4 are effective for fiscal
years beginning after May 15, 2002. Provisions of the statement relating to the
amendment of SFAS 13 are effective for transactions occurring after May 15, 2002
and the other provisions of the statement are effective for financial statements
issued on or after May 15, 2002. Fortune has reviewed SFAS 145 and its adoption
is not expected to have a material effect on its consolidated financial
statements.
In July 2002, the FASB issued SFAS No. 146, Accounting for Exit or
Disposal Activities ("SFAS 146"). SFAS 146 applies to costs associated with an
exit activity (including restructuring) or with a disposal of long-lived assets.
Those activities can include eliminating or reducing product lines, terminating
employees and contracts, and relocating plant facilities or personnel. SFAS 146
will require a Company to disclose information about its exit and disposal
activities, the related costs, and changes in those costs in the notes to the
interim and annual financial statements that include the period in which an exit
activity is initiated and in any subsequent period until the activity is
completed. SFAS 146 is effective prospectively for exit or disposal activities
initiated after December 31, 2002, with earlier adoption encouraged. SFAS 146
supersedes Emerging Issues Task Force Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring), and requires liabilities
associated with exit and disposal activities to be expensed as incurred and can
be measured at fair value. SFAS 146 is effective for exit or disposal activities
that are initiated after December 31, 2002.
12
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
Recent Events
In February 2002 Fortune acquired a 25% working interest and a
co-operating position along with PrimeEnergy Management Corporation in a
large-scale onshore oil and gas exploration and development program in Texas.
The centerpiece of this program is a large onshore Texas 2D seismic database
comprising approximately 50,000 linear miles in approximately 105 counties of
the Texas Gulf Coast, East Texas, and South Texas. Fortune and Prime will be in
charge of leasing, drilling, and producing each prospect in the program. Fortune
anticipates that its share of this initial operating phase may require up to
$3,000,000 of capital spending during the first year of the program, after which
Fortune believes the program will be self-funding, based on reasonable success
levels. Fortune believes at least 250 prospect leads may be identified from the
reprocessed data that should in turn generate a minimum of 50 drillable
prospects over the next few years. Drilling commenced on the first prospect
generated under this program on August 7, 2002 and additional prospect wells are
expected to commence thereafter.
Financing Arrangements
In order to finance its initial participation in this program, Fortune
obtained $500,000 in short-term bridge financing in February 2002 through a
combination of $260,000 of loans and $240,000 of Series B preferred stock from
various investors including members of Fortune's board of directors, current
shareholders, C. K. Cooper & Company, Inc., Fortune's managing dealer in the
Series A preferred stock offering discussed below, and other unaffiliated
investors. In May 2002, the preferred stock portion of the financing was
redeemed primarily with $200,000 received by Fortune from an additional bridge
loan. As of June 30, 2002, the bridge loans outstanding amount to $460,000. The
interest rate on the loans is 10% per annum, payable quarterly. The dividend on
the retired Series B preferred stock was also 10% per annum. The loans include
$125,000 due August 19, 2002 and $335,000 due October 2, 2002.
Fortune currently does not have sufficient cash to repay the $125,000
bridge loan that is due August 19, 2002. Fortune is attempting to negotiate an
extension of this loan or raise other funds to repay it. See "Risks Associated
with Fortune - Liquidity Constraints" below for further discussion of this. Any
of the bridge loans may be prepaid at any time without penalty. As additional
consideration for providing the financing, the investors in the initial $500,000
of bridge financing receive warrants to purchase shares of common stock at an
amount and premium to current share price which depends on when the financing is
repaid.
Private Placement Offerings
To fund our continued participation in the new onshore exploration
program, Fortune closed a private placement offering on May 15, 2002 for the
sale of 26,000 Units. The Units were priced at $10 each. Each Unit consists of
one share of Fortune Series A Convertible Participating Preferred Stock and one
three-year common stock purchase warrant. Each warrant is exercisable into one
share of Fortune common stock at a price of $0.90 per share. Upon closing,
Fortune received $201,600, net of underwriter's commissions and certain
underwriter's accountable offering expenses. Fortune incurred additional
expenses of $74,704 in connection with this offering.
In June 2002, Fortune began discussions with an underwriter concerning
another private placement offering of securities.
13
Results of Operations
Comparison of 2002 Operating Results to 2001
Quarter ended June 30, 2002 and 2001
Fortune's net loss to common stockholders decreased 59% to $82,000 for the
second quarter of 2002 from $199,000 for the second quarter of 2001 because the
$268,000 of income from variable accounting for stock option plans and lower
expenses in most categories more than offset lower revenues.
Fortune's oil and gas prices decreased 8% and 32%, respectively, in the
second quarter 2002 versus the same 2001 period. Fortune's oil and gas
production also decreased 6% and 23%, respectively. Fortune's production gains
that resulted from successful drilling and workover operations over the past
year at Cadiz, La Rosa and Gamble Gully were not sufficient to offset the loss
of our well at the Cutoff Field and declines from depletion. Consequently,
Fortune's oil and gas revenues for the quarter ended June 30, 2002 decreased 45%
to $260,000 compared to $471,000 reported during the second quarter of 2001.
Analysis of change in oil and gas revenues -
Quarter Ended
June 30,
------------------ Percent
2002 2001 Change
-------- -------- --------
Production
Oil - Bbl 1,700 1,800 (6)%
Gas - Mcf 66,500 86,600 (23)%
Prices
Oil - $/Bbl $23.59 $25.63 (8)%
Gas - $/Mcf 3.32 4.91 (32)%
Revenues
Oil $ 40,000 $ 46,000 (14)%
Gas 220,000 425,000 (48)%
The La Rosa C-12 well was spud on December 11, 2001 and logged on January
13, 2002 as a discovery. Log evaluation indicates that the well has
approximately 20 feet of aggregate pay sand in multiple zones. The well was
completed on February 18, 2002 and commenced production at approximately 40 to
50 barrels of oil per day and 30,000 cubic feet of gas per day. Fortune owns an
18.75% working interest in the well and incurred approximately $31,000 for its
share of drilling and completion costs.
The La Rosa C-8 well was spud on May 29, 2002 and logged on June 3, 2002
as a new discovery. Log evaluation indicates that the well has an aggregate 22
feet of pay sand in two pay zones. The well is currently producing approximately
400,000 cubic feet of gas per day on a 7/64th choke. Fortune owns a 10% working
interest in the well; its share of the drilling and completion cost was
approximately $27,000.
Analysis of change in selected expenses -
Quarter Ended
June 30,
------------------ Percent
2002 2001 Change
-------- -------- --------
Production and operating expense $105,000 $155,000 (32)%
- per MCFE 1.37 1.59 (14)%
Depreciation, depletion
and amortization 112,000 142,000 (21)%
- per MCFE 1.46 1.46 -
14
Production and operating expense decreased by $50,000 for the second
quarter of 2002 versus 2001 primarily because of lower production taxes that
resulted from the lower revenues during 2002
Fortune's provision for depletion, depreciation and amortization (DD&A)
decreased by $30,000 in the second quarter of 2002 as compared to 2001 because
of the lower production and the impact of ceiling impairment writedowns in prior
quarters.
Quarter Ended
June 30,
-------------------- Percent
2002 2001 Change
--------- --------- ---------
General and administrative expense $ 292,000 $ 315,000 (7)%
Interest expense 81,000 69,000 17 %
Interest expense - amortization
of financing costs 18,000 - N/A
General and administrative expense decreased $23,000 for the second
quarter of 2002 versus 2001 primarily because of lower personnel costs as a
result of staff reductions. General and administrative expenses in 2002 includes
a $35,000 consulting fee paid to C. K. Cooper & Company to provide strategies
and financial planning services to Fortune. We implemented a plan to reduce core
general and administrative expenses in 2002 in the event that we are not
successful in the private placement offering discussed above. Certain reductions
took effect at January 1, 2002 and other reductions have been made or are
anticipated over the course of the year, if needed.
Total interest expense increased by $30,000 as a result of the bridge
financing discussed in Recent Events above. Amortization of finance costs
include the cost associated with the bridge financing and the imputed cost of
deferring the interest on the 12% subordinated convertible notes.
As of March 31, 2002, Fortune's stock price closed at $0.47 per share,
resulting in certain of our employee stock options being "in-the-money" in the
amount of $350,000. Fortune expensed this amount during the first quarter of
2002 in accordance with the requirement of variable accounting for stock option
plans. As of June 30, 2002, Fortune's stock price closed at $0.24 per share,
resulting in a reversal of $268,000 of the expense that had been recorded in the
first quarter of 2002. The "reversal" was recorded as $268,000 in income from
stock option variable accounting during the second quarter of 2002. There were
no corresponding charges or credits during the corresponding periods of 2001.
Six months ended June 30, 2002 and 2001
Reductions in expenses in most categories were insufficient to offset the
decrease in revenues in 2002. Consequently, Fortune's net loss to common
stockholders increased 671% to $802,000 for the first six months of 2002 versus
$104,000 for the same 2001 period.
Fortune's oil and gas prices decreased 21% and 54%, respectively, during
the first six months of 2002 versus the same 2001 period. Fortune's oil and gas
production also decreased 7% and 30%, respectively. Fortune's production gains
that resulted from successful drilling and workover operations over the past
year at Cadiz, La Rosa and Gamble Gully were not sufficient to offset the loss
of our wells at South Timbalier Block 86 and Cutoff Field and declines from
depletion. Consequently, Fortune's oil and gas revenues for the first six months
of 2002 decreased 65% to $465,000 compared to $1,315,000 reported during the
same period of 2001.
15
Analysis of change in oil and gas revenues -
Six Months Ended
June 30,
-------------------- Percent
2002 2001 Change
--------- --------- ---------
Production
Oil - Bbl 3,800 4,100 (7) %
Gas - Mcf 133,400 190,800 (30) %
Prices
Oil - $/Bbl $21.28 $26.80 (21) %
Gas - $/Mcf 2.89 6.32 (54) %
Revenues
Oil $ 80,000 $109,000 (26) %
Gas 385,000 1,206,000 (68) %
In early 2000, the South Timbalier 86 well was recompleted and began
producing at a significantly higher rate beginning in February 2000. During the
first quarter of 2001, the well produced approximately 13,900,000 cubic feet of
gas, 31 barrels of oil and generated $121,000 of oil and gas revenue net to
Fortune's interest. This well stopped producing on March 13, 2001; although it
produced approximately 2 million cubic feet of gas per day for a brief period
during August 2001. The operator has informed Fortune that they have no further
plans to attempt to restore production. Fortune currently owns a 4% overriding
royalty interest in this well.
The La Rosa C-12 well was completed on February 18, 2002 and commenced
production at approximately 40 to 50 barrels of oil per day and 30,000 cubic
feet of gas per day.
Analysis of change in selected expenses -
Six Months Ended
June 30,
---------------------- Percent
2002 2001 Change
---------- ---------- -----------
Production and operating expense $ 224,000 $ 323,000 (31)%
- per MCFE 1.44 1.50 (4)%
Depreciation, depletion and
amortization 212,000 309,000 (31)%
- per MCFE 1.36 1.44 (5)%
Production and operating expense decreased by $99,000 for the first six
months of 2002 versus 2001 primarily because of lower production taxes that
resulted from the lower revenues during 2002
Fortune's provision for DD&A decreased by $97,000 in the first six months
of 2002 as compared to 2001 because of the lower production and the impact of
ceiling impairment writedowns in prior quarters. The lower DD&A rate per MCFE
results from the prior ceiling impairment writedowns.
Six Months Ended
June 30,
---------------------- Percent
2002 2001 Change
---------- ---------- ----------
General and administrative expense $ 596,000 $ 673,000 (11)%
Interest expense 156,000 139,000 12 %
Interest expense - amortization
of financing cost 24,000 - N/A
16
General and administrative expense decreased $77,000 for the first six
months of 2002 versus 2001 primarily because of lower personnel costs as a
result of staff reductions. General and administrative expenses in 2002 includes
a $35,000 consulting fee paid to C. K. Cooper & Company to provide strategies
and financial planning services to Fortune. We have implemented a plan to reduce
core general and administrative expenses in 2002 in the event that we are not
successful in the private placement offering discussed above. Certain reductions
took effect at January 1, 2002 and other reductions have been made or are
anticipated over the course of the year, if needed.
Total interest expense increased by $41,000 as a result of the bridge
financing discussed in Recent Events above.
Liquidity and Capital Resources
Cash Balance, Working Capital and Cash Flows from Operating Activities
Fortune reported negative cash flow of $341,000 from its operating
activities during the first six months of 2002 compared to positive cash flow of
$537,000 during the same 2001 period. Before considering the effect of changes
in operating assets and liabilities, cash flow was a negative $444,000 during
the first six months of 2002 compared to a positive $229,000 during the same
2001 period. As discussed above, lower production and lower oil and gas prices
account for this significant decrease in cash flow. Fortune is attempting to
reverse this negative trend in cash flow by seeking to invest its capital
resources in successful exploration and development projects.
Analysis of changes in selected liquidity measures -
As of
--------------------------
June 30, December 31, Percent
2002 2001 Change
------------ ------------ ------------
Cash balance $ 115,000 $ 507,000 (77)%
Restricted joint venture cash 51,000 - N/A
Net working capital (486,000) 397,000 N/A
Long-term debt 2,295,000 2,295,000 -
Fortune's working capital deficit at June 30, 2002 includes $125,000 of
bridge financing due August 19, 2002 and $335,000 due October 2, 2002. See
"Risks associated with Fortune - Liquidity Constraints" below.
In February 2002, Fortune and PrimeEnergy, the co-operators of the new
onshore exploration program, each deposited $287,500 into a joint venture cash
account. These funds are being used to fund the initial program expenditures.
Three months ended
June 30,
-------------------------- Percent
2002 2001 Change
------------ ------------ ------------
Cash flow from operations before
changes in operating assets
and liabilities $ (206,000) $ (57,000) (261)%
Adjustment for change in operating
assets and liabilities 80,000 74,000 8 %
------------ ------------ ------------
Cash flow from operating
activities $ (126,000) $ 17,000 N/A
============ ============
17
Lower production and lower oil and gas prices for the first quarter of
2002 contributed to the lower cash flow during the period versus the same 2001
period.
Six months ended
June 30,
-------------------------- Percent
2002 2001 Change
------------ ------------ ------------
Cash flow from operations before
changes in operating assets
and liabilities $ (444,000) $ 229,000 N/A
Adjustment for change in
operating assets and
liabilities 103,000 308,000 (67)%
------------ ------------ ------------
Cash flow from
operating activities $ (341,000) $ 537,000 N/A
============ ============
Cash Used in Investing Activities - Capital Expenditures
Expenditures for oil and gas properties for the first six months of 2002
were $496,000 compared to $440,000 for the same period in 2001.
The 2002 expenditures include primarily:
- exploration costs attributable to the new onshore exploration program;
- drilling and completing the successful La Rosa C-12 and C-8 wells; and
- drilling the unsuccessful Gamble Gully GU #6 well #1.
The 2001 expenditures include primarily:
- drilling and completing the successful Brooks #3 well at Cadiz
prospect;
- drilling and completing the successful Gamble Gully GU #5 well #1 well;
- land, seismic and well cost for the unsuccessful West Point well;
- the multiple well recompletion program at La Rosa; and
- seismic interpretation costs and delay rentals at Espiritu Santo
Bay and La Rosa.
Oil and Gas Prices
Conditions outside of our control influence the prices we receive for oil
and gas. Currently, Gulf Coast spot prices are approximately $26.60 per barrel
for oil and $2.75 per MCF for gas.
18
Forward Looking Statements
All statements, trend analyses and other information contained in this
10-QSB relating to our production, our reserves, markets for our production and
trends in our results of operations or financial conditions, as well as other
forward-looking statements including those containing words such as "will,"
"should," "could," "may," "anticipate," "believe," "plan," "estimate," "expect,"
"intend," "project," "forecast," and other similar expressions, constitute
forward-looking statements under the Private Securities Litigation Reform Act of
1995. These forward-looking statements involve known and unknown risks and
uncertainties that may cause results and conditions to differ materially from
the forward-looking statements. Some of the risk factors that may affect Fortune
and any forward-looking statements made by us are described below.
Risks Associated with Fortune
Liquidity Constraints. Fortune is currently experiencing negative cash
flow from operations. Fortune is required to make quarterly interest payments in
the amount of $68,850 on its 12% convertible notes. These payments are due each
January 1, April 1, July 1 and October 1 that the notes are outstanding.
Eighteen of 22 note holders who represent $56,850 of the quarterly interest
payment agreed to defer their April 1, 2002 interest payment for one year in
exchange for a one year extension of certain of their common stock purchase
warrants. The same number and interest amount also agreed to defer their July 1,
2002 payment until October 1, 2002 in exchange for an additional warrant
extension and a reduction in their note conversion price. It is possible that
Fortune will not be able to meet subsequent interest payment obligations. If we
fail to pay interest on the $2,295,000 convertible notes, the entire balance
could become due and payable upon written notice from a majority of the
noteholders.
In July and August 2002, bridge lenders holding an aggregate of $335,000
in loans agreed to extend the due date from August 19, 2002 until October 2,
2002. As of August 14, 2002, Fortune's cash balance of $22,000 is not sufficient
to repay the one remaining lender in the amount of $125,000 that is due August
19, 2002. Fortune is still in discussions with the lender who did not extend the
due date of its loan to attempt to get an extension beyond August 19. Fortune is
also in discussions with other parties to raise other funds to repay the bridge
lender if it does not agree to an extension. If an extension is not granted or
other funds are not raised for repayment, the bridge lender may begin
foreclosure proceedings on the Cadiz Field, the collateral for its loan. If
foreclosure proceedings commence, Fortune may attempt to sell the property on
its own and repay the loans. The Cadiz Field represented 26% and 8% of Fortune's
discounted present value of future net revenues from total proved developed
producing reserves and total proved reserves, respectively, as of December 31,
2001. The field also accounted for $22,000 (14%) of Fortune's revenues net of
operating costs during the second quarter of 2002. The remaining bridge loans
are due October 2, 2002. These loans include a $200,000 loan that is secured by
all of Fortune's other producing properties. Failure to repay this loan on its
due date could result in the foreclosure by the lender of Fortune's remaining
properties.
Fortune's viability as a going concern is dependent on raising sufficient
capital to meet our debt obligations and fund our future operations. It is very
difficult for small-cap energy companies to raise additional funds because of
the recent volatility of the oil and gas industry. However, our liquidity
concerns should be mitigated if private placement offerings are achieved. No
assurance can be given that our efforts at raising capital will cure our
liquidity concerns.
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, 2001, Fortune spent approximately $1.7
million in its oil and gas exploration, development and acquisition activities.
Under the new onshore exploration program we expect to fund certain expenditures
19
during the first twelve months of the program estimated to be up to $3 million
to Fortune's working interest. Subsequent expenditures are also expected to be
significant. In addition, from time to time Fortune receives proposals to
participate in development and exploratory wells or other projects on owned as
well as non-owned properties. Fortune expects to be presented with proposals for
development wells and/or exploratory wells at its Espiritu Santo Bay and LaRosa
properties, as well as on prospects generated through the onshore exploration
program. At Fortune's current rate of negative cash flow, we may not be able to
participate in such operations at our current working interest levels.
Our need to raise funds. If no additional funds are raised in Fortune's
current private placement offering, we may not have sufficient capital to
conduct all of our planned activities in the onshore exploration program. Our
current funds may be too small to allow us to maximize the potential return on
our investment and may not permit Fortune to participate at its full working
interest level. This may have an adverse effect on Fortune's expected return
from the program.
Risks associated with the Onshore Exploration Program. Fortune has
acquired a 25% working interest in the onshore exploration program and will be a
co-operator of any properties acquired and prospect drilled through the program.
The other operator, PrimeEnergy Management Corporation, has a right to withdraw
from the program under certain circumstances, including if Fortune fails to
raise at least $3,000,000 of net proceeds for oil and gas exploration. Such a
withdrawal would not affect Fortune's interest in or its right to continue
participation in the program. It would mean, however, that Fortune may be
required to assume Prime's 25% working interest under certain circumstances or
to find other industry partners to undertake Prime's financial responsibilities.
The further processing and reprocessing of the onshore exploration program
seismic data obtained from Exxon is entirely dependent on payments by the
third-party seismic partners. If the seismic partners fail to pay the required
amounts on a quarterly basis, Fortune may lose access to any further seismic
data if other arrangements are not made. Management believes, however, that the
amount of data already reprocessed and the number of prospects already
identified makes the onshore exploration program worthwhile even if such an
event were to occur.
A third party seismic brokerage company has the right to license the
reprocessed data generated in the onshore exploration program to competitors of
Fortune. As a result, we may be competing with others to acquire leases and
conduct exploration activities based on this data. However, we will have first
access to this data and we believe that this should provide us with a
competitive advantage provided we have adequate funds to promptly acquire the
leases.
The seismic database that is the centerpiece of the onshore exploration
program is exclusively 2D seismic data. Exploration prospects identified using
2D seismic data, including their projected oil and gas reserve potential, may
not be as accurately delineated prior to drilling, as can sometimes be attained
by the use of 3D seismic data.
Fortune has substantial debt due in 2007. At June 30, 2002, Fortune had
$2,295,000 of 12% subordinated convertible notes outstanding that are due
December 31, 2007. All of these notes are convertible by the holder at $0.65 to
$0.75 per share or redeemable by Fortune at par. Fortune has realized
significant net losses that have resulted in an accumulated deficit of
approximately $31 million at June 30, 2002. Fortune also realized negative cash
flows in calendar years 1998, 1999, 2001 and year-to-date 2002. Based on these
historical operating results, historical fluctuating oil and gas prices and the
uncertainties of projecting long-term production and cash flows from current oil
and gas prices and reserves, there is risk that Fortune's cash flow will not
increase sufficiently to allow us to repay the convertible subordinated notes or
to make the required quarterly interest payments in cash or at all as they
become due.
20
Fortune has obtained interest deferments for a substantial portion of the
two most recent interest payments. Fortune may request deferment of future
interest payments but there is no assurance that the note holders will agree to
additional deferments. If we do not increase cash flow sufficiently or we
experience increases in capital requirements, and we are unable to raise
capital, we may need to take other steps to maintain our ability to service the
notes. Those steps might include reducing overhead, foregoing our participation
in projects or selling assets. In the event that Fortune defaults in the payment
of interest or principal obligations on this debt, it may become immediately due
and payable.
Fortune's reliance on exploratory projects increases the risks inherent in
the oil and gas industry. We base our decisions to participate in exploration
projects on assumptions and judgments concerning the oil and gas industry, such
as future oil and gas prices, competition for leases, reserves, and equipment,
and our perceived chance of success. These assumptions and judgments may be
speculative and are often subjective. Although we can obtain information with
respect to the potential of oil or gas properties, it is impossible to determine
with certainty the ultimate production potential, if any, of a particular
project. Moreover, the successful completion of an oil or gas well does not
insure a profit on our investment, since completion and production expenses may
exceed the value of the future production. We primarily invest in exploration
projects, where the risks are substantially greater than investing in wells
drilled into already producing formations. Fortune has realized less success
than originally anticipated in 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 in recent years. Fortune has incurred
substantial net losses in prior years. Oil and gas prices remain volatile and
our production has declined; accordingly, it is likely that Fortune will
continue to incur losses.
Our oil and gas reserves 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 currently producing. We are not adding reserves at
present at the pace at which they are being produced. Without adding additional
reserves in the future, our oil and gas reserves and production will decline.
Fortune's estimates of proved reserves and future net revenue may not be
accurate. Fortune's proved reserve data represent estimates which may prove to
be incorrect over time. The accuracy of any reserve estimate is a function of
available data and of engineering and geological interpretation and judgment.
The estimates are based upon certain assumptions about future production levels,
future drilling, future oil and gas prices and future operating costs, some or
all of which will likely change over time. Estimates and classifications of the
economically recoverable oil and gas reserves by different engineers or by the
same engineers at different times may vary substantially. Certain of Fortune's
proved reserves have a short production history and approximately 54% of
Fortune's proved reserves as of December 31, 2001 were undeveloped. Undeveloped
reserves require significant expenditures of capital before production can
commence. Estimates of undeveloped reserves and those with a short production
history are inherently more uncertain than estimates of producing reserves with
a long production history.
Our revenue is dependent upon a limited number of producing wells. During
the second quarter of 2002, Fortune derived approximately 28% of its revenues
from three wells: South Timbalier Block 76, Cadiz Brooks #1 and Cadiz Brooks #3.
A significant curtailment or loss of production from an individually significant
well for a prolonged period before we could replace that well would have a
material adverse effect on our projected operating results and financial
condition.
21
Fortune is dependent on operators, consultants and partners over whom it
has little control. Historically, we have been dependent on other oil and gas
companies to conduct operations in a prudent, competent, and timely manner on
our properties. Although we are actively involved in project evaluations, we
often have little or no control over the manner or timing of such operations. If
the operator is not prudent, we could 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 geological, geophysical, and
engineering evaluation of properties and projects, we rely heavily on outside
consultants for their expertise. Fortune has no long-term agreements with such
consultants, all of whom are available to other oil and gas companies, including
our competitors. In the current environment of volatile oil and gas prices, our
partners may determine that projects which have previously been agreed upon are
no longer economically feasible. If this were to occur, projects could be
delayed or cancelled completely. If, on the other hand, projects are accelerated
because of high oil and gas prices, Fortune may not have the capital resources
to participate. We are seeking to eliminate or significantly reduce this risk by
becoming the operator in the new onshore exploration program and adding Ronald
Nowak as Fortune's President and Chief Operating Officer effective January 1,
2002.
Accounting rules may result in additional write-downs of property values.
We report our operations using the full-cost method of accounting for oil and
gas properties. Under these rules, all exploration and development costs are
capitalized. 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 unevaluated 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 determined to be worth less than that
cost. For example, we recognized $2.2 million of impairments in 2001. As a
result of continued volatile oil and gas prices, we may incur future
impairments.
Stock option plans may result in earnings fluctuations. Fortune follows
the intrinsic value method of accounting for stock option grants. However,
Fortune's stock option plans provide for reducing the stock option exercise
price to par value ($0.01 per share) in the event of a change of control of
Fortune not approved by its board of directors. This change of control provision
requires Fortune to follow variable accounting for its stock options while they
are outstanding. Under variable accounting, increases in Fortune's stock price
above the option exercise price as of the end of each quarter will result in an
expense equal to the excess of the stock price over the exercise price
multiplied by the number of such options. Subsequent decreases in Fortune's
stock price will result in a reversal of all or part of this expense. Variable
accounting for stock options may result in significant fluctuations in Fortune's
quarterly operating results.
There are uninsured risks in our operations which could cause material
losses. The operators of our projects 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.
Our business could be materially and adversely affected if we lose the
services of our two key officers. We depend primarily on the abilities and
continued participation of our two key employees, Tyrone J. Fairbanks, our
Chairman and Chief Executive Officer, and Ronald P. Nowak, our President and
Chief Operating Officer. The loss of either Mr. Fairbanks or Mr. Nowak could
have a material adverse effect on our operations. In an effort to reduce the
risk, we have entered into employment agreements with Messrs. Fairbanks and
Nowak which contain termination provisions upon the occurrence of certain
events. As of the date hereof none of these events have occurred. We also have
obtained $500,000 of key man life insurance on the life of Mr. Fairbanks.
22
Industry Conditions; Fluctuations in the Energy Market. Fortune's revenues
and profitability are substantially dependent upon prevailing prices for oil and
gas. Prices for oil and gas are subject to fluctuations in response to
relatively minor changes in supply of and demand for oil and gas, market
uncertainty and a variety of additional factors that are beyond our control.
These factors include political conditions in the Middle East and elsewhere, the
domestic and foreign supply of oil and gas, the level of consumer demand,
weather conditions, domestic and foreign government regulations, the price and
availability of alternative fuels and overall economic conditions. The excess or
short supply of oil has placed pressures on prices and has resulted in price
fluctuations, which may adversely impact Fortune's cash flow and revenues. The
price of gas has exhibited market demand fluctuations; however, because most of
the gas consumed domestically is produced within the United States, the price
for gas has not exhibited the price fluctuations that oil prices have
experienced under conditions of high import levels. In addition to the issue of
availability and capacity of gas pipelines, various factors, including the
effect of federal and state regulation of production and transportation, general
economic conditions, changes in supply due to drilling by other producers and
changes in demand, may adversely affect Fortune's ability to market its oil and
gas production.
Governmental Regulation. Fortune's business is subject to certain federal,
state and local laws and regulations relating to the exploration for and
development, production, marketing and transmission of oil and gas, as well as
environmental and safety matters. In particular, oil and gas production,
operations and economics are, or have been, affected by price controls, taxes
and other laws relating to the oil and gas industry and by changes in such laws
and regulations. Fortune cannot predict how existing laws and regulation may be
interpreted by enforcement agencies or court rulings, whether additional laws
and regulations will be adopted or the effect such changes may have on its
business or financial condition. There is no assurance that laws and regulations
enacted in the future will not adversely affect Fortune's business.
Environmental Regulation. Fortune is subject to numerous federal, state
and local environmental laws and regulations governing the production, drilling
and exploration of oil and gas, including spillage, noise pollution, air
quality, leakage, and disposal of water, and ecosystem preservation. To date,
expenditures related to complying with these laws and for remediation of
existing environmental contamination have not been material. Nevertheless, the
discharge of oil, gas, or other pollutants in the air, soil or water may give
rise to liabilities on our part to the government and third parties and may
require us to incur costs to remedy the discharge. No assurance can be given
that we will be able to comply with existing, proposed or future governmental
regulations concerning the environment, or that we will not incur additional
capital expenditures in order to comply with such laws and regulations. Any
additional expenditure may adversely affect Fortune's business and may delay or
prevent the commencement or continuance of its operations.
The market for Fortune common stock is limited and trading rules adversely
affect its marketability and liquidity. Because our securities are not traded on
a national securities exchange or quoted on NASDAQ, trading in our common stock
must be effected in compliance with Rule 15g under the Securities Exchange Act
of 1934. Broker-dealers who recommend non-NASDAQ and non-exchange listed
securities to persons other than established customers and accredited investors
must make a special written suitability determination for the purchaser and
receive the purchaser's written agreement to a transaction prior to sale.
Securities are exempt from this rule if the market price is at least $5.00 per
share or other exemptions are available. Fortune's stock price is currently
significantly lower than that. Such other exemptions include an equity security
issued by an issuer that has
o net tangible assets of at least $5 million, if such issuer has been
in continuous operation for less than three years, or
o average revenue of at least $6 million for the proceeding three years.
We do not satisfy either of these criteria. The regulations require the
delivery, prior to any transaction involving a penny stock, of a disclosure
schedule explaining the penny stock market and the risks associated therewith.
The applicability of the penny stock rule to our common stock materially and
adversely affects its market liquidity.
23
The number of shares eligible for future sale could potentially dilute the
price of Fortune stock. At July 31, 2002, 16,684,892 shares of our common stock
were outstanding, of which 3,496,418 shares were "restricted securities" as that
term is defined in Rule 144 under the Securities Act and the remainder are
freely tradeable. At that date, we also had outstanding options and private
warrants to acquire 7,846,368 shares of common stock that, if all were
exercised, would result in proceeds to Fortune of $8,030,982. At July 31, 2002,
we also had $2,295,000 of notes convertible into 3,448,712 shares of common
stock, subject to adjustment. At that date Fortune also had Series A preferred
stock outstanding that was convertible into 742,857 shares of common stock. The
issuance of substantial additional shares or sales of substantial amounts of the
common stock in the public market could adversely affect the market price of
Fortune's common stock.
The number of additional warrants issuable to the lenders on the bridge
financing will range from 156,000 to 169,500. These warrants will entitle the
warrant holders to acquire an equivalent number of common shares.
Additional dilution may result if Fortune is successful raising more
capital to repay its bridge financing and fund its new exploration program.
Additional factors. Additional factors that apply generally to the oil and
gas industry but that could cause actual events to vary from those discussed in
this annual report include: inability to obtain critical supplies, equipment,
personnel and consultants.
24
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
See note 9 of the footnotes to the financial statements in Part I herein
for a description of legal proceedings.
ITEM 2. Change in Securities
On May 15, 2002, Fortune closed on the sale of 26,000 Units of a private
placement offering and received $201,600, net of underwriter's commission and
certain underwriter's accountable offering expenses. Each Unit was priced at $10
each and consisted of one share of Fortune Series A Convertible Participating
Preferred Stock and one three-year common stock purchase warrant. The preferred
shares have a liquidity preference of $10.00 per share. Each warrant converts
into one share of Fortune common stock at an exercise price of $0.90 per share.
Fortune incurred $74,704 of additional costs associated with this offering, all
of which were charged to capital in excess of par value upon closing the
offering.
The preferred shares will pay both a fixed and a contingent cash dividend
quarterly. The fixed dividend is payable at 8% per year. The contingent dividend
will be 0.1875% of Fortune's net oil and gas revenue from the new onshore
exploration program discussed above.
Fortune will be restricted from issuing certain securities while the
preferred shares are outstanding. Each preferred share was originally
convertible into shares of Fortune common stock at $0.45 per common stock share.
In June 2002, the conversion price was reduced to $0.35 per share in exchange
for the preferred stockholders consent to Fortune's contingent issuance of
additional preferred stock on parity with the Series A Preferred stock in a new
private placement.
The Series A preferred stock will convert automatically if Fortune's
common stock price reaches $0.90 per share for a 10-day trading period. Fortune
may redeem the shares for $25 per share of preferred stock. The preferred
shareholders will have certain other rights if Fortune fails to pay the
preferred stock dividends.
The managing dealer of the Series A offering also received 13,888 Fortune
three-year common stock purchase warrants exercisable at $0.90 per share.
ITEM 3. Defaults Upon Senior Securities
None
ITEM 4. Submission of Matters to a Vote of Securities Holders
None
ITEM 5. Other Information
None
25
ITEM 6. Exhibits and Reports on Form 8-K
(a) EXHIBITS
Exhibit No. Description
----------- -----------
None
(b) REPORTS ON FORM 8-K / 8K-A
A report on Form 8-K was filed with the Securities and Exchange Commission
on May 16, 2002 to report Fortune's press release of its first quarter 2002
financial results and additional financing.
A report on Form 8-K was filed with the Securities and Exchange Commission
on June 29, 2002 to report Fortune's amendments to certain exploration
agreements and to file its Certificate of Designation of Preference for its
Series A Preferred Stock and amendments thereto.
A report on Form 8-K was filed with the Securities and Exchange Commission
on July 1, 2002 to report Fortune's press release announcing its recent
exploration discovery and exploration program update.
*Filed herewith.
26
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
Chairman, Chief Executive Officer,
Director and Chief Accounting Officer
By: /s/ Ronald P. Nowak
---------------------------------------
Ronald P. Nowak
President and Chief Operating Officer
Date: August 14, 2002
27
EXHIBIT A-1
I, Tyrone J. Fairbanks, state and attest that:
(1) To the best of my knowledge, based upon a review of the covered reports
of Fortune Natural Resources Corporation, and, except as corrected or
supplemented in a subsequent covered report:
o No covered report contained an untrue statement of a material fact as
of the end of the period covered by such report (or in the case of a
report on Form 8-K or definitive proxy materials, as of the date on
which it was filed); and
o No covered report omitted to state a material fact necessary to make
the statements in the covered report, in light of the circumstances
under which they were made, not misleading as of the end of the
period covered by such report (or in the case of a report on Form 8-K
or definitive proxy materials, as of the date on which it was filed).
(2) I have reviewed the contents of this statement with the Company's audit
committee.
(3) In this statement under oath, each of the following, if filed on or
before the date of this statement, is a "covered report":
o Annual Report on Form 10-KSB filed with the Commission for the year
ended December 31, 2001 of Fortune Natural Resources Corporation;
o All report on Form 10-QSB, all reports on Form 8-K and all definitive
proxy materials of Fortune Natural Resources Corporation filed with
the Commission subsequent to the filing of the Form 10-KSB identified
above; and
o Any amendments to any of the foregoing.
/s/ Tyrone J. Fairbanks
- ------------------------------------------------
Tyrone J. Fairbanks, Chief Financial Officer
Date: August 14, 2002
EXHIBIT A-2
I, Tyrone J. Fairbanks, state and attest that:
(1) To the best of my knowledge, based upon a review of the covered reports
of Fortune Natural Resources Corporation, and, except as corrected or
supplemented in a subsequent covered report:
o No covered report contained an untrue statement of a material fact as
of the end of the period covered by such report (or in the case of a
report on Form 8-K or definitive proxy materials, as of the date on
which it was filed); and
o No covered report omitted to state a material fact necessary to make
the statements in the covered report, in light of the circumstances
under which they were made, not misleading as of the end of the
period covered by such report (or in the case of a report on Form 8-K
or definitive proxy materials, as of the date on which it was filed).
(2) I have reviewed the contents of this statement with the Company's audit
committee.
(3) In this statement under oath, each of the following, if filed on or
before the date of this statement, is a "covered report":
o Annual Report on Form 10-KSB filed with the Commission for the year
ended December 31, 2001 of Fortune Natural Resources Corporation;
o All report on Form 10-QSB, all reports on Form 8-K and all definitive
proxy materials of Fortune Natural Resources Corporation filed with
the Commission subsequent to the filing of the Form 10-KSB identified
above; and
o Any amendments to any of the foregoing.
/s/ Tyrone J. Fairbanks
- ------------------------------------------------
Tyrone J. Fairbanks, Chief Executive Officer
Date: August 14, 2002
STATE OF TEXAS
COUNTY OF HARRIS
I, Michal J. King, hereby acknowledge that the attached certifications
were signed before me on the 14th day of August, 2002, by TYRONE J. FAIRBANKS,
known to be the Chief Executive Officer and Chief Financial Officer of Fortune
Natural Resources Corporation.
/s/ Michal J. King
----------------------------
Michal J. King
My commission expires: april 15, 2005
[SEAL]