SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1996 Commission File No. 0-22750
ROYALE ENERGY, INC.
(Name of Small Business Issuer in its charter)
California 33-0224120
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
7676 Hazard Center Drive, Suite 1500
San Diego, CA 92108
(Address of principal executive offices)
Issuer's telephone number: 619-297-8505
Securities registered pursuant to Section 12(b) of the Act: None
Securities to be registered pursuant to Section 12(g) of the Act:
Common Stock, no par value
(Title of Class)
Check whether the issuer (1) has 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 [__]
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B is not contained herein, and will not be contained, to the
best or registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. [__]
State issuer's revenues for its most recent fiscal year: $9,997,594.
At March 3, 1997, there were outstanding 2,722,530 shares of registrant's
Common Stock held by non-affiliates, with an aggregate market value of
approximately $14,021,030, based on the closing Nasdaq price on that date.
At March 3, 1997, there were outstanding a total of 3,856,862 shares of
registrant's Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE: None
Transitional Small Business Disclosure Format (check one): Yes [__]; No [X]
Exhibit Index appears on page 25.
<PAGE> 2
TABLE OF CONTENTS
PART I..........................................................1
Item 1.Description of Business.............................1
Item 2.Description of Property.............................5
Item 3.Legal Proceedings...................................9
Item 4.Submission of Matters to a Vote of Security Holders10
PART II........................................................10
Item 5.Market Price of the Company's Common Stock and
Related Stockholder Matters..........................10
Item 6.Management's Discussion and Analysis of Financial
Condition and Results of Operations..................11
Item 7.Financial Statements and Supplementary Data........15
Item 8.Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure..................15
Part III.......................................................15
Item 9.Directors, Executive Officers, Promoters and Control
Persons, Compliance with Section 16(a) of the Exchange
Act..................................................15
Item 10.Executive Compensation............................18
Item 11.Security Ownership of Certain Beneficial Owners and
Management...........................................20
Item 12.Certain Relationships and Related Transactions....23
Item 13.Exhibits, Lists, and Reports on Form 8-K..........25
Signatures................................................27
Financial Statements................................... F-1
ii
<PAGE> 3
ROYALE ENERGY, INC.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
Royale Energy, Inc. (the "Company"), is an independent oil and
natural gas producer. The Company's principal lines of business
are the acquisition of oil and gas lease interests and proved
reserves, drilling of both exploratory and development wells, and
sales of fractional working interests in wells to be drilled by
the Company. The Company owns wells and leases in major
geological basins located mainly in California. The Company
offers fractional working interests and seeks to minimize the
risks of oil and gas drilling by selling multiple well drilling
ventures which do not include the use of debt financing. The
Company was incorporated in California as Royale Energy Funds,
Inc., in 1986 and commenced operations in 1988. In 1994 its name
was changed to Royale Energy, Inc. Since February 25, 1997,
Common Stock of the Company has been traded on the Nasdaq
National Market System; prior to that date, it was traded on the
Nasdaq Small Cap Market. On February 15, 1997, the Company had
11 full time employees.
During the fiscal year ended December 31, 1996, the Company
continued its exploration and development of natural gas
properties in northern California. The Company drilled nine
wells in 1996, of which it elected to complete five as
commercially productive wells. Four wells drilled in 1996 were
plugged and abandoned as dry holes. The Company's estimated
total natural gas reserves rose from approximately 9.6 Bcf at
January 1, 1996 to approximately 12.9 Bcf at January 1, 1997.
Plan of Business
The Company is engaged in the acquisition of interests in oil and
natural gas reserves by sponsoring public and private joint
ventures. Management believes that the Company's shareholders
are better served by diversification and limitation of total
exposure in individual drilling projects. For this reason, the
Company invites other investors to participate in the Company's
drilling projects. Through its participation in joint ventures,
the Company can acquire interests and develop oil and natural gas
properties with limited expense and risk and still receive an
interest in the revenues and reserves produced from these
properties.
After acquiring the leases or lease participation, the Company
drills or participates in the drilling of developmental and
exploratory oil and natural gas wells on its property at its own
cost, and/or finances part of the drilling cost by selling
fractional interests in undeveloped wells. From inception
through December 31, 1996, the Company has sold fractional
interests to accredited investors who have paid the Company
approximately $16,256,712 for the drilling, completion and
enhancement of 55 wells. Of these 55 wells, 42 were deemed
commercially productive oil or natural gas wells. As of December
31, 1996, the Company had recorded $1,504,041 as a current
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liability for the Company's obligation to drill four additional
wells in which the Company has sold fractional interests.
When the Company sells fractional interests to raise capital to
drill oil and natural gas wells, the Company generally agrees to
drill these wells on a "turnkey contract" basis, so that the
holders of the fractional interests prepay a fixed amount for the
drilling and completion of a specified number of wells. Under a
turnkey contract, if the actual cost to drill and complete wells
is less than the amount paid by the interest holders, the Company
retains the balance. If the drilling and completion costs exceed
the amount paid by the fractional interest holders to drill the
wells and the Company participates as a working interest owner,
the excess is capitalized as the cost of the Company's working
interest.
When the Company receives funds from an investment in a Turnkey
Drilling Investment sold by it, a percentage of the invested
funds are used by the Company to prepay lease costs, intangible
drilling costs, and other costs as required to allow the drilling
project to proceed without delay. These funds are non-refundable
once the investment has been made. The non-refundable portion of
the total Turnkey Drilling Investment is based on a percentage
calculated by estimating the pre-drilling costs as a percentage
of total drilling costs for a particular investment. The Company
recognizes the non-refundable portion of the total investment as
revenue and the related pre-drilling costs are expensed. The
Company records the remaining funds from the sale of working
interests as income at the commencement of drilling, and carries
its obligation to expend the remaining unexpended funds for
drilling wells on behalf of the investors as a current liability.
See, Note 1 to the Company's Consolidated Financial Statements.
The Company maintains internal records of the expenditure of each
investor's funds for drilling projects and maintains a separate
bank account for unexpended drilling funds.
For the years ended December 31, 1996 and 1995, the Company
reported gross revenues in the amounts of $4,775,175 and
$4,091,049, respectively, in connection with the drilling of
wells on a turnkey contract basis, which represents 47.8% and
49.1% of the Company's total revenues for those years. These
amounts are offset by drilling expenses and development costs of
$1,530,597 and $1,520,429, respectively. The Company hires, in
addition to its own engineering staff, independent contractors to
drill, test, complete and equip the wells that it drills.
Wells completed by the Company are generally operated by the
Company. Prior to December 1995, the Company's wells were
operated by a wholly owned subsidiary, Royale Operating Company,
but in December 1995 Royale Operating Company was dissolved and
its operations were assumed by the Company. As operator, the
Company receives fees and expense reimbursements set by industry
standards from the owners of fractional interests in the wells.
For the years ended December 31, 1996, and 1995, the Company (and
its former subsidiary) earned gross revenues in the amounts of
$329,397 and $215,993, from operation of the wells, which
represent 3.3% and 2.6% of the Company's total revenues on a
consolidated basis for those years, respectively. As of January
1, 1997, the Company is the operator of 26 natural gas wells on
properties leased by the Company in the Sacramento Basin in
California.
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For the years ended December 31, 1996, and 1995, the Company had
oil and natural gas sales from production of its wells in the
amounts of $1,267,919 and $743,079, respectively, which
represents 12.7% and 8.9%, of the Company's total revenues for
those years.
Prior to December 1996, the Company purchased natural gas on a
spot basis from wells operated by the Company and from
unaffiliated producers and resold the gas to consumers in the
open market. The purchasers were mainly utilities and
manufacturers located in California. This was essentially a
brokerage operation which generates a large volume of sales
revenue at small profit margins. Prior to 1996, these operations
were conducted through a wholly owned subsidiary, Royale Natural
Gas Marketing, Inc. ("RNGM"), the operations of which were
discontinued in the first quarter of 1996 when the Company took
over this business directly. In December 1996, the Company's gas
marketing operations were discontinued. The Company (including
RNGM) recorded gas distribution sales of $3,625,103 and
$3,277,978 in the years ended December 31, 1996 and 1995,
respectively. The Company recorded cost of gas distribution
sales of $3,629,991 $3,204,261 in fiscal years 1996 and 1995,
respectively.
Affiliated Entities
On December 31, 1996, Royale Petroleum Corporation ("RPC") owned
31.47% of the Company's Common Stock (including shares which RPC
had the right to acquire upon the exercise of warrants which it
held on that date). RPC is a holding company which is owned
equally by Donald H. Hosmer and Stephen M. Hosmer, who are
brothers. Donald H. Hosmer is president and director of the
Company, and Stephen Hosmer is chief financial officer and
director of the Company. Donald H. and Stephen M. Hosmer are
sons of Harry E. Hosmer, chairman of the Company's board of
directors. See, Security Ownership of Certain Beneficial Owners
and Management. RPC is a predecessor and affiliate of the
Company. RPC is a Delaware corporation formed in 1985.
During 1996, the Company liquidated two former affiliates, Royale
Energy Corporation, a Delaware corporation, and Royale Energy
Company, a California corporation. In 1996, the Company also
dissolved two limited partnerships for which Royale Energy
Company had formerly acted as a general partner.
The Company had no subsidiaries at December 31, 1996. During
1996, the Company sold one wholly owned subsidiary, Royale
Covenant Securities Corporation, and discontinued the operations
of another wholly owned subsidiary, RNGM. See, Management's
Discussion and Analysis of Results of Operations.
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Competition, Markets and Regulation
Competition
The exploration and production of oil and natural gas is an
intensely competitive industry. The sales of securities
including interests in oil and gas programs such as those the
Company sells is also very competitive. The Company encounters
competition from other oil and natural gas producers, as well as
from other entities which invest in oil and gas for their own
account or for others, many of which companies are substantially
larger than the Company.
Markets
The quantities of, and price obtainable for, oil and natural gas
production from the Company's oil and natural gas properties, are
affected by market factors beyond the Company's control. Such
factors include: the extent of domestic production; the level of
imports of foreign oil and natural gas; the general level of
market demand on a regional, national and worldwide basis;
domestic and foreign economic conditions that determine levels of
industrial production; political events in foreign oil-producing
regions; and variations in governmental regulations including
environmental, energy conservation, and tax laws or the
imposition of new regulatory requirements upon the oil and
natural gas industry. There can be no assurance that oil and
natural gas prices will not increase or decrease in the future,
thereby increasing or decreasing the revenues that the Company
receives from its oil and natural gas sales.
Regulation
Environmental Regulation - The exploration, development,
production and processing of oil and natural gas are subject to
various federal and state laws and regulations to protect the
environment. Various federal and state agencies are considering,
and some have adopted, other laws and regulations regarding
environmental controls that could adversely affect the business
of the Company. These laws and regulations may require: the
acquisition of a permit by operators before drilling commences;
prohibition of drilling activities on certain lands lying within
wilderness areas or where pollution arises; and imposition of
substantial liabilities for pollution resulting from drilling
operations, particularly operations in offshore waters or on
submerged lands. Compliance with such legislation and
regulations, together with any penalties resulting from
noncompliance therewith, may also increase the cost of oil and
natural gas development and production. Certain of these costs
may ultimately be borne by the Company. The Company does not
presently anticipate that compliance with federal, state and
local environmental regulations will have a material adverse
effect on capital expenditures, earnings or the competitive
position of the Company in the oil and natural gas industry;
however, since these laws and regulations change frequently, the
costs of the Company's compliance with existing and future
environmental regulations cannot be predicted.
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<PAGE> 7
Federal Regulation of Natural Gas - The transportation and sale
of natural gas in interstate commerce is regulated by agencies of
the federal government. The following discussion is intended
only as a summary of the principal statutes, regulations and
orders that may affect the Company's production and sale of
natural gas. This summary should not be relied upon as a
complete review of applicable natural gas regulatory provisions.
FERC Order No. 500 - In 1989, the Federal Energy Regulatory
Commission ("FERC") adopted in final form Order No. 500 affecting
the transportation and marketability of natural gas.
Traditionally, natural gas has been sold by producers to pipeline
companies, which then resold the natural gas to end-users. FERC
Order No. 500 alters this market structure by requiring
interstate pipelines that transport natural gas for others to
provide transportation service to producers, distributors and all
other shippers of natural gas on a nondiscriminatory, "first-
come, first served" basis ("open access transportation"), so that
producers and other shippers can sell natural gas directly to
end-users. FERC Order No. 500 contains additional provisions
intended to promote greater competition in natural gas markets.
FERC Order No. 500 has been judicially criticized, and remains
subject to judicial review and requests for rehearing.
State Regulations - Production of oil and natural gas from the
Company's operations is affected to some degree by state
regulations. Many states in which the Company operates have
statutory provisions regulating the production and sale of oil
and natural gas, including provisions regarding deliverability.
Such statutes, and the regulations promulgated in connection
therewith, are generally intended to prevent waste of oil and
natural gas and to protect correlative rights to produce oil and
natural gas produced by assigning allowable rates of production
to each well or proration unit.
The preceding discussion of regulation of the oil and natural gas
industry is not intended to constitute a complete discussion of
the various statutes, rules, regulations or governmental orders
to which the Company's operations may be subject.
ITEM 2. DESCRIPTION OF PROPERTY
Since 1993, the Company has concentrated on development of
properties in the Sacramento Basin of Northern California. In
1996, the Company drilled five commercially productive gas wells
and four dry holes in Northern California. In 1995, the Company
drilled six commercially productive gas wells and two dry holes
in Northern California. The Company also owns interests in 16
existing wells in Northern California as a result of purchases of
producing properties during 1994. The Company also owns proved,
undeveloped reserves in the Fort Worth Basin in Texas, as well as
other interests in properties in Texas and Oklahoma in connection
with joint ventures in which the Company is a participant but is
not the operator.
Following industry standards, the Company generally acquires oil
and natural gas acreage without warranty of title except as to
claims made by, through, or under the transferror. In these cases
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due diligence as to title is attempted prior to
acquisition, but there are no assurances that losses will not
result from title defects or from defects in the assignment of
leasehold rights. Title to property most often carries
encumbrances, such as royalties, overriding royalties, carried
and other similar interests and contractual obligations as are
customary within the oil and natural gas industry.
The following is a discussion of the Company's significant oil
and natural gas properties. Reserves at January 1, 1997, for
each property discussed below, have been determined by Richard
Stephen Schuster, Professional Engineer in accordance with his
report dated February 25, 1997 (the most recent report
available).
Northern California
The Company owns lease interests in 10,986.32 gross (6,906.78
net) acres in the Sacramento and San Joaquin Basins in Northern
California. In 1994 the Company purchased 16 wells in Northern
California from Arkoma Production of California for $2,238,640,
of which $1,065,000 was borrowed from private lending sources.
That note was repaid in full in mid 1996, a little more than two
years after the debt was incurred. In addition, the Company
participated in drilling one commercially productive gas well in
Northern California in 1994 and drilled six commercially
productive gas wells in 1995 and five commercially productive
wells in 1996 in this area. At December 31, 1996, the Company
operated 26 wells in the Sacramento Basin in Northern California.
At the end of 1996, the Company's estimated total reserves in
Northern California were approximately 10.8 Bcf, according to
the Company's independently prepared reserve report. The Company
expects that its drilling program will continue to concentrate on
Northern California properties in 1997.
Hood County, Texas
The Company owns lease interests in 1,494.7 gross (1,494.7 net)
acres in the Fort Worth Basin in Hood County, Texas, which
contained estimated proved, undeveloped reserves at January 1,
1997, of 2,100,039 Mcf of natural gas, according to the Company's
independently prepared reserve report. The lease interests and
undeveloped reserves in Hood County were retained by the Company
after it sold lease interests in nine producing wells during the
second quarter of 1996. See, Management's Discussion and
Analysis of Financial Condition and Results of Operations.
Developed and Undeveloped Leasehold Acreage
As of December 31, 1996, the Company owned leasehold interests in
the following developed and undeveloped properties in both gross
and net acreage.
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<TABLE>
<CAPTION>
Developed Undeveloped
Gross Net Gross Net
Acres Acres Acres Acres
<S> <C> <C> <C> <C>
California 4,867.54 1,638.18 6,118.78 5,268.60
Texas 1,386.30 1,188.81 1,494.65 1,494.65
All other states 2,421.00 216.00 0 0
Total 8,674.84 3,042.98 7,613.43 6,763.25
</TABLE>
Drilling Activities
The following table sets forth the Company's drilling activities
during the years ended December 31, 1994, 1995, and 1996. All
wells are located in the Continental U.S., in California, Texas,
Oklahoma, and North Dakota.
<TABLE>
<CAPTION>
Gross Wells (b) Dry Wells
----------------------------- ---------------------
Year Type of Well (a) Total Producing (c) Dry (d) Producing (c) Dry (d)
<S> <S> <C> <C> <C> <C> <C>
1994 Exploratory 0 0 0 0 0
Developmental 6 5 1 0.4416 0.9775
1995 Exploratory 1 0 1 0 0.1000
Developmental 7 6 1 1.2360 0.1762
1996 Exploratory 1 0 1 0 0.3263
Developmental 8 5 3 1.2573 1.0383
</TABLE>
(a) An exploratory well is one that is drilled in search of new
oil and natural gas reservoirs, or to test the boundary
limits of a previously discovered reservoir. A
developmental well is one drilled on a previously known
productive area of an oil and natural gas reservoir with the
objective of completing that reservoir.
(b) Gross wells represent the number of actual wells in which
the Company owns an interest. The Company's interest in
these wells may range from 1% to 100%.
(c) A producing well is one that is producing oil and/or natural
gas that is being purchased on the market.
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(d) A dry well is a well that is not deemed capable of producing
hydrocarbons in paying quantities.
As of December 31, 1996, the Company had 3 gross (0.058 net)
oil wells and 24 gross (4.3 net) currently producing natural gas
wells.
Production
The following table summarizes, for the periods indicated, the
Company's net share of oil and natural gas production, average
sales price per barrel (Bbl), per thousand cubic feet (Mcf) of
natural gas, and the Mcf equivalent (Mcfe) for the barrels of oil
based on a 10 to 1 ratio of the price per barrel of oil to the
price per Mcf of natural gas. "Net" production is production
that is owned by the Company either directly or indirectly
through partnership or joint venture interests produced to its
interest after deducting royalty, limited partner or other
similar interests. The Company generally sells its oil and
natural gas at prices then prevailing on the "spot market" and
does not have any material long term contracts for the sale of
natural gas at a fixed price.
<TABLE>
<CAPTION>
12 Months 12 Months 12 Months
Ended Ended Ended
12/31/96 12/31/95 12/31/94
-------- -------- --------
<S> <C> <C> <C>
NET VOLUME
Oil (Bbl) 76 543 261
Gas (Mcf) 705,926 576,894 621,431
Mcfe 706,686 582,324 624,041
AVERAGE SALES PRICE
Oil (Bbl) $16.07 $15.63 $15.00
Gas (Mcf) $1.79 $1.41 $1.72
Net Production
Costs & Taxes $260,789 $373,859 $395,139
Lifting Costs $0.37 $0.64 $0.63
</TABLE>
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Net Proved Oil and Natural Gas Reserves
As of January 1, 1997, the Company had proved developed reserves
of 6,978,805 Mcf of natural gas and 1,647 barrels of oil, and
total proved reserves of 12,909,322 Mcf of natural gas and 1,647
barrels of oil on all properties leased by the Company. Proved
developed reserves are those reserves which are expected to be
recovered from already producing completion intervals and are
currently producing to a market. Total proved reserves include
proved developed reserves and those reserves that are estimated
to be recoverable from new wells on undrilled acreage or from
existing wells where a major capital expenditure is required for
additional completion.
Oil and gas reserve estimates and the discounted present value
estimates associated therewith are based on numerous engineering,
geological and operational assumptions that generally are derived
from limited data. Common assumptions include such matters as
the areal extant and average thickness of a particular reservoir,
the average porosity and permeability of the reservoir, the
anticipated future production from existing and future wells,
future development and production costs and the ultimate
hydrocarbon recovery percentage. As a result, oil and gas
reserve estimates and discounted present value estimates are
frequently revised in subsequent periods to reflect production
data obtained after the date of the original estimate. If the
reserve estimates are inaccurate, production rates may decline
more rapidly than anticipated, and future production revenues may
be less than estimated.
Additional data relating to the Company's oil and natural gas
properties is disclosed in Supplemental Information About Oil and
Gas Producing Activities (Unaudited), attached to the Company's
consolidated financial statements which are part of this
document. The oil and natural gas reserve information disclosed
in the supplement to the financial statements are based upon the
reserve reports for the years ended December 31, 1996 and 1995,
prepared by an independent reserve engineering consultant,
Richard Stephen Schuster, P.E.
ITEM 3. LEGAL PROCEEDINGS
On September 30, 1994, a suit was filed in U.S. District Court
for the Northern District of Texas against the Company, its
president, executive vice president, a former officer of the
Company, and two other members of the board of directors,
alleging violations of the registration and anti-fraud provisions
of federal securities laws, the Texas Securities Act, and various
other related causes of action arising from sales of undivided
working interests in oil and gas leases in Hood County, Texas, to
one individual in 1990 and 1991, and seeking damages of $89,973
plus interest and attorney fees. The case was transferred to the
Southern District of California in March 1996. Discovery has
been completed and the case has been set for trial beginning June
2, 1997. The Company's management deny any liability and intend
to vigorously contest the suit.
On March 13, 1995, the same plaintiff that filed the suit described
in the previous paragraph, filed suit against the same defendants
in State District Court in Hood County, Texas, alleging nearly
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identical causes of action and damages as were
alleged in the state claims in the Northern District of Texas
suit. This case was dismissed in 1996, on motion by the Company.
The Company incurred no liability in this action.
On June 13, 1995, a suit was filed in Federal District Court for
the Middle District of Florida against the Company and the board
of directors, by Pyramid Holdings, Inc., Daniel Allen, Gaming
Ventures, L.L.C., and S.C. Marketing, Inc., alleging violations
of the registration and anti-fraud provisions of federal and
state securities laws and other related causes of action arising
from sales of 170,000 shares of Common Stock of the Company in a
private placement in May 1994, and seeking damages of $1,020,000,
punitive damages of $5,000,000, plus interest and legal fees.
This suit was settled in October 1996. As part of the
settlement, the Company agreed to repurchase 37,500 shares of its
common stock at a total price of $187,500 in no more than
eighteen monthly installments beginning December 1, 1996. See,
Note 15 to the Company's Consolidated Financial Statements.
During 1996 the Company was also involved in other legal
proceedings of a routine nature, incidental to the conduct of its
business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of fiscal 1996, no matters were
submitted to a vote of the security holders of the Company.
PART II
ITEM 5. MARKET PRICE OF THE COMPANY'S COMMON STOCK AND RELATED
STOCKHOLDER MATTERS
As of December 31, 1996, a total of 3,834,049 Shares of the
Company's Common Stock were issued and outstanding which were
held by approximately 1,179 shareholders and of which 2,239,545
Shares were eligible for public trading, according to the records
of the Company's transfer agent.
On February 25, 1997, the Company's Common Stock began trading on
the Nasdaq National Market System. From October 1994 until
February 24, 1997, the Company's Common Stock was traded on the
Nasdaq Small Cap Market. On February 25, 1997, eleven NASD
member firms were making a market in the Company's Common Stock.
The following table reflects high and low bid price per share
quotations in the Nasdaq Small Cap Market from January 1995
through December 1996 The quotations reflect high and low
closing sale prices.
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<TABLE>
<CAPTION>
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
High Low High Low High Low High Low
---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1995 3 1/4 1 5/8 2 5/8 1 11/16 2 3/8 1 5/8 2 1/2 1 17/32
1996 2 3/4 1 3/4 3 3/4 2 7/8 3 5/8 2 3/4 5 4 1/4
</TABLE>
Dividends
The Company has not declared or paid any dividends to its common
shareholders and does not presently intend to do so. The future
determination as to the payment of dividends will depend on the
Company's financial condition and other factors deemed relevant
by the Company's board of directors.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
Company's Financial Statements and Notes thereto and other
financial information relating to the Company included elsewhere
in this document.
The most significant factors affecting the Company's results of
operations are (i) the increase in the sales price of natural
gas, (ii) recording of turnkey drilling revenues and the
associated drilling expense, (iii) the containment of costs and
expenses on a company wide basis, and (iv) the increase in
natural gas reserves owned by the Company.
The Company's estimated total proved, developed natural gas
reserves rose from 4,121,616 Mcfe at January 1, 1996 to 6,978,275
Mcfe at January 1, 1997, a 69% increase, while the Company's
estimated total natural gas reserves increased from 9,607,860
Mcfe at January 1, 1996, to 12,925,792 Mcfe at January 1, 1997, a
34.5% increase. The Company's management attributes this
increase to the successful drilling of five commercially
productive wells during 1996.
CHANGES IN OPERATIONS DURING 1996
During 1996, the Company reevaluated its non-core business
operations with a view to disposing of less profitable
operations. As a result of its reevaluation, the Company took
the following steps. In the second quarter of 1996, the Company
sold its subsidiary, Royale Covenant Securities Corporation,
which resulted in a $18,781 gain. During the fourth quarter
1996, the Company determined not to pursue the creation of the
previously proposed Royale Energy Income Trust and, therefore,
wrote off $125,250 which it had accumulated as organizational
expenses for the Trust. Also during the fourth quarter of 1996,
the Company discontinued its natural gas brokerage operations
through the Royale Natural Gas Marketing Division. The Company's
management believes that disposition and discontinuance of these
operations will enable management to better
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<PAGE> 14
focus on the main business of the Company, of developing and
operating natural gas and oil wells.
RESULTS OF OPERATIONS FOR THE TWELVE MONTHS ENDED DECEMBER 31,
1996, AS COMPARED TO THE TWELVE MONTHS ENDED DECEMBER 31, 1995
For the year ended December 31, 1996, the Company achieved a net
operating profit of $1,773,144, a $959,093 or 117.8% improvement
over the net operating profit in 1995 of $814,051. The Company's
management attributes this improvement to increased revenues from
sales of natural gas and turnkey drilling, and cost containment
procedures. For fiscal 1996, the Company reported a net profit
of $1,398,807, compared to the net profit of $544,643 in 1995.
Total revenues for the year ended December 31, 1996 were
$9,997,594, which was an increase of $1,656,495 or 19.9%, when
compared to 1995. The increase in total revenues can be
primarily attributed to increases in both natural gas sales and
turnkey drilling revenues.
Oil and gas revenues for the year ended December 31, 1996 were
$1,267,919 compared to $743,079 for the same period in 1995,
which represents a $524,840 or 70.6% increase. This increase in
revenues was mainly due to the increase in production and price
the Company received for its natural gas production. The net
sales volume for the year ended December 31, 1996, was 705,926
Mcf with an average price of $1.79 per mcf, versus 576,894 Mcf
with an average price of $1.41 per Mcf for the same period in
1995. The Company's net sales volume for oil production was 76
barrels with an average price of $16.07 per Bbl for the period
ended December 31, 1996, compared to 543 barrels at an average
price of $15.63 per Bbl for the same period in 1995.
During the first quarter of 1995, the Company sold production
interests in producing properties, which were a continuation of
the 1994 drilling programs, in the amount of $13,000, while
recording costs of these sales of $9,285. The Company did not
record any sales or costs of this type during 1996.
The Company's oil and gas production costs, which are comprised
of lease operating expenses, decreased by $110,289, or 24.5%, to
$340,331 for the year ended December 31, 1996, from $450,620 for
the same period in 1995. This decrease in costs can be
attributed to operating efficiencies realized by changes made in
compression facilities made during 1995. For fiscal 1996, the
Company's gross margins on oil and gas production were 73.2%,
compared to 39.4% in 1995. The increase in gross margin was due
to both the increase in the price of natural gas during the
latter part of 1996 and to the decrease in associated production
costs.
For the year ended December 31, 1996, turnkey drilling revenues
increased $684,126, from $4,091,049 to $4,775,175, or 16.7% for
the year. The Company also experienced a $10,168 or 0.67%
increase in drilling and development costs from $1,520,429 in
1995 to $1,530,597 in 1996. This increase in turnkey revenues
and expenses was due to the Company's drilling of nine wells,
five of which were commercially productive, that were sold to
outside parties in 1996, versus six productive wells and two dry
holes in 1995. The Company's gross margins, or profits, on
drilling depend on the Company's ability to accurately estimate
the costs associated with the development
12
<PAGE> 15
of projects in which it sells working interests to investors.
Costs associated with contract drilling depend on location, well
depth, weather, and availability of drilling contractors and
equipment. The Company's gross margins on drilling were 67.9% and
62.8% for the years ended December 31, 1996 and 1995, respectively.
The Company's Royale Natural Gas Marketing Division recorded
sales for the year in 1996 in the amount of $3,625,103, for which
it incurred costs of sales of $3,629,991. For the same period in
1995, sales were$3,277,978, which were offset by cost of sales of
$3,204,261. This represents an increase in sales of $347,125 or
10.6% and an increase in costs of $425,730 or 13.3%. These
increases were primarily due to increase sales of the Company's
own natural gas production. Although the Natural Gas Marketing
Division has historically contributed a large portion of the
Company's total revenues, its operating margin has been
relatively narrow; in 1996 and 1995, it was -0.13% and 2.3%
respectively. In December 1996, the Natural Gas Marketing
Division was discontinued after management determined that the
thin margins on which it operated did not justify continued
operation and attention to it by management, especially in
comparison to the other, more profitable aspects of the Company's
business.
The aggregate of supervisory fees and other income was $329,397
for the year ended December 31, 1996, an increase of $113,404
(52.5%) from $215,993 during the same period in 1995. This
increase was mainly the result of a $70,000 gain due to the
partial forgiveness of the note payable in connection with the
1994 purchase of producing properties from Arkoma Production of
California and an increase in interest income of $38,428 due to
increase short-term investment of the Company's available cash.
Supervisory fees are charged in accordance with the Council for
Petroleum Accountants Society's (COPAS) policy for reimbursement
of costs associated with the joint accounting for billing,
revenue disbursement, and payment of taxes and royalties. These
charges are reevaluated each year and adjusted up or down as
deemed appropriate by a published report to the industry by Ernst
& Young, public accountants. Supervisory fees increased by
$17,714 or 10.5%, from $168,351 in 1995 to $186,065 in 1996.
This change can be attributed to the increased number of wells
that the Company operates.
Depreciation, depletion and amortization expense increased to
$479,842 from $399,212, an increase of $80,630 (20.2%) for the
year ended December 31, 1996, as compared to 1995. This increase
in expense can be attributed to the drilling of nine new wells
during 1996.
In the fourth quarter of 1995 the Company adopted SFAS No. 121,
which requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. In addition,
management also periodically assesses the value of significant
proved and unproved properties and charges impairments of value
to expense. As a result of these reevaluations, a total of
$213,938 was recorded as an impairment loss for 1995 and $215,000
was recorded as an impairment loss for 1996.
During the second quarter of 1996, the Company sold some of its oil
and gas lease interests in Hood County, Texas. The sale of these
interests resulted in a loss of $144,836. During the third quarter
13
<PAGE> 16
of 1996, the Company reviewed the economic viability of
two of its leases located in Texas, the Gonzales and Bruner
leases, and as a result of the reevaluation wrote off these
leases, resulting in a $42,812 expense. In the fourth quarter of
1996, direct working interest owners of properties previously
developed by the Company in Andrews County, Texas, sold their
remaining interests in those properties, and upon their sale the
Company wrote off $63,694 which had been due from the working
interest owners for joint interest expenses. These actions,
together with other dispositions upon the discontinuance of
certain less profitable operations totaling $106,469 (See,
Changes in Operations During 1996, above), resulted in losses on
asset dispositions in 1996 of $357,811. This figure represented
a 76% increase over 1995 losses from disposed assets. In 1995,
the Company had realized losses of $202,905 upon the disposition
certain unprofitable oil and gas properties.
General and administrative expenses increased slightly by
$37,436, or 3.05%, from $1,228,378 for the year ended December
31, 1995, to $1,265,814 for the same period in 1996. Legal and
accounting expense increased to $268,683 for the same period,
compared to $208,295 for the year in 1995, a $60,388 (29%)
increase. This increase can be attributed to increased
litigation costs during the latter part of 1996. Marketing
expense for the year ended December 31, 1996, increased $201,562
or 68.9%, to $494,192, compared to $292,630 for the same period
in 1995. Marketing expense for the Company varies from period to
period according to the number of marketing conferences attended
by Company personnel and associated travel costs.
During the first half of 1996, the Company incurred interest
expense of $14,296 on the note payable issued in connection with
the purchase of producing properties from Arkoma Production of
California. Interest expense for the year in 1995, for this
note, was $64,103. In July 1996, a final payment of $169,817 was
made to the note holder to retire the note, which had an
inception date of April 1994 and an original principal balance of
$1,605,144.
CAPITAL RESOURCES AND LIQUIDITY:
At December 31, 1996, the Company had current assets totaling
$4,881,195 and current liabilities totaling $3,451,746. The
Company's working capital surplus at December 31, 1996, was
$1,429,449, compared to a working capital deficit at December 31,
1995, of $349,352. The increase in working capital surplus in
1996 was due mainly to the increased net operating income
generated by the Company. In addition, the Company drew upon its
revolving line of credit for approximately $300,000 for working
capital purposes, at the end of 1996. Management believes that
the Company has sufficient liquidity for the short term.
Operating Activities. For the year ended December 31, 1996, cash
provided by operating activities totaled $1,765,996 compared to
$1,903,363 provided by operations for the same period in 1995.
This increase in cash provided can be mainly attributed to
increased accounts receivable at the end of 1996 when compared to
the end of 1995.
Investing Activities. Net cash used by investing activities,
primarily in capital acquisitions of oil and gas properties,
amounted to $682,589 for the period, compared to $736,045 used by
investing
14
<PAGE> 17
activities for the same period in 1995. The primary
reason for the difference was proceeds received by the Company
for the sale of its Hood County, Texas, properties.
Financing Activities. For the year ended December 31, 1996, net
cash used by financing activities was $104,823, compared to cash
used by financing activities for the period in 1995 of $230,321.
The reason for the decrease in cash used for financing in 1996
was the Company's repayment in mid 1996 of the indebtedness that
it had incurred in 1994 for the purchase of 16 producing wells
from Arkoma Production of California.
ITEM 7. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See, pages F-1, et seq., included herein.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, CONTROL PERSONS, COMPLIANCE
WITH SECTION 16(a) OF THE EXCHANGE ACT
Listed below is certain information about the current directors
and executive officers of the Company. Directors are elected by
shareholders at each annual shareholders' meeting and serve until
their successors are elected and qualified. Officers serve at
the discretion of the board of directors.
The following persons currently serve as the directors and
executive officers of the Company, its subsidiaries and
affiliated companies.
<TABLE>
<CAPTION>
First Became Director
Name Age or Executive Officer Positions Held
- ------------- -- -------------------- --------------
<S> <C> <C> <C>
Harry E. Hosmer (1) 65 1987 Chairman of the Board.
Donald H. Hosmer 40 1991 President, Secretary and
Director. Chairman of the
Board and President of Royale
Petroleum Corporation ("RPC").
</TABLE>
15
<PAGE> 18
<TABLE>
<CAPTION>
First Became Director
Name Age or Executive Officer Positions Held
- ------------- -- -------------------- --------------
<S> <C> <C> <C>
Stephen M. Hosmer 30 1991 Chief Financial Officer and
Director. Secretary and
Director of RPC.
Oscar A.
Hildebrandt (2) 61 1995 Director.
Rodney Nahama 65 1994 Director.
Henry C. Thorne (1) (2) 66 1991 Director and Assistant
Secretary.
George M. Watters (1) (2) 77 1991 Director.
</TABLE>
(1) Member of the audit committee.
(2) Member of the compensation committee.
The following summarizes the business experience of each director
and executive officer for the past five years.
HARRY E. HOSMER is the Chairman of the Board of the Company. In
April 1982, Mr. Hosmer founded a former affiliate, Royale Energy
Company, to act as general partner of oil and gas limited
partnerships which it sponsored. In October 1985, Mr. Hosmer
and three of his sons founded RPC, the largest shareholder of the
Company. Mr. Hosmer served as President of the Company from its
inception until June 1995. He is a member of the Communications
and Capital Formations Committees of the Independent Petroleum
Association of America.
DONALD H. HOSMER is President and Director of the Company and
Chairman and President of RPC. He is responsible for marketing
working interests in oil and gas projects developed by the
Company. He is also responsible for investor relations and
communications. He conducts workshops and is the Company liaison
to the numerous seminars and conferences in which the Company
participates. Donald H. Hosmer is the son of Harry E. Hosmer and
brother of Stephen M. Hosmer.
STEPHEN M. HOSMER is Chief Financial Officer and Director of the
Company. Mr. Hosmer joined the Company as the Management
Information Systems Manager in May 1988, responsible for developing
and maintaining the Company's computer software. Mr. Hosmer
developed programs and software systems used by the Company.
Mr. Hosmer graduated from Oral Roberts University in Tulsa,
Oklahoma, in May 1988 with a Bachelor of Science in Business
Administration. He is a member of the Natural Gas Producers
Committee of the California Independent Petroleum Landmen's
Association. Stephen M. Hosmer is the son of Harry E.
Hosmer and brother of Donald H. Hosmer.
16
<PAGE> 19
DR. OSCAR A. HILDEBRANDT, D.V.M., is a Director and is Chairman
of the Company's Compensation Committee. From 1994 to 1995 he
served as an advisory member of the Company's Board of Directors.
Dr. Hildebrandt practiced veterinary medicine as President of
Medford Veterinary Clinic, Medford, Wisconsin, from 1960 to 1990.
Since 1990, Dr. Hildebrandt has engaged independently in
veterinary practice consulting services. He has served on the
board of directors of Fidelity National Bank - Medford,
Wisconsin, and its predecessor bank from 1965 to the present and
is past chairman of the board of the Bank. From 1990 to the
present he has acted as a financial advisor engaged in private
business interests. Dr. Hildebrandt received a Bachelor of
Science degree from the University of Wisconsin in 1954 and a
Doctor of Veterinary Medicine degree from the University of
Minnesota in 1958.
RODNEY NAHAMA was employed as president and chief executive
officer of Nahama & Weagant Energy Co. from 1971 until March
1994. Since March 1994, Mr. Nahama has pursued private business
interests, including the provision of geologic consulting
services to the Company. Mr. Nahama holds a B.A. degree in
geology from the University of California, Los Angeles, and an
M.A. degree in geology from the University of Southern
California. He was an independent exploration geologist from
1965 to 1971 and prior to that served as a geologist with Franco
Western Oil Company from 1963 to 1965. Between 1957 and 1963,
Mr. Nahama worked as an exploration geologist with Honolulu Oil
Company, Getty Oil Company, and Sunray Oil Company. Mr. Nahama
is a member of the American Association of Petroleum Geologists,
the San Joaquin Geological Society, the California Independent
Producers Association and the Independent Petroleum Association
of America.
HENRY C. THORNE is a Director of the Company. Mr. Thorne is a
former manager of Business and Regional Development for AMOCO
Corporation. Mr. Thorne retired from AMOCO Corporation in
December 1986, and in early 1987 he founded Petrochem
International, a venture development company which assists
clients in development of international export-import markets.
Mr. Thorne has served as President of Petrochem International
from its inception through the present. Mr. Thorne received his
Bachelor's Degree in chemical engineering with distinction from
Cornell University and his Masters degree in Business
Administration with distinction from Northwestern University. He
is a member of the Commercial Development Association, the
Licensing executives Society and the American Institute of
Chemical Engineers.
GEORGE M. WATTERS has been retired from full time employment during
the last five years. Mr. Watters retired from AMOCO Corporation in
1983 after serving for 24 years in senior management positions with
AMOCO Corporation and its affiliates. From 1987 to the present Mr.
Watters has managed his personal investments. Mr. Watters has
also served from 1983 to the present as managing director of Kuo
International Oil (UK) Ltd. responsible for acquiring crude oil in
Europe, Africa and the Middle East, and has served as managing
director of USA Petroleum International from 1987 to the present.
Mr. Watters received his Bachelor of Science degree from
Massachusetts Institute of Technology in 1942.
17
<PAGE> 20
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Section 16(a) of the Securities Exchange Act of 1934 and
Securities and Exchange Commission regulations require that the
Company's directors, certain officers, and greater than 10
percent shareholders are required to file reports of ownership
and changes in ownership with the SEC and the NASD and to furnish
the Company with copies of all such reports they file. The
Company has never received a copy of any report pursuant to
Section 16(a) of the Securities Exchange Act from Mr. Owen
LeTissier, a resident of the British Channel Islands who is
believed by the Company to hold more than 10 percent of its
Common Stock. See, Security Ownership of Certain Beneficial
Owners and Management - Common Stock. Except for possible
reporting obligations, if any, by Mr. LeTissier, and based solely
upon a review of the copies of the forms furnished to the
Company, or written representations from certain reporting
persons that no reports were required, the Company believes that
no person failed to file required reports on a timely basis
during or in respect of 1996.
ITEM 10. EXECUTIVE COMPENSATION
The following table summarizes the compensation of the chairman
of the board and the president of the Company and its
subsidiaries, Harry E. Hosmer and Donald H. Hosmer (the "Named
Officers), for the fiscal years ended December 31, 1996, 1995,
and 1994.
<TABLE>
<CAPTION>
Long Term
Annual Compensation Compensation
------------------------- Awards
(a) (b) (c) (d) (e)
Other Securities
Name Period Covered Salary Compensation * Underlying Options
- --------------- -------------- -------- ------------ ------------------
<S> <S> <C> <C> <C>
Donald H. FYE 12/31/96 $100,000 $703 0
Hosmer, CEO FYE 12/31/95 $100,000 $785 30,000
FYE 12/31/94 $89,583 $5,500 0
Harry E. Hosmer, FYE 12/31/96 $122,444 $882 0
Chairman FYE 12/31/95 $110,000 $1,295 30,000
FYE 12/31/94 $120,000 $1,190 0
</TABLE>
* Under the terms of a plan adopted by the board of directors in
1989, Harry E. and Donald H. Hosmer have elected to participate
in wells drilled by the Company. See, Certain Relationships and
Related Transactions. The costs incurred by Messrs. Harry and
Donald Hosmer
18
<PAGE> 21
for interests acquired in wells pursuant to this policy are less
than would have been the cost of purchasing an equivalent
percentage as working interests in these wells which are sold to
unaffiliated outside investors. The difference between the
Hosmers' actual cost and the cost incurred by outside investors
could be considered as additional compensation to them.
However, the Company's management does not believe that the
amount of such difference is significant. In addition, prior to
June 1995, the Company advanced funds to Harry and Donald Hosmer
to pay for their well participation interests. To the extent
that the advances amount to interest free loans, Harry and Donald
Hosmer could also be considered to have received additional
compensation. The Other Compensation in the foregoing table
consists of the amounts which the Company's management believe
may be considered income to be imputed from such foregone
interest. The imputed interest was estimated using approximate
amounts due at the end of each period, as if that amount had been
due for the entire period. The imputed interest rate used by the
Company is currently 7.5% simple interest per annum. In June
1995, the Company's policy regarding advancement of funds was
changed. The Current policy requires that all such purchases of
interests in wells must be paid in cash prior to the drilling of
the well.
The Company does not maintain a retirement plan or "Section
401(k)" compensation plan on behalf of its employees.
STCK OPTIONS GRANTED IN 1996
No stock options were granted to officers, directors, or
employees during 1996.
AGGREGATED 1996 OPTION EXERCISES AND YEAR-END VALUES
Neither of the Named Officers exercised any stock options or
stock appreciation rights in 1996, 1995, or 1994. The following
table summarizes the number and value of all unexercised stock
options held by the Named Officers at the end of 1996.
<TABLE>
<CAPTION>
(a) (b) (c)
Number of Securities Value of Unexercised In-
Underlying Unexercised the-Money Options/SARs
Optins/SARs at FY-End (#) at FY-End ($) (1)
Name Exercisable/Unexercisable (2) Exercisable/Unexercisable
- --------------- ------------------------------ -------------------------
<S> <C> <C>
Harry E. Hosmer 15,000/30,000 $15,000/$63,000
Donald H. Hosmer 15,000/30,000 $15,000/$63,000
</TABLE>
19
<PAGE> 22
(1) Based on a fair market value of $4.00 per share, which was the
minimum bid price of the Company's Common Stock in the Nasdaq
Small Cap Market on December 31, 1996.
(2) All unexercisable options held by Named Officers on December 31,
1996, became exercisable on March 10, 1997.
COMPENSATION OF DIRECTORS
The Company compensates non-employee directors for their service
on the board of directors. No directors received any stock
options or stock appreciation rights in 1996. The following
table sets forth information regarding the cash compensation paid
to directors, other than Named Officers, in 1996.
<TABLE>
<CAPTION>
(a) (b) (c)
Annual Retainer Consulting Fees/
Fees Other Fees (1)
- -------------------- --------------- ----------------
<S> <C> <C>
Oscar A. Hildebrandt $6,800 $9,225
Rodney Nahama $6,800 $2,600
Henry C. Thorne $7,300 (2) $850
George M. Watters $7,300 (2) $3,550
</TABLE>
(1) Consists of payments for directors fees due for services in
prior years.
(2) Includes $500 paid for service as a committee member in 1996.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
The following tables set forth certain information regarding the
ownership of the Company's voting securities as of December 31,
1996, by: (i) each person who is known by the Company to own
beneficially more than 5% of the outstanding shares of each class
of equity securities, (ii) each director of the Company, and
(iii) all directors and officers of the Company as a group.
Except pursuant to applicable community property laws and except
as otherwise indicated, each shareholder identified in the table
possesses sole voting and investment power with respect to its or
his shares.
Common Stock
On December 31, 1996, 3,834,049 shares of the Company's Common
Stock were outstanding.
20
<PAGE> 23
<TABLE>
<CAPTION>
Shares Owned (1)
-------------------------------
Shareholder (2) Number Percent
- ---------------------------- ------------------- -------
<S> <C> <C>
Royale Petroleum Corporation 1,279,243 (3) (4) 31.47%
Donald H. Hosmer 1,049,688 (3) (4) 31.89%
Harry E. Hosmer 15,000 (4) 0.39%
Oscar A. Hildebrandt 41,422 (5) 1.08%
Stephen M. Hosmer 1,049,938 (3) (4) 31.77%
Owen LeTissier 500,000 (6) 13.04%
St. Peter Port
Guernsey, Channel Islands
Henry C. Thorne 13,472 0.35%
George M. Watters 47,500 (7) 1.24%
All directors and officers
as a group (7 persons) 1,423,887 (3) 34.52%
</TABLE>
(1) Includes shares which the listed shareholder has the right to
acquire before March 1,1997, from options or warrants.
(2) Unless otherwise indicated, the mailing address of each listed
shareholder is 7676 Hazard Center Drive, Suite 1500, San
Diego, California 92108.
(3) Because Messrs. Donald and Stephen Hosmer are directors of
Royale Petroleum Corporation ("RPC") and have power to vote
the shares of Common Stock owned by RPC, pursuant to Rule
13d-3 promulgated under the Securities Exchange Act of 1934,
as amended, each of them may be deemed to be the beneficial
owner of all the Common Stock owned by RPC. Accordingly, the
1,279,243 shares of the Company owned by RPC are included in
the number of shares held by both Donald and Stephen Hosmer
and in the number of shares owned by all officers and
directors as a group.
(4) Donald H. and Stephen M. Hosmer are sons of Harry E. Hosmer,
Chairman of the Board.
(5) Includes shares held by a family partnership of which Dr.
Hildebrandt is a 50% partner and shares held by a trust
of which Dr. Hildebrandt is trustee.
(6) The Company's transfer records reflect that Owen LeTissier
holds 400,000 shares (10.43% of the outstanding shares at
December 31, 1996) as the Trustee of two foreign
21
<PAGE> 24
charitable trusts which were formed in 1994 by Harry E. Hosmer,
the chairman of the board. Mr. LeTissier holds sole voting
power over the shares, although Harry E. Hosmer acts as an
adviser to the Trusts. The beneficiaries of the Trusts are
certain charitable organizations, although the wife and
certain sons of Harry E. Hosmer have the right to become
beneficiaries of the Trusts after his death. Donald and
Stephen Hosmer have indicated that, in the event they are
named as beneficiaries, they have no intention to elect to
become beneficiaries and will decline to exercise any rights
under the trusts to vote or otherwise control the shares of
the Company which the Trusts hold. Accordingly, the ownership
interest of Donald and Stephen Hosmer do not reflect the shares
owned by the Trusts. The Company's transfer records also
indicate that 100,000 shares are held by Stratford
Investments, Limited, which the Company believes to be an
affiliate of Mr. LeTissier.
(7) Includes Common Stock held by a trust of which Mr. Watters is
the Trustee.
PREFERRED STOCK
Holders of each series of preferred shares have voting rights
equal to the number of shares into which they are convertible.
None of the Preferred shareholders have the right to vote as much
as 5% of the shares entitled to vote when taking into account the
total number of both Common and Preferred Shares. On December
31, 1996, there were 24,375 shares of Series A and 115,000
shares of Series AA Convertible Preferred Stock outstanding. The
shares of each series of Convertible Preferred Stock is
convertible into the Company's Common Stock at the option of the
security holder, at the rate of two shares of Convertible
Preferred Stock for each share of Common Stock.
<TABLE>
<CAPTION>
Series A Series AA
---------------- ----------------
Shareholder (1) Number Percent Number Percent
- --------------------------------- ------ ------- ------ -------
<S> <C> <C> <C> <C>
Richard G. and Margaret E. Algire 3,125 12.8%
Charles J. Anderson 25,000 21.7%
Flora M. Bardet 12,500 10.9%
Larry Burns 6,250 5.4%
Marjorie Carson 6,250 5.4%
Virginia L. Hoffman 12,500 51.3%
Navin G. Leap 15,000 13.0%
Overland Bank 6,250 5.4%
Karl Sanders 2,500 10.3%
</TABLE>
22
<PAGE> 25
<TABLE>
<CAPTION>
Series A Series AA
---------------- ----------------
Shareholder (1) Number Percent Number Percent
- -------------------------------- ------ ------- ------ -------
<S> <C> <C> <C> <C>
George Singleton 6,250 5.4%
Charles Swaner 6,250 5.4%
James S. Trowbridge 6,250 25.6%
William W. Well 6,250 5.4%
Jerome Winston 6,250 5.4%
All officers and directors
as a group 0 0.0% 0 0.0%
</TABLE>
(1) The mailing address of each listed shareholder is 7676 Hazard
Center Drive, Suite 1500, San Diego, California 92108.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In 1989, the board of directors adopted a policy (the "1989
policy") as to all directors and officers of the Company that
permits each director and officer to purchase from the Company,
at its cost, up to one percent (1%) fractional interest in any
well to be drilled by the Company. When an officer or director
elects to make such a purchase, the amount charged per each
percentage working interest is equal to the actual pro rata cost
to the Company of drilling and completion costs, rather than the
higher amount that the Company charges to working interest
holders for the purchase of a percentage working interest in a
well. Of the current officers and directors, Donald Hosmer,
Stephen Hosmer, Harry E. Hosmer, Henry Thorne, and Oscar
Hildebrandt have at various times elected to purchase interests
in certain wells drilled by the Company under the 1989 policy. A
former officer of the Company, Douglas E. Hosmer ( a son of Harry
E. Hosmer and brother of Donald and Stephen Hosmer), also had
purchased working interests under this policy while he was
employed by the Company.
Under the 1989 policy, officers and directors may elect to
participate in wells at any time up until drilling of the
prospect commences. Participants do not pay a set, turnkey price
(as do outside investors who purchase undivided working interests
from the Company), but are liable for all direct costs and
expenses through completion of a well, whether or not the well
drilling and completion expenses exceed the Company's cost
estimates. Thus, they participate on terms much the same as
would be afforded to other oil and gas industry participants or
joint venturers. Participants are invoiced for their share of
direct costs of drilling and completion as expenses are incurred
by the Company.
Officer and director participants under this program do not pay
some expenses paid by outside, retail investors in working interest
such as sales commission, if any, or marketing expenses. The
23
<PAGE> 26
outside, turnkey drilling agreement investors, on
the other hand, are not obligated to pay additional costs if a
drilling project experiences cost overruns or unanticipated
expenses in the drilling and completion stage. Accordingly, the
Company's Management believes that the terms on which officers
and directors participate in wells under the Board of Directors'
policy are being offered their interests on terms the same as
could be obtained by unaffiliated oil and gas industry
participants in arms-length transactions, albeit those terms are
different than the turnkey agreement under which outside
investors purchase fractional undivided working interests from
the Company.
Donald and Stephen Hosmer have each individually participated in
23 wells under the 1989 policy. Donald and Stephen Hosmer have
also participated in 9 wells in the name of RPC, a corporation
jointly owned by them, beginning in 1996. The Hosmer Trust, a
trust for the benefit of family members of Harry E. Hosmer, has
participated in 24 wells. Douglas Hosmer (a former officer of
the Company) participated in 14 wells.
Pursuant to the 1989 policy, in 1995, the Hosmer Trust, Donald
Hosmer, and Stephen Hosmer were each charged $1,522 for costs
related to one well in which they had each agreed, in 1995, to
acquire a 0.5% interest. In 1995, Donald and Stephen Hosmer were
each charged a total of $2,113 for purchasing a 0.5% interest in
one well and a 0.25% interest in a second well. The cost of
purchasing direct working interests of similar size in those two
wells would have been $7,533.
During 1996, Donald and Stephen Hosmer invested in nine wells
under the 1989 policy in the name of RPC. RPC was charged a
total of $4,619 for a 0.25% interest in each of the nine wells
drilled by the Company in 1996, with the exception of Bowerbank
#4A and #4B, in which its interests were 0.0625% and 0.1875%,
respectively. The amount charged was based on those costs
actually billed through December 31, 1996. Certain of the wells
in which RPC invested were not completed in 1996, and additional
costs relating to those wells will be incurred and billed to RPC
during 1997. The cost of purchasing a 0.25% direct working
interest in the nine wells would have been $15,395. In addition,
during 1996 RPC was charged $1,303 for costs related to one well
in which Donald and Stephen Hosmer had originally invested
individually, prior to 1996, under the 1989 policy.
During 1995, Oscar A. Hildebrandt invested $7,841 in working
interests in three wells under the 1989 policy. The cost of
purchasing the same percentage interest in direct working
interests would have been $12,954. During 1996, Dr. Hildebrandt
invested $ 12,954 in working interests in five wells under the
under the 1989 policy. The cost of purchasing the same
percentage interest in direct working interests would have been
$29,155.
Prior to June 1995, the Company had advanced to the participants
under the 1989 policy, the funds with which to purchase their
interests, with funds to be repaid from future production from the
working interests, with advances to be repaid from well production.
Each month, participants are credited with well income and charged
with well expenses from producing wells, at the same
24
<PAGE> 27
time as other investors including working interest
purchasers. Each officer and director who participates in one or
more wells with the Company has a single account to which all
charges and income from all wells is credited. The Company has
advanced a total of $50,814 to the Hosmer Trust for participation
in 24 wells, of which $18,758 and $4,767 remained outstanding at
December 31, 1995 and 1996, respectively. See, Executive
Compensation. The Company has advanced Donald and Stephen Hosmer
each a total of $28,906 for their interests in 23 wells, of which
a total of $13,247 and $5,481 remained unpaid by each of them at
December 31, 1995 and 1996, respectively. The Company advanced a
total of $12,132 to Douglas Hosmer for his participation
interests, of which $4,251 and $0 remained outstanding at
December 31, 1995 and 1996, respectively. In June 1995, the
Company's policy regarding the advancement of funds was changed.
Current policy requires that all such purchases of interests in
wells must be paid in cash prior to the drilling of the well.
During 1995, one independent director, Henry Thorne, was
partially compensated for directors' fees and reimbursed for
expenses incurred for board meetings by receiving an assignment
of a 0.5% interest in one well drilled by the Company. The value
of the well interest he received was $1,826, calculated on
approximately the same basis as that under which directors could
have participated in the well under the 1989 policy. In 1996,
Mr. Thorne was also partially compensated for directors' fees and
expenses by receiving an assignment of a 0.5% interest in one
well. The value of the well interest that he received was
$1,864, also calculated on approximately the same basis as that
under which directors and officers could have participated in
the wells under the 1989 policy.
ITEM 13. EXHIBITS, LISTS, AND REPORTS ON FORM 8-K
(a) Certain of the Exhibits set forth in the following index are
incorporated by reference.
3.1 Restated Articles of Incorporation of Royale Energy, Inc.,
incorporated by reference to Exhibit 3.1 of the Company's
Form 10-SB Registration Statement.
3.2 Certificate of Amendment to the Articles of Incorporation of
Royale Energy, Inc. (effecting reverse stock split and
defining certain rights of equity security holders),
incorporated by reference to Exhibit 3.1 of the Company's
Form 8-K dated October 31, 1994.
3.3 Bylaws of Royale Energy, Inc., incorporated by reference to
Exhibit 3.2 of the Company's Form 10-SB Registration
Statement.
4.1 Certificate of Determination of the Series A Convertible
Preferred Stock, incorporated by reference to Exhibit 4.1 of
the Company's Form 10-SB Registration Statement.
25
<PAGE> 28
4.2 Certificate of Determination of the Series AA Convertible
Preferred Stock, incorporated by reference to Exhibit 4.2 of
the Company's Form 10-SB Registration Statement.
10.1 Wellbore Farmout Agreement between Royale Energy Funds,
Inc., and Pacific Gas & Electric Co., dated March 15, 1993,
incorporated by reference to Exhibit 10.2 of the Company's
Form 10-SB Registration Statement.
10.2 Purchase and Sale Agreement between Arkoma Production of
California, et al., and Royale Energy Funds, Inc.,
incorporated by reference to Exhibit 10.1 of the Company's
Form 8-K Report dated April 12, 1994, as amended.
10.3 Form of Indemnification Agreement, incorporated by reference
to Exhibit 10.3 of the Company's Form 10-SB Registration
Statement.
(b) Reports on Form 8-K
The Company filed a Report on Form 8-K dated October 10, 1996, to
report that the Company had retained the Peter Grandich Company
("PGC"), a financial public relations firm, to provide investor
relations consulting services to the Company. PGC assists the
Company in distributing reports concerning the Company's
operations to financial news services and in maintaining contact
between the Company and investors. The Company pays fees to PGC
based on specific financial public relations tasks and events.
26
<PAGE> 29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
ROYALE ENERGY, INC.
Date: April 14, 1997 /s/ DONALD H. HOSMER
Donald H. Hosmer, President
Pursuant to the requirements of the Securities Exchange Act
of 1934, this report has been signed below by the following
persons on behalf of the registrant and in the capacities
indicated.
Date:__________________ ____________________________
Harry E. Hosmer, Chairman of
the Board
Date: April 14, 1997 /s/ DONALD H. HOSMER
Donald H. Hosmer, Chief
Executive Officer,
President, Secretary, and
Director
Date: April 14, 1997 /s/ STEPHEN M. HOSMER
Stephen M. Hosmer, Chief
Financial Officer
and Director
Date: April 14, 1997 /s/ OSCAR A. HILDEBRANDT
Oscar A. Hildebrandt, Director
Date:__________________ ____________________________
Rodney Nahama, Director
Date:__________________ ____________________________
Henry C. Thorne, Director
Date: April 14, 1997 /s/ GEORGE M. WATTERS
George M. Watters, Director
<PAGE> 30
ROYALE ENERGY, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
<TABLE>
<CAPTION>
Page
<S> <C>
Index to Financial Statements F-1
Report of Brown, Armstrong, Randall and Reyes, Independent Auditors F-2
Consolidated Balance Sheets at December 31, 1996 and 1995 F-3
Consolidated Statements of Income for the Years Ended
December 31, 1996 and 1995 F-5
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1996 and 1995 F-6
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1996 and 1995 F-8
Notes to the Consolidated Financial Statements F-10
Supplemental Information About Oil and Gas Producing Activities
(Unaudited) F-24
</TABLE>
Financial statement schedules have been omitted since they are either not
required, are not applicable, or the required information is shown in the
financial statements and related notes.
F-1
<PAGE> 31
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Royale Energy, Inc.
We have audited the accompanying consolidated balance sheets of
Royale Energy, Inc. (a California corporation) and consolidated
subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of income, stockholders' equity and cash
flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly in all material respects, the financial position of Royale
Energy, Inc. and consolidated subsidiaries as of December 31,
1996 and 1995, and the results of their operations and their cash
flows for the years then ended in conformity with generally
accepted accounting principles.
BROWN ARMSTRONG RANDALL & REYES
ACCOUNTANCY CORPORATION
Bakersfield, California
February 14, 1997
F-2
<PAGE> 32
<TABLE>
<CAPTION>
ROYALE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
ASSETS
December 31,
-----------------------
1996 1995
---------- ----------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents $2,595,444 $1,616,860
Accounts receivable 1,928,472 879,165
Receivables from related parties 34,897 24,468
Note receivable 131,847 33,500
Other current assets 190,535 100,730
---------- ----------
Total Current Assets 4,881,195 2,654,723
---------- ----------
Oil and gas properties (successful efforts basis),
equipment and fixtures, net 3,478,707 3,756,646
---------- ----------
OTHER ASSETS
Receivables from related parties, net 3,535 53,376
Deferred costs on trust organization - 125,250
Other - 1,132
---------- ----------
Total Other Assets 3,535 179,758
---------- ----------
$8,363,437 $6,591,127
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 33
<TABLE>
<CAPTION>
ROYALE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
December 31,
-----------------------
1996 1995
---------- ----------
<S> <C> <C>
CURRENT LIABILITIES
Accounts payable and accrued expenses $1,947,705 $2,357,514
Current portion of long-term debt - 113,621
Deferred revenue from turnkey drilling 1,504,041 532,940
---------- ----------
Total Current Liabilities 3,451,746 3,004,075
---------- ----------
Long-Term Debt, net of current portion 300,000 320,043
Redeemable Preferred Stock
Series A, convertible preferred stock, no par value,
259,250 shares authorized; 24,375 and
36,875 shares, respectively, issued and outstanding 79,100 129,100
---------- ----------
STOCKHOLDERS' EQUITY
Common stock, no par value, 10,000,000 shares
authorized; 3,834,049 and 3,980,549 shares,
respectively, issued and outstanding 8,386,273 8,289,398
Convertible preferred stock, Series AA, no par value,
147,500 shares authorized; 115,000 and 135,000
shares, respectively, issued and outstanding 460,000 540,000
Accumulated deficit (4,292,682) (5,691,489)
---------- ----------
Total paid in capital and accumulated deficit 4,553,591 3,137,909
Less cost of treasury stock 4,200 and 0 shares,
respectively (21,000) -
---------- ----------
Total Stockholders' Equity 4,532,591 3,137,909
---------- ----------
$8,363,437 $6,591,127
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 34
<TABLE>
<CAPTION>
ROYALE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
Year Ended December 31,
-----------------------
1996 1995
---------- ----------
<S> <C> <C>
REVENUES
Sale of oil and gas $1,267,919 $ 743,079
Gas distribution 3,625,103 3,277,978
Turnkey drilling 4,775,175 4,091,049
Sale of direct working interests - 13,000
Supervisory fees and other 329,397 215,993
---------- ----------
Total Revenues 9,997,594 8,341,099
---------- ----------
COSTS AND EXPENSES
Cost of gas distribution sales 3,629,991 3,204,261
General and administrative 1,265,814 1,228,378
Turnkey drilling and development 1,530,597 1,520,429
Lease operating 340,331 450,620
Cost of direct working interests sales - 9,285
Lease impairment 215,000 213,938
Legal and accounting 268,683 208,295
Marketing 494,192 292,630
Depreciation, depletion and amortization 479,842 399,212
---------- ----------
Total Costs and Expenses 8,224,450 7,527,048
---------- ----------
INCOME FROM OPERATIONS 1,773,144 814,051
---------- ----------
OTHER (EXPENSE)
Interest (14,926) (64,103)
Loss on asset disposition (357,811) (202,905)
---------- ----------
Total Other (Expense) (372,737) (267,008)
---------- ----------
INCOME BEFORE INCOME TAX EXPENSE 1,400,407 547,043
INCOME TAX EXPENSE 1,600 2,400
---------- ----------
NET INCOME $1,398,807 $544,643
========== ==========
NET INCOME PER COMMON AND COMMON
EQUIVALENT SHARE $ .34 $ .14
========== ==========
NET INCOME PER SHARE - FULLY DILUTED $ .34 $ .14
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 35
<TABLE>
<CAPTION>
ROYALE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
Preferred Stock
Common Stock Series AA Treasury Stock
--------------------- --------------------- ------------------
Number Number
of Shares of Shares
Issued and Issued and Accumulated Number
Outstanding Amount Outstanding Amount Deficit of Shares Amount
--------- ---------- --------- -------- ----------- --------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1995 3,960,299 $8,091,248 147,500 $590,000 $(6,236,132) - $ -
Shares issued in connection
with property acquisition 1,500 - - - - - -
Compensation recognized
on stock options issued - 48,150 - - - - -
Shares issued in connection
with preferred stock
Series A conversion 12,500 100,000 - - - - -
Shares issued (redeemed)
in connection with
preferred stock Series
AA conversion 6,250 50,000 (12,500) (50,000) - - -
Net income - - - - 544,643 - -
--------- ---------- ------- -------- ----------- --------- -------
Balance,
December 31, 1995 3,980,549 $8,289,398 135,000 $540,000 $(5,691,489) - $ -
========= ========== ======= ======== =========== ========= ======
</TABLE>
(Continued on next page)
F-6
<PAGE> 36
<TABLE>
<CAPTION>
ROYALE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996 AND 1995
Preferred Stock
Common Stock Series AA Treasury Stock
------------------- ------------------- ------------------
Number Number
of Shares of Shares
Issued and Issued and Accumulated Number
Outstanding Amount Outstanding Amount Deficit of Shares Amount
--------- ------ --------- ------ ------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 3,980,549 $8,289,398 135,000 $540,000 $(5,691,489) - $ -
Shares issued in connection
with preferred stock
Series A Conversion 6,250 50,000 - - - - -
Shares issued in connection
with preferred stock
Series AA conversion 3,750 30,000 (7,500) (30,000) - - -
Shares issued in connection
with property acquisition
cancelled (166,500) - - - - - -
Shares donation 10,000 16,875 - - - - -
Shares purchased - - - - - 4,200 21,000
Shares redeemed and
cancelled - - (12,500) (50,000) - - -
Net income - - - - 1,398,807 - -
Balance, --------- ---------- ------- -------- ----------- ----- -------
December 31, 1996 3,834,049 $8,386,273 115,000 $460,000 $(4,292,682) 4,200 $21,000
========= ========== ======= ======== =========== ===== =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE> 37
<TABLE>
<CAPTION>
ROYALE ENERGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
1996 1995
---------- ----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $1,398,807 $ 544,643
Adjustment to reconcile net income to net
cash provided by operating activities:
Depreciation, depletion and amortization 479,842 399,212
Loss on disposal of assets 357,811 202,905
Loss on lease impairment 215,000 213,938
Stock option compensation for officers and directors - 48,150
(Increase) decrease in:
Accounts receivable (1,049,307) (26,801)
Receivable from related parties (10,429) (11,596)
Prepaid expenses and other assets (89,805) (17,998)
Notes receivable (98,347) -
Other 1,132 5,222
Increase(Decrease) in:
Accounts payable and accrued expenses (409,809) 796,851
Deferred revenues - DWI 971,101 (251,163)
---------- ----------
Net Cash Provided by Operating Activities 1,765,996 1,903,363
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for oil and gas properties (688,194) (706,842)
Proceeds from sale of oil and gas properties 51,374 1,017
Other capital expenditures (45,769) (30,220)
---------- ----------
Net Cash Used by Investing Activities (682,589) (736,045)
---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
(Increase) decrease in receivable from
related parties, net 49,841 66,199
Proceeds from line of credit 300,000 -
Principal payments on notes payable (433,664) (296,520)
Treasury stock purchased (21,000) -
---------- ----------
Net Cash Used by Financing Activities (104,823) (230,321)
---------- ----------
NET INCREASE IN CASH AND CASH EQUIVALENTS 978,584 936,997
CASH AT BEGINNING OF YEAR 1,616,860 679,863
---------- ----------
CASH AT END OF YEAR $2,595,444 $1,616,860
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-8
<PAGE> 38
<TABLE>
<CAPTION>
ROYALE ENERGY FUNDS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31,
-----------------------
1996 1995
---------- ----------
<S> <C> <C>
SUPPLEMENTAL INFORMATION:
Cash paid for interest $ 14,930 $ 70,248
Cash paid for taxes 1,600 7,852
NONCASH TRANSACTIONS:
Series A preferred stock exchanged
for common stock 50,000 100,000
Compensation recognized on stock options - 48,150
Series AA stock exchanged for common stock 30,000 50,000
Common stock issued for charitable donation 16,875 -
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-9
<PAGE> 39
ROYALE ENERGY, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
This summary of significant accounting policies of Royale Energy, Inc. and
Subsidiaries (the "Company") is presented to assist in understanding the
Company's financial statements. The financial statements and notes are
representations of the Company's management, which is responsible for their
integrity and objectivity. These accounting policies conform to generally
accepted accounting principles and have been consistently applied in the
preparation of the financial statements.
Description of Business
The Company is an independent oil and gas producer which also has operations
in the areas of natural gas marketing and turnkey drilling. The Company owns
wells and leases in major geological basins located in California. The Company
offers fractional working interests and seeks to minimize the risks of oil
and gas drilling by selling multiple well drilling ventures which do not
include the use of debt financing.
Business Combinations
The financial statements for the year ended December 31, 1995 are consolidated
and include the accounts of Royale Energy, Inc. and its wholly owned
subsidiaries, Royale Operating Company, Royale Covenant Securities Corporation
and Royale Natural Gas Marketing, Inc. All significant intercompany accounts
and transactions have been eliminated in the consolidation. At their meeting
of December 15, 1995, the Board of Directors voted to dissolve Royale
Operating Company. During 1996, by Board of Directors action, Royale
Covenant Securities Corporation was sold. Additionally, Royale Natural Gas
Marketing, Inc. was dissolved. The accounts and operations of Royale
Operating Company and Royale Natural Gas Marketing, Inc. were absorbed by
Royale Energy, Inc., and there was no material effect on these financial
statements.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the estimate of Company oil and gas reserves prepared by AN
independent engineering consultant. Such estimates are subject to numerous
uncertainties inherent in the estimation of quantities of proved reserves.
Estimated reserves are used in the calculation of depletion, depreciation and
amortization as well as the Company's assessment of proved oil and gas
properties for impairment.
Revenue Recognition
The Company recognizes revenues from the sales of oil and gas in the period of
delivery.
F-10
<PAGE> 40
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Oil and Gas Property and Equipment (Successful Efforts)
The Company accounts for its oil and gas exploration and development costs
using the successful efforts method. Under this method, costs to acquire
mineral interests in oil and gas properties, to drill and complete development
wells, and drill and complete exploratory wells that find proved reserves are
capitalized. Exploratory dry-hole costs and other exploratory costs,
including geological and geophysical costs, are charged to expense when
incurred. The costs of carrying and retaining unproved properties are also
expensed when incurred. Depletion, depreciation and amortization of oil and
gas producing properties are computed on an aggregate basis using the units-
of-production method.
In March 1995, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 121, "Accounting for
the Impairment of Long-Lived Assets and/or Long-Lived Assets to be Disposed
of." This statement requires that long-lived assets be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount
of an asset may not be recoverable. It establishes guidelines for determining
recoverability based on future net cash flows from the use of the asset and
for the measurement of the impairment loss. Impairment loss under SFAS No. 121
is calculated as the difference between the carrying amount of the asset and
its fair value. Any impairment loss is recorded in the current period in which
the recognition criteria are first applied and met. Under the successful
efforts method of accounting for oil and gas operations, the Company
periodically assessed its proved properties for impairments by comparing the
aggregate net book carrying amount of all proved properties with their
aggregate future net cash flows. The statement requires that the impairment
review be performed on the lowest level of asset groupings for which there are
identifiable cash flows. In the case of the Company, this results in a
property by property impairment review.
The Company adopted SFAS No. 121 in the fourth quarter of 1995, and primarily
as a result of implementation, recorded an impairment loss on certain oil and
gas properties totaling $95,388. The impairment loss on the oil and gas
properties was calculated as the difference between the asset book carrying
amounts and future undiscounted net cash flow projections, giving
consideration to recent prices, pricing trends and estimated reserve
quantities. These projections represent the Company's best estimate of fair
value based on the information available.
In addition to recognition of impairment under SFAS No. 121, management also
periodically assesses the value of significant proved and unproved properties
and charges estimated impairments of value to expense. In 1996 and 1995,
$215,000 and $118,550, respectively, was recorded as an impairment loss based
on management's assessment.
Upon the sale of oil and gas reserves in place, costs less accumulated
amortization of such property are removed from the accounts and resulting gain
or loss on sale is reflected in operations. Upon abandonment of properties,
the reserves are deemed fully depleted and any unamortized costs are recorded
in the statement of operations under loss on leases.
Cash and Cash Equivalents
Cash and cash equivalents include cash on hand and on deposit, and highly
liquid debt instruments with maturities of three months or less.
F-11
<PAGE> 41
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Equipment and Fixtures
Equipment and fixtures are stated at cost and depreciated over the estimated
useful lives of the assets, which range from three to seven years, using the
straight-line method. Repairs and maintenance are charged to expense as
incurred. When assets are sold or retired, the cost and related accumulated
depreciation are removed from the accounts and any resulting gain or loss is
included in income.
Maintenance and repairs, which neither materially add to the value of the
property nor appreciably prolong its life, are charged to expense as incurred.
Gains or losses on dispositions of property and equipment, other than oil and
gas, are reflected in operations.
Capitalization of Interest
Interest cost is capitalized on construction and development programs until
placed into operation.
Deferred Revenue from Turnkey Drilling
The Company enters into turnkey drilling agreements with investors to develop
leasehold acreage acquired by the Company. The Company receives funds from
investors for the drilling and completion of oil and gas wells. If the
drilling effort is successful, each investor receives a working interest in
the wells, and the Company also participates as a working interest owner. In
years previous to 1995, the Company deferred these funds and costs related to
the drilling of wells until the commencement of actual drilling operations,
which usually occurs within one year. At the commencement of drilling, the
Company recognized the associated deferred drilling funds as revenue and
deferred costs as expenses. During the year ended December 31, 1995, the
Company modified the Turnkey Drilling Contract and Investment Program. The
program modifications require a percentage of total funds invested to be used
by the Company to prepay intangible drilling costs and other costs as required
to allow the drilling projects to proceed without delay. These funds are non-
refundable once the investment has been made. The non-refundable portion of
the total Turnkey Drilling investment is based on a percentage calculated by
estimating the pre-drilling costs as a percentage of total drilling costs for
a particular investment. The non-refundable portion of the total investment is
recognized as revenue and the related pre-drilling costs are expensed. Net
revenue recognized for the year ended December 31, 1995, rather than deferred
under the prior Turnkey Drilling Program is $338,635. If costs exceed revenues
and the Company participates as a working interest owner, the excess is
capitalized as the cost of the Company's working interest. If the Company is
unable to drill the wells, the deferred funds received would be returned to
the investors. Included in cash and cash equivalents are amounts restricted
for use in the completion of Turnkey drilling programs in progress. At
December 31, 1996 and 1995, restricted balances for deferred Turnkey drilling
were $1,098,384 and $445,305, respectively.
Deferred Costs on Trust Organization
Deferred costs consist of expenses incurred by the Company to establish an
energy investment trust. The trust was not capitalized at December 31, 1996,
and the $125,250 in deferred costs was charged to operations in 1996.
F12
<PAGE> 42
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Earnings Per Share
The computation of earnings per common and common equivalent share is based
upon the weighted average number of common shares outstanding during the
period plus (in periods in which they have dilutive effect) the effect of
common shares contingently issuable, primarily from stock options and
warrants.
The fully diluted per share computation reflects the effect of warrants in
periods in which such exercise would cause dilution. Fully diluted earnings
per share also reflect additional dilution related to stock options due to the
use of the market price at the end of the period, when market price is higher
than the average price for the period, and convertible preferred stock.
The weighted average number of common and common equivalent shares used to
compute earnings per share is:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995
--------- ---------
<S> <C> <C>
For earnings per common and common equivalent shares 4,077,920 3,968,417
For earnings per share assuming full dilution 4,163,483 3,968,417
</TABLE>
Income Taxes
The provision for income taxes is based on pretax financial accounting income.
Deferred tax assets and liabilities are recognized for the expected tax
consequences of temporary differences between the tax basis of assets and
liabilities and their reported net amounts.
Concentration of Credit Risk
The Company sells oil, gas and natural gas liquids produced by the Company as
well as production purchased from outside sources to utility companies and
manufacturers principally located in California. Revenue generated by these
sales is recognized upon delivery of the product to the purchaser. Credit is
extended based on an evaluation of the customer's financial condition, and
generally collateral is not required. The following summarizes the accounts
receivable balances and sales activity with significant customers for the year
ended December 31, 1996.
<TABLE>
<CAPTION>
Accounts
Customer Receivable Sales
- -------- ---------- ----------
<S> <C> <C>
A $ 19,724 $1,125,432
B - 678,843
C - 498,346
</TABLE>
The Company places its temporary cash investments with a high quality credit
financial institution.
F-13
<PAGE> 43
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Fair Values of Financial Instruments
Disclosure of the estimated fair value of financial instruments is required
under SFAS No. 107, "Disclosure About Fair Value of Financial Instruments."
The fair value estimates are made at discrete points in time based on relevant
market information and information about the financial instruments. These
estimates may be subjective in nature and involve uncertainties and
significant judgment and therefore cannot be determined with precision.
The Company includes fair value in the notes to consolidated financial
statements when the fair value of its financial instruments is different from
the book value. The Company assumes that the book value of financial
instruments that are classified as current approximate fair value because of
the short maturity of these instruments. For noncurrent financial instruments,
the Company uses quoted market prices or, to the extent that there are no
available quoted market prices, market prices for similar instruments.
Reclassification
Certain amounts in the financial statements have been reclassified to be
consistent and comparable from year-to-year.
NOTE 2 - NOTE RECEIVABLE
Notes receivable at December 31, 1996 consist of $103,844 note from an
individual secured by oil and natural gas interests bearing an interest rate
of prime plus 1.5%, and a note from a corporation in the amount of $28,003
secured by Royale Covenant Security Corporation stock, bearing an interest
rate of prime plus 1.5%.
NOTE 3 - OIL AND GAS PROPERTIES, EQUIPMENT AND FIXTURES
Oil and gas properties, equipment and fixtures consist of the following at
December 31:
<TABLE>
<CAPTION>
Oil and Gas
1996 1995
---------- ----------
<S> <C> <C>
Proved properties:
Producing properties, including intangible
drilling costs $2,866,941 $3,013,695
Lease and well equipment 2,030,728 1,983,434
---------- ----------
4,897,669 4,997,129
Accumulated depletion, depreciation and
amortization (1,086,487) (1,104,195)
Reserve for lease impairment (428,938) (213,938)
---------- ----------
3,382,244 3,678,996
---------- ----------
Commercial and Other
Furniture and equipment 214,800 174,654
Accumulated depreciation 118,337 97,004
---------- ----------
96,463 77,650
---------- ----------
$3,478,707 $3,756,646
========== ==========
</TABLE>
F-14
<PAGE> 44
NOTE 3 - OIL AND GAS PROPERTIES, EQUIPMENT AND FIXTURES (Continued)
The following sets forth costs incurred for oil and gas property acquisition
and development activities, whether capitalized or expensed:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Development $ 592,806 $ 706,842
</TABLE>
Results of Operations from Oil and Gas Producing and Exploration Activities
The results of operations from oil and gas producing and exploration
activities (excluding corporate overhead and interest costs) for the two years
ended December 31, are as follows:
<TABLE>
<CAPTION>
1996 1995
---------- ---------
<S> <C> <C>
Oil and gas sales $1,267,919 $ 743,079
Production related costs (340,331) (450,620)
Depreciation, depletion and amortization (458,951) (382,188)
---------- ----------
Results of operations from producing
and exploration activities $ 468,637 $ (89,729)
========== ==========
</TABLE>
NOTE 4 - TURNKEY DRILLING CONTRACTS
The Company receives funds under turnkey drilling contracts which requires the
Company to drill oil and gas wells within a reasonable time period from the
date of receipt of the funds. As of December 31, 1996 and 1995, the Company
had recorded deferred turnkey drilling revenue associated with undrilled wells
of $1,504,041 and $532,940, respectively, as a current liability.
NOTE 5 - LONG-TERM DEBT
Long-term debt at December 31, consist of the following:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Note payable for the purchase of the Arkoma oil and
gas leases in California dated April 12, 1994, maturing
April 12, 1998, interest at prime plus 2.5% compounded
monthly. The prime rate of 8.5% plus the 2.5% spread
resulted in a rate of 11.0% at December 31, 1995.
Monthly payments equaling 40% of gross revenue from
producing properties listed in the note agreement, with a
minimum monthly payment of 2.5% of the outstanding
principal balance, secured by property and 165,000
shares of common stock of Royale Energy, Inc. $ - $ 433,664
</TABLE>
F-15
<PAGE>45
NOTE 5 - LONG TERM DEBT (Continued)
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Revolving line of credit with a maximum available
of $1,250,000 for working capital purposes,
acquisitions, and development of oil and gas
properties. Interest at New York prime plus 150
basis points, resulting in a rate of 9.75% at
December 31, 1996. Interest payable monthly, with
the outstanding principal due at maturity on
May 30, 1998. Secured by property and
assignment of production. 300,000 -
Less current portion - 113,621
---------- ----------
$300,000 $320,043
========== ==========
</TABLE>
Maturities of long-term debt for years subsequent to December 31, 1996 are as
follows:
<TABLE>
<CAPTION>
December 31,
<S> <C>
1997 $ -
1998 300,000
----------
$ 300,000
==========
</TABLE>
The loan agreement for the revolving line of credit prohibits the purchase of
treasury stock; however, the lender has waived this requirement under specific
circumstances. The Company purchased treasury stock under this waiver in 1996.
Subsequent to December 31, 1996, the Company paid the line of credit down in
full.
F-16
<PAGE> 46
NOTE 6 - INCOME TAXES
The provisions for income taxes for the years ended December 31, 1996 and 1995
represents minimum state taxes.
As of December 31, 1996, the Company had federal and state net operating loss
carryforwards as indicated:
<TABLE>
<CAPTION>
Year Year of Net Operating
Originated Expiration Loss
__________ __________ _____________
<S> <C> <C>
1988 2003 $ 50,966
1989 2004 885,795
1990 2005 970,101
1991 2006 227,241
1993 2008 1,654,713
----------
$3,788,816
==========
</TABLE>
The Company files consolidated federal and state tax returns.
The components of the net deferred tax assets were as follows:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Deferred Tax Assets:
Net operating loss carryforwards $1,288,197 $1,664,535
Statutory depletion carryforwards 182,622 -
Accumulated depreciation 94,487 -
---------- ----------
Total Deferred Tax Assets 1,565,306 1,664,535
---------- ----------
Valuation Allowance (1,565,306) (1,664,535)
---------- ----------
Net Deferred Tax Assets $ - $ -
========== ==========
</TABLE>
A full valuation allowance has been established for the deferred tax assets
generated by net operating loss carryforwards due to the uncertainty of future
utilization. Carryforwards available for financial statement purposes to
offset income in future years approximate $2,450,501.
F-17
<PAGE> 47
NOTE 6 - INCOME TAXES (Continued)
A reconciliation of the Company's provision for income taxes and the amount
computed by applying the U.S. statutory federal income tax rate of 34% at
December 31, 1996 and 1995, respectively, to pretax income is as follows:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Tax computed at 34%, respectively $ 476,138 $ 185,995
Increase (decrease) in taxes resulting from:
Net operating loss carryforwards (476,138) (185,995)
State taxes, net of federal income tax benefit 1,600 2,400
---------- ----------
$ 1,600 $ 2,400
========== ==========
Effective Tax Rate 0.1% 0.4%
</TABLE>
NOTE 7 - REDEEMABLE PREFERRED STOCK
In 1993, the Company's Board of Directors authorized the issuance of 259,250
shares of Series A Convertible Preferred Stock which were sold through a
private placement offering. The Series A Convertible Preferred Stock was
offered in units. Each unit consisted of 25,000 shares of Series A
Convertible Preferred Stock and a 0.1% interest in the distributions of the
Royale Energy Income Trust, to be formed. The Company had the right to sell
fractional units. The Series A Convertible Preferred Stock has a stated value
of $4 per share and provides shareholders with a one time 10% dividend payable
thirty days after the expiration of one year from the date of purchase. The
dividend has been paid on all outstanding shares at December 31, 1994. There
were no dividends declared and/or paid during 1995 or 1996.
The Series A Convertible Preferred Stock is convertible any time at the basic
conversion rate of one share of common stock for two shares of Series A
Convertible Preferred Stock, subject to adjustment. The Company has the option
to call, at any time, the Series A Convertible Preferred Stock at either the
issue price of $4 per share plus 10%, if called within one year after
issuance, or $4 per share thereafter. (Subject to the holders' conversion
rights outlined above).
Upon the sale of 50% of the units of beneficial interest in Royal Energy
Income Trust, a holder of Series A Convertible Preferred Stock may require the
Company to redeem their Series A Convertible Preferred Stock at the issue
price of $4 per share plus accrued dividends, if any.
The Series A Convertible Preferred Stock has a liquidation preference to the
common stock equal to $4 per share plus accrued dividends. Holders of Series A
Convertible Preferred Stock shall have voting rights equal to the number of
shares of common stock into which the Series A Convertible Preferred Stock may
be converted.
On October 28, 1993, the Company's Series A Convertible Preferred Stock
shareholders were made a one time offer to convert their Series A Convertible
Preferred Stock to common stock. This conversion would be at one share of
common stock for each share of Series A Convertible Preferred Stock, rather
than at the original conversion price of $4 per share. This conversion would
not affect the shareholders' rights and incentives in the Royale Energy Income
Trust. As of December 31, 1996, 209,875 shares of Series A Convertible
Preferred Stock had been converted to 191,125 shares of common stock.
F-18
<PAGE> 48
NOTE 8 - SERIES AA PREFERRED STOCK
In April 1992, the Company's Board of Directors authorized the sale of Series
AA Convertible Preferred Stock. Holders of Series AA Convertible Preferred
Stock have dividend, conversion and preference rights identical to Series A
Convertible Preferred Stockholders (Note 7). The Series AA Convertible
Preferred Stock does not have the right of redemption at the shareholders'
option. As of December 31, 1996 and 1995, there were 115,000 and 135,000
shares issued and outstanding, respectively. The dividend has been paid on
all shares outstanding at December 31, 1996.
NOTE 9 - COMMON STOCK
During 1996, 3,750 shares of common stock were issued for conversion of 7,500
Series AA Preferred Stock, and 6,250 common shares were issued for conversion
of 12,500 shares of Series A Preferred Stock. Also in 1996, 166,500 common
shares were returned by the holder of the Arkoma note and were cancelled.
Additionally in 1996, 10,000 shares were issued and donated to a charitable
organization.
NOTE 10 - STOCK WARRANTS
Changes in the Company's common stock warrants were as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1996 1995
---------- ----------
<S> <C> <C>
Outstanding warrants at beginning of period 480,555 480,555
Additional warrants issued
- Exercise of stock warrants - -
- Warrants expired or ineligible 250,000 -
---------- ----------
Outstanding warrants at end of period 230,555 480,555
</TABLE>
The Company's affiliate, RPC, acquired 111,111 shares of the Company's common
stock during the year ended December 31, 1993, at a purchase price of
$333,333. This transaction was pursuant to the exercise of a stock purchase
warrant granted to RPC by the Company's Board of Directors on December 18,
1992, to purchase a maximum of 166,666 shares at the minimum bid price on
December 18, 1992 of $3.00 per share. Warrants to purchase the remaining
55,555 additional shares pursuant to this grant will expire on December 31,
1997.
At the November 3, 1993 Board of Directors meeting, the Board of Directors
granted RPC additional warrants to purchase 175,000 shares of the Company's
common stock at prices ranging from $1.50 to $3.00 per share. This grant will
expire on December 31, 1997. As of December 31, 1996, no warrants were
exercised pursuant to this grant. The difference between market and option
prices, $75,000, was recorded as compensation for the RPC shareholders.
F-19
<PAGE> 49
NOTE 11 - OPERATING LEASES
In November 1991, the Company entered into a forty-three month noncancellable
operating lease for the rental of office space which expired in July 1995.
The lease provided for annual rent escalations resulting in rent payments
which range from $8,260 to $14,868 over the term of the lease. The
accompanying consolidated financial statements reflect rent expense on a
straight-line basis over the term of this lease.
In August 1995, the Company entered into a new sixty month noncancellable
operating lease, which expires in July 2000. The lease calls for monthly
payments ranging from $10,875 to $12,325. Future minimum lease obligations as
of December 31, 1996 are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
<S> <C>
1997 $ 136,665
1998 141,013
1999 145,359
2000 86,275
-----------
$ 509,312
==========
</TABLE>
Rental expense for the years ended December 31, 1996 and 1995, was $132,911
and $99,488, respectively.
NOTE 12 - COMMITMENTS AND CONTINGENCIES
Litigation
The Company occasionally becomes party to lawsuits which arise in the ordinary
course of business. In the opinion of management, based on advice of legal
counsel, pending or threatened litigation involving the Company will not have
a material adverse affect upon its financial condition or results of
operations.
NOTE 13 - RELATED PARTY TRANSACTIONS
Significant Ownership Interests
On December 31, 1996, 27.48% of the Company's common stock was owned by Royale
Petroleum Corporation (RPC). RPC is a company which is owned equally by Donald
H. Hosmer and Stephen M. Hosmer. The Company's former president and former
chief executive officer, Harry E. Hosmer, is principal adviser to trusts which
own 10.43% of the Company's common stock at December 31, 1996. Donald H. and
Stephen M. Hosmer are sons of Harry E. Hosmer. Donald H. Hosmer and Stephen
M. Hosmer are also officers and directors of the Company.
F-20
<PAGE> 50
NOTE 13 - RELATED PARTY TRANSACTIONS (Continued)
Related Party Receivables
Amounts due from officers were $34,897 and $75,845 at December 31, 1996 and
1995, respectively. Receivables from other related parties amounted to $3,535
and $1,999 on December 31, 1996 and 1995, respectively.
Stock Compensation Plan
On December 18, 1992, the Board of Directors granted the directors and
executive officers of the Company 60,000 options to purchase common stock at
an exercise or base price of $1.50 per share. All options are exercisable on
or after the second anniversary of the date of grant. Also on this date, the
Board of Directors voted to adopt a policy of awarding stock options to key
employees based on performance, with a minimum of 5,000 shares and maximum of
15,000 shares per employee. The details of this policy have not yet been
formulated and no such options have been awarded under the policy.
At the March 10, 1995 Board of Directors meeting, directors and executive
officers of the Company were granted 154,000 options to purchase common stock
at an exercise or base price of $1.90 per share. These options were granted
for a period of ten years, and may be exercised after the second anniversary
of the grant. The Company applies APB Opinion 25 and related interpretations
in accounting for its plans. Accordingly, the Company recorded $48,150 as
compensation expense for the directors and officers in 1995. Had compensation
cost for the Company's stock-based compensation plan been determined based on
the fair value at the grant date for awards consistent with the method of FASB
Statement 123, the Company's net income and earnings per share would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <S> <C> <C>
Net income As reported $1,398,807 $ 544,643
Pro forma 1,398,807 384,893
Primary earnings per share As reported $ .34 $ .14
Pro forma .34 .10
Fully diluted earnings
per share As reported $ .34 $ .14
Pro forma .34 .10
</TABLE>
The fair value of the option grant was estimated on the date of granting using
the Black-Scholes American option-pricing model with the following
assumptions: risk-free interest rate 7.5 percent, dividend yield rate of zero,
expected life of 8.2 years, and volatility of 57.7 percent.
F-21
<PAGE> 51
NOTE 13 - RELATED PARTY TRANSACTIONS (Continued)
Stock Compensation Plan (Continued)
A summary of the status of the Company's stock option plan as of December 31,
1996 and 1995, and changes during the years ending on those dates is presented
below:
<TABLE>
<CAPTION>
1996 1995
-------------------------- ------------------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
------- -------------- ------- --------------
<S> <C> <C> <C> <C>
Fixed Options
Outstanding at beginning
of year 214,000 $1.79 60,000 $1.50
Granted - 154,000 1.90
Exercised - -
------- -------
Outstanding at end of year 214,000 214,000
======= =======
Options exercisable at
year end 60,000 60,000
Weighted-average fair
value of options granted
during the year $ - $ 1.35
</TABLE>
The following table summarizes information about fixed stock options
outstanding at December 31, 1996:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
----------------------------------------------- --------------------------------
Weighted-
Number Average Number
Range of Outstanding at Remaining Weighted- Outstanding at Weighted-
Exercise December 31, Contractual Average December 31, Average
Prices 1996 Life (Years) Exercise Price 1995 Exercise Price
- -------- ------------ ------------ -------------- ------------ --------------
<C> <C> <C> <C> <C> <C>
$ 1.50 60,000 6.0 $ 1.50 60,000 $1.50
$ 1.90 154,000 8.2 1.90 - -
------- ------
$1.50 to
$1.90 214,000 7.6 1.79 60,000 1.50
======= ======
</TABLE>
The Board of Directors adopted a policy in 1989 that permits directors and
officers of the Company to purchase from the Company, at the Company's book
value, up to one percent of a fractional interest in any well to be drilled by
the Company. Current and former officers and directors, and a trust organized
for the benefit of the family of a Company officer, received as compensation
or were billed $21,774 and $9,049 for their interests for the years ended
December 31, 1996 and 1995, respectively.
F-22
<PAGE> 52
NOTE 14 - ENVIRONMENTAL MATTERS
The Company has established procedures for the on-going evaluation of its
operations to identify potential environmental exposures and assure compliance
with regulatory policies and procedures. Management monitors these laws and
regulations and periodically assesses the propriety of its operational and
accounting policies related to environmental issues. The nature of the
Company's business requires routine day-to-day compliance with environmental
laws and regulations. The Company incurred no environmental investigation,
compliance and remediation costs in 1996 or 1995.
The Company is unable to predict whether its future operations will be
materially affected by these laws and regulations. It is believed that
legislation and regulations relating to environmental protection will not
materially affect the results of operations of the Company.
NOTE 15 - LITIGATION SETTLEMENTS
In 1996, the Company agreed to purchase 37,500 shares of its common stock from
an investor as part of a litigation settlement. The stock was to be purchased
at a total price of $187,500 in no more than eighteen monthly installments
beginning no later than December 1, 1996. As of December 31, 1996, the Company
had purchased 4,200 shares at a cost of $21,000.
NOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Operating revenues, operating income, net income, and earnings per common
share by quarters from 1996 and 1995 are shown below. The Company, in its
opinion, has included all adjustments necessary for a fair presentation of the
results of operations for the quarters. Due to the nature of Turnkey Drilling
Revenues, which are recognized at specified times over program development on
specified wells, annual amounts are not generated evenly by quarter during
the year.
<TABLE>
<CAPTION>
Earnings Weighted
Net (Loss) per Average
Income Common Shares
Quarter Ended Net Sales Gross Profit (Loss) Share Outstanding
- ----------------- ---------- ------------ ---------- ---- -----------
<S> <C> <C> <C> <C> <C>
December 31, 1996 $3,008,221 $1,299,194 $ 538,377 0.14 3,909,277
1995 2,968,263 1,287,846 412,176 0.10 3,803,234
September 30, 1996 $2,860,866 1,029,360 440,803 0.11 3,962,359
1995 2,180,406 855,276 382,067 0.10 3,608,675
June 30, 1996 $2,333,053 1,215,756 382,653 0.10 3,960,299
1995 2,164,167 611,950 300,300 0.08 3,522,913
March 31, 1996 $1,795,454 496,414 36,974 0.01 3,960,299
1995 1,028,263 763 (549,900) (0.14) 3,479,139
</TABLE>
F-23
<PAGE> 53
ROYALE ENERGY, INC. AND SUBSIDIARIES
SUPPLEMENTAL INFORMATION ABOUT OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)
The following estimates of proved oil and gas reserves, both developed and
undeveloped, represent interests owned by the Company located solely in the
United States. Proved reserves represent estimated quantities of crude oil
and natural gas which geological and engineering data demonstrate to be
reasonably certain to be recoverable in the future from known reservoirs under
existing economic and operating conditions. Proved developed oil and gas
reserves are reserves that can be expected to be recovered through existing
wells, with existing equipment and operating methods. Proved undeveloped oil
and gas reserves are reserves that are expected to be recovered from new wells
on undrilled acreage, or from existing wells for which relatively major
expenditures are required for completion.
Disclosures of oil and gas reserves which follow are based on estimates
prepared by independent engineering consultants for the years ended December
31, 1996 and 1995. Such estimates are subject to numerous uncertainties
inherent in the estimation of quantities of proved reserves and in the
projection of future rates of production and the timing of development
expenditures. These estimates do not include probable or possible reserves.
These estimates are furnished and calculated in accordance with requirements
of the Financial Accounting Standards Board and the Securities and Exchange
Commission (SEC). Because of unpredictable variances in expenses and capital
forecasts, crude oil and natural gas price changes, largely influenced and
controlled by U.S. and foreign government actions, and the fact that the bases
for such estimates vary significantly, management believes the usefulness of
these projections is limited. Estimates of future net cash flows presented do
not represent management's assessment of future profitability or future cash
flows to the Company. Management's investment and operating decisions are
based upon reserve estimates that include proved reserves prescribed by the
SEC as well as probable reserves, and upon different price and cost
assumptions from those used here.
It should be recognized that applying current costs and prices and a 10
percent standard discount rate does not convey absolute value. The discounted
amounts arrived at are only one measure of the value of proved reserves.
F-24
<PAGE> 54
Changes in Estimated Reserve Quantities
<TABLE>
The net interest in estimated quantities of proved developed reserves of crude
oil and natural gas at December 31, 1996 and 1995 and changes in such
quantities during each of the years then ended, were as follows:
<CAPTION>
1996 1995
------------------ ------------------
Oil Gas Oil Gas
(BBL) (MCF) (BBL) (MCF)
------ ---------- ------ ---------
<S> <C> <C> <C> <C>
Proved developed and
undeveloped reserves:
Beginning of period 22,401 9,383,850 21,877 6,627,837
Revisions of previous estimates (20,732) 2,071,879 15,598 4,225,321
Production (22) (672,383) (15,074) (3,211,572)
Extensions, discoveries and
improved recovery - 2,125,976 - 1,747,478
Purchase of minerals in place - - - -
Sale of minerals in place - - - (5,214)
------ ---------- ------- ---------
Proved reserves end of period 1,647 12,909,322 22,401 9,383,850
====== ========== ======= =========
Gas equivalent reserve 16,470 224,010
====== =======
Proved developed reserves:
Beginning of period 1,852 4,121,616 1,464 3,280,953
====== ========== ======= =========
End of period 1,647 6,978,805 1,852 4,121,616
</TABLE>
Standardized measure of discounted future net cash flows relating to proved
oil and gas reserves
The standardized measure of discounted future net cash flows is presented
below for the two years ended December 31, 1996.
The future net cash inflows are developed as follows:
(1) Estimates are made of quantities of proved reserves and the future
periods during which they are expected to be produced based on year-
end economic conditions.
(2) The estimated future production of proved reserves is priced on the
basis of year-end prices.
(3) The resulting future gross revenue streams are reduced by estimated
future costs to develop and to produce proved reserves, based on
year end estimates.
(4) The resulting future net revenue streams are reduced to present
value amounts by applying a ten percent discount.
Disclosure of principal components of the standardized measure of discounted
future net cash flows provides information concerning the factors involved in
making the calculation. In addition, the disclosure of both undiscounted and
discounted net cash flows provides a measure of comparing proved oil and gas
reserves both with and without an estimate of production timing. The
standardized measure of discounted future net cash flow relating to proved
reserves reflects estimated income taxes.
F-25
<PAGE> 55
<TABLE>
<CAPTION>
1996 1995
----------- ------------
<S> <C> <C>
Future cash inflows $45,882,082 $16,418,681
Future production costs (11,985,243) (6,691,945)
Future development costs (2,263,988) (2,390,356)
Future income tax expenses (9,489,856) (1,922,643)
Future net cash flows 22,142,995 5,413,737
10% annual discount for estimated timing
of cash flows (10,121,742) (2,716,322)
Standardized measure of discounted
future net cash flow $12,021,253 $2,697,415
</TABLE>
Changes in standardized measure of discounted future net cash flow from proved
reserve quantities
This statement discloses the sources of changes in the standardized measure
from year to year. The amount reported as "Net changes in prices and
production costs" represents the present value of changes in prices and
production costs multiplied by estimates of proved reserves as of the
beginning of the year. The "accretion of discount" was computed by multiplying
the ten percent discount factor by the standardized measure on a pretax basis
as of the beginning of the year. The "Sales of oil and gas produced, net of
production costs" are expressed in actual dollar amounts. "Revisions of
previous quantity estimates" is expressed at year-end prices. The "Net change
in income taxes" is computed as the change in present value of future income
taxes.
<TABLE>
<CAPTION>
1996 1995
---------- ----------
<S> <C> <C>
Standardized measure - beginning of year $ 2,697,415 $2,558,613
----------- ----------
Sales of oil and gas produced,
net of production costs (970,483) (2,263,723)
Revisions of estimates of reserves provided
in prior years:
Net changes in prices and production costs 10,634,281 1,042,311
Sales of minerals in place - (1,136)
Extensions, discoveries and improved recovery 3,722,480 1,441,927
Accretion of discount (57,512) (21,087)
Net change in income taxes (4,004,928) (59,490)
Net increase 9,323,838 138,802
Standardized measure - end of year $12,021,253 $2,697,415
=========== ==========
</TABLE>
F-26
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
REGISTRANT'S FINANCIAL STATEMENTS AND RELATED NOTES CONTAINED IN FORM 10-KSB AS
FILED HEREWITH, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS AND RELATED NOTES.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 2,595,444
<SECURITIES> 0
<RECEIVABLES> 2,095,216
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,881,195
<PP&E> 5,100,388
<DEPRECIATION> (1,633,762)
<TOTAL-ASSETS> 8,363,437
<CURRENT-LIABILITIES> 3,451,746
<BONDS> 0
79,100
460,000
<COMMON> 8,386,273
<OTHER-SE> (4,313,682)
<TOTAL-LIABILITY-AND-EQUITY> 8,363,437
<SALES> 9,668,197
<TOTAL-REVENUES> 9,997,594
<CGS> 5,500,919
<TOTAL-COSTS> 8,224,450
<OTHER-EXPENSES> 357,811
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 14,926
<INCOME-PRETAX> 1,400,407
<INCOME-TAX> 1,600
<INCOME-CONTINUING> 1,398,807
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,398,807
<EPS-PRIMARY> .34
<EPS-DILUTED> .34
</TABLE>
