[DESCRIPTION] FORM 10-KSB
<PAGE> 1
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, 1997Commission File No. 0-22750
ROYALE ENERGY, INC.
(Name of Small Business Issuer in its charter)
California 33-0224120
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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: $9,066,126
At March 31, 1998, there were outstanding 2,719,968 shares of
registrant's Common Stock held by non-affiliates, with an aggregate
market value of approximately $11,559,864, based on the closing Nasdaq
price on that date.
At March 31, 1998, there were outstanding a total of 3,864,300 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 24.
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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 Holders9
PART II. . . . . . . . . . . . . . . . . . . . . . . . . . . . .9
Item 5. Market Price of the Company's Common Stock and Related
Stockholder Matters . . . . . . . . . . . . . . .9
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . 10
Item 7. Financial Statements and Supplementary Data . . 14
Item 8. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. . . . . . . . . . . . 14
Part III . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Item 9. Directors, Executive Officers, Promoters and Control
Persons, Compliance with Section 16(a) of the Exchange Act14
Item 10. Executive Compensation. . . . . . . . . . . . . 17
Item 11. Security Ownership of Certain Beneficial Owners and
Management. . . . . . . . . . . . . . . . . . . 19
Item 12. Certain Relationships and Related Transactions. 22
Item 13. Exhibits, Lists, and Reports on Form 8-K. . . . 24
Signatures. . . . . . . . . . . . . . . . . . . . . . . . 25
Financial Statements. . .. . .. . .. . .. . .. . .. . .. . . F-1
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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 (symbol
ROYL); prior to that date, it was traded on the Nasdaq Small Cap Market.
On March 21, 1998, the Company had 13 full time employees.
During the fiscal year ended December 31, 1997, the Company continued
its exploration and development of natural gas properties in northern
California. The Company drilled thirteen wells in 1997, of which it
elected to complete nine as commercially productive wells. Four wells
drilled in 1997 were plugged and abandoned as dry holes. The Company's
estimated total natural gas reserves rose from approximately 12.9 Bcf at
January 1, 1997 to 16.9 Bcf at January 1, 1998.
For the years ended December 31, 1997 and 1996, the Company reported
gross revenues in the amounts of $5,638,437 and $4,775,175,
respectively, in connection with the drilling of wells on a turnkey
contract basis, which represents 62.2% and 47.8% of the Company's total
revenues for those years. These amounts are offset by drilling expenses
and development costs of $3,163,945 and $1,530,597, respectively. The
Company hires, in addition to its own engineering staff, independent
contractors to drill, test, complete and equip the wells that it drills.
For the years ended December 31, 1997, and 1996, the Company had oil and
natural gas sales from production of its wells in the amounts of
$2,992,679 and $1,267,919, respectively, which represents 33.0% and
12.7%, of the Company's total revenues for those years.
Plan of Business
The Company is engaged in the acquisition of interests in oil and
natural gas reserves by sponsoring private joint ventures. Management
believes that the Company's shareholders are better served by
diversification and limitation of total exposure in individual drilling
projects. Through its participation in joint ventures, the Company can
acquire interests and develop oil and
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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 development and exploratory oil and
natural gas wells on its property. To the extent that the Company
retains all or any portion of the working interest, the Company pays its
proportionate share of the actual cost of drilling, testing, and
completing the project.
The Company may also elect to finance part of the drilling cost by
selling fractional interests in undeveloped wells. 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, the Company recognized gross revenue
for the amount paid by the purchaser and agrees to pay the expense of
drilling and development of the well for the participants. The actual
drilling and development costs may or may not be greaterthan the gross
revenue which is recognized by the Company for its fractional interest
sales.
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 Financial Statements. The Company maintains internal
records of the expenditure of each investor's funds for drilling
projects.
Wells completed by the Company are generally operated by the Company. As
operator, the Company receives fees set by industry standards from the
owners of fractional interests in the wells and expense reimbursements.
For the years ended December 31, 1997, and 1996, the Company (and its
former subsidiary) earned gross revenues in the amounts of $388,085 and
$329,397, from operation of the wells, which represent 4.3% and 3.3% of
the Company's total revenues on a consolidated basis for those years,
respectively. As of January 1, 1998, the Company is the operator of 51
natural gas wells on properties leased by the Company in the Sacramento
Basin in California.
* * *
The Company's business is not dependent on a single customer or a few
customers and management does not believe it will be in the foreseeable
future. Oil and natural gas purchasers are readily available in today's
markets, and the Company does not believe that the loss of any customer
would have a material affect on the Company's business or ability to
find ready
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purchasers for its oil and gas production at current market prices.
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. In December 1996, the Company's
gas marketing operations were discontinued.
The oil business is not generally seasonal in nature. Natural gas
demand and the prices paid for gas have become seasonal, showing
decreases in the summer and fall.
Affiliated Entities
On December 31, 1997, Royale Petroleum Corporation ("RPC") owned 27.14%
of the Company's Common Stock (excluding rights to purchase shares
pursuant to warrants). 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, 1997.
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.
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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
Production, transportation, and sale of oil and natural gas from the
Company's operations are affected to some degree by federal and state
laws and 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 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.
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.
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Item 2. Description of Property
Since 1993, the Company has concentrated on development of properties in
the Sacramento Basin of Northern California. In 1997, the Company
drilled nine commercially productive gas wells and four dry holes in
Northern California. In 1996, the Company drilled five commercially
productive gas wells and four dry holes in Northern California. The
Company also owns interests in 35 existing wells in Northern California
as a result of purchases of producing properties during 1994 and 1997.
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 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 Company has available a $5,000,000 revolving credit line from a
major commercial bank for working capital purposes, acquisitions, and
development of oil and gas properties. At December 31, 1997, $3,900,000
in loans were outstanding under this credit line. All of the Company's
oil and gas properties and an assignment of production are pledged to
secure this credit line.
The following is a discussion of the Company's significant oil and
natural gas properties. Reserves at January 1, 1998, for each property
discussed below, have been determined by Mark E. Andersen, Professional
Engineer, in accordance with his report dated March 28, 1998 (the most
recent report available).
Northern California
The Company owns lease interests in 36,906.44 gross (26,175.30 net)
acres in the Sacramento and San Joaquin Basins in Northern California.
At December 31, 1997, the Company operated 51 wells in Northern
California, and its estimated total gas reserves in Northern California
were approximately 16.3 Bcf, according to the Company's independently
prepared reserve report.
During 1997, the Company acquired interests in sixteen gas wells and one
sale water disposal well in the Sacramento Basin from Vernon E.
Faulconer, Inc., for a purchase price of approximately $3.3 million.
The Company expects to drill additional wells on the Faulconer leases,
which cover approximately 10,000 acres. All of the Company's drilling
and development operations in 1997
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were conducted in Northern California, and it expects to continue
drilling in this region during 1998.
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, 1998, of 605,616 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.
Developed and Undeveloped Leasehold Acreage
As of December 31, 1997, the Company owned leasehold interests in the
following developed and undeveloped properties in both gross and net
acreage.
<TABLE>
<CAPTION>
Developed Undeveloped
Gross Net Gross Net
Acres Acres Acres Acres
<S> <C> <C> <C> <C>
California 9,946.53 6,785.59 26,959.91 19,389.71
Texas 1,386.30 1,188.81 1,494.65 1,494.65
All other States 2,421.00 216.00 - -
Total 13,753.83 8,190.40 28,454.56 20,884.36
</TABLE>
Drilling Activities
The following table sets forth the Company's drilling activities during
the years ended December 31, 1995, 1996, and 1997. All wells are
located in the Continental U.S., in California, Texas, Oklahoma, and
North Dakota.
<TABLE>
<CAPTION>
Gross Wells(b) Net Wells
---------------------------- --------------------
Year Type of Well(a) Total Producing(c) Dry (d) Producing(c) Dry(d)
<S> <S> <C> <C> <C> <C> <C>
1995 Exploratory 1 - 1 - 0.1000
Developmental 7 6 1 1.2360 0.1762
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Gross Wells(b) Net Wells
---------------------------- --------------------
Year Type of Well(a) Total Producing(c) Dry (d) Producing(c) Dry(d)
1996 Exploratory 1 - 1 - 0.3263
Developmental 1 5 3 1.2573 1.0383
1997 Exploratory 3 1 2 .4430 .6150
Developmental 10 8 2 3.1507 .7650
</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.
(d) A dry well is a well that is not deemed capable of producing
hydrocarbons in paying quantities.
As of December 31, 1997, the Company had 3 gross (0.058 net) oil
wells and 46 gross (20.87 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.
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<TABLE>
<CAPTION>
12 Months 12 Months 12 Months
Ended Ended Ended
12/31/97 12/31/96 12/31/95
<S> <C> <C> <C>
NET VOLUME
Oil (Bbl) 679 22 543
Gas (Mcf) 1,365,562 672,383 576,894
Mcfe 1,376,334 672,603 582,324
AVERAGE SALES PRICE
Oil (Bbl) $14.42 $16.07 $15.63
Gas (Mcf) $2.26 $1.79 $1.41
Net Production
Costs & Taxes $460,768 $260,789 $373,859
Lifting Costs $0.34 $0.37 $0.64
</TABLE>
Net Proved Oil and Natural Gas Reserves
As of January 1, 1998, the Company had proved developed reserves of
8,606,456 Mcf of natural gas and 4,698 barrels of oil, and total proved
reserves of 16,882,699 Mcf of natural gas and 4,698 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.
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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 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, 1997 and
1996, prepared by the Company's independent reserve engineering
consultants.
Item 3. Legal Proceedings
In May 1997 a suit was filed in San Diego, California, Superior Court
against the Company, its chairman, its president, and other defendants
(Lucille F. Beigel, et al., v. Royale Energy, Inc., et al., No. 710630).
This is a case alleging fraud, breach of contract, and related claims
brought by several direct working interest owners and one Company
shareholder who invested primarily in the Texas wells from 1989 to 1994.
Discovery has commenced. The Company has denied any wrongdoing,
believes it has meritorious defenses including the statute of
limitations, and intends to vigorously contest the allegations of the
complaint.
Item 4. Submission of Matters to a Vote of Security Holders
During the fourth quarter of fiscal 1997, 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, 1997, a total of 3,864,300 shares of the Company's
Common Stock were issued and outstanding which were held by
approximately 1,100 shareholders and of which 2,468,913 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 March 31, 1998, approximately ten 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 1996 through December 1997. 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>
1996 2 1 3 2 3 2 5 4 1/4
1997 3 41/16 5 4 5 37/16 5 1/4 3
</TABLE>
Dividends
The Company has not declared or paid any cash 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.
Issuance of Common Stock upon Conversion of Preferred Stock
During the fourth quarter of 1997, 2,500 shares of the Company's Common
Stock were issued to a holder of the Company's previously issued Series
A Convertible Preferred Stock, pursuant to the individual exercise by
one shareholder of the right to convert shares of Preferred Stock to
Common Stock. The sole consideration received by the Company was the
Preferred Stock surrendered in the conversion. Each outstanding share
of Series A Preferred Stock is convertible to Common Stock at a ratio of
one share of Common Stock to be issued for each two shares of Preferred.
The Preferred Stock had originally been issued prior to 1994 in a
private placement pursuant to Section 4(2) of the Securities Act of
1933, and to the extent, if any, that the individual shareholder's
conversion of Preferred shares to Common might be considered a sale of
securities, the 1997 issuance of Common upon conversion of Preferred
shares was also made pursuant to Section 4(2) of the Securities Act of
1933.
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) changes 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 6,995,275 Mcfe at January 1, 1997 to 8,658,502 at January 1,
1998, a 23.8% increase, while the Company's
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estimated total natural gas reserves increased from 12,925,792 Mcfe at
January 1, 1997, to 17,031,701 Mcfe at January 1, 1998, a 31.8%
increase. The Company's management attributes this increase to the
successful drilling of nine commercially productive wells during 1997.
The Company valued its oil and gas properties at $9,380,742 at December
31, 1997, an increase of $5,998,498 (177%) from $3,382,244 at December
31, 1996. In June 1997, the Company purchased lease interests covering
approximately 10,000 acres in the Sacramento Basin, Northern California,
including interests in sixteen gas wells and one salt water disposal
well, for approximately $3.3 million, of which price $3 million was
financed from its banking line of credit. The remaining increase in oil
and gas properties is attributable to successful drilling and
development operations in Northern California and to capitalization of
the repurchase of interests in wells previously drilled by the Company
as part of settlement of a lawsuit in October 1997. See, Notes 1 and 14
to the Company's Financial Statements.
During 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128 (SFAS 128),
"Earnings Per Share," which was adopted by the Company for the year
ended December 31, 1997. SFAS 128 replaces the presentation of primary
earnings per share with a presentation of basic earnings per share based
upon the weighted average number of common shares for the period. See,
Note 1 to the Company's Financial Statements.
The Company has reviewed its management information systems to determine
whether, in the Year 2000, it can expect any difficulties with its
computer systems which may be encountered by software systems which do
not adequately identify dates which end in years with "00" as the last
two digits. Based on its review, the Company has not identified or
encountered any such problems. The Company uses mainly "off the shelf"
software programs and is receiving updated programs as available from
its software suppliers to the extent that any of these programs may
require Year 2000 updates.
Results of Operations for the Twelve Months Ended December 31, 1997, as
Compared to the Twelve Months Ended December 31, 1996
For the year ended December 31, 1997, the Company reported a net profit
of $1,510,383, a 111,576 (8.0%) increase from the net profit of
$1,398,807 in 1996. Total revenues and expenses for the year ended
December 31, 1997 both decreased from 1996. Revenues for 1997 were
$9,066,125, compared to $9,997,594 in 1996, and 1997 expenses were
$7,304,467, compared to $8,224,450 in 1996. The decrease in total
revenues and expenses can be primarily attributed to discontinuance at
the end of 1996 of the Company's natural gas marketing program, which
had contributed significant revenues but marginal profits. On the other
hand, the Company's revenues from its core businesses of oil and gas
sales and turnkey drilling both increased in 1997, and with the result
that the Company's income from operations and after tax income both
increased substantially over 1996, and profits from oil and gas
production rose $1,453,654, or 157%, from $927,588 in 1996 to $2381,242
in 1997.
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Oil and gas revenues for the year ended December 31, 1997 were
$2,992,679 compared to $1,267,919 for the same period in 1996, which
represents a $1,724,760 or 136.0% increase. This increase in revenues
was mainly due to the increase in gas production. The net sales volume
for the year ended December 31, 1997, was 1,365,562 Mcf with an average
price of $2.26 per Mcf, versus 672,383 Mcf with an average price of
$1.79 per Mcf for the same period in 1996. The Company's net sales
volume for oil production was 679 barrels with an average price of
$14.42 per Bbl for the period ended December 31, 1997, compared to 22
barrels at an average price of $16.07 per Bbl for the same period in
1996.
The Company's oil and gas production costs, which are comprised of lease
operating expenses, increased 79.7% to 611,437 for the year ended
December 31, 1997, a $271,106 increase from $340,331 for the same period
in 1996. This increase in costs can be attributed to the Company's
expanded production operations from additional wells during 1997. For
fiscal 1997, the Company's gross margins on oil and gas production were
119%, compared to 73.24% in 1996. The increase in gross margin was due
to the increase in the average price the Company received for its
natural gas during 1997.
For the year ended December 31, 1996, turnkey drilling revenues
increased $863,262, from $4,775,175 to $5,638,437, or 18.1% for the
year. The Company experienced a $1,633,348 or 106.7% increase in
drilling and development costs from $1,530,597 in 1996 to $3,163,945.
This increase in turnkey revenues and expenses was due to the Company's
drilling of 13 wells, 9 of which were commercially productive, that were
sold to outside parties in 1997, versus nine productive wells and four
dry holes in 1996. The Company's gross margins, or profits, on drilling
depend on the Company's ability to accurately estimate the costs
associated with the development 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
43.9% and 67.9% for the years ended December 31, 1997 and 1996,
respectively.
The aggregate of supervisory fees and other income was $388,085 for the
year ended December 31, 1997, an increase of $58,688 (17,8%) from
$329,397 during the same period in 1996. 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
$95,499 or 51.3%, from $186,065 in 1996 to $281,564 in 1997. This
change can be attributed to the increased number of wells that the
Company operates.
Depreciation, depletion and amortization expense increased to $665,694
from $479,842, an increase of $185,852 (38.7%) for the year ended
December 31, 1997, as compared to 1996. This increase in expense can be
attributed to the drilling of 13 new wells during 1997.
12
<PAGE> 15
The Company periodically reviews its long-lived assets for impairment
whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable, pursuant to SFAS No. 121. 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 $215,000 was
recorded as an impairment loss for 1996 and $300,000 was recorded as an
impairment loss for 1997.
During 1996, the Company realized losses from sale of Texas leasehold
interests and discontinuance of unprofitable operations totaling
$357,811. The Company had no such losses on asset dispositions during
1997. The Company believes that the disposition of Texas operations and
focus on relatively more profitable California operations have increased
the Company's operating efficiency.
General and administrative expenses increased by $171,232, or 13.5%,
from $1,265,814 for the year ended December 31, 1996, to $1,437,046 for
the same period in 1997. Legal and accounting expense increased to
$658,864 for the same period, compared to $268,683 for the year in 1996,
a $390,181 (145.2%) increase. This increase can be attributed to trial
litigation costs during the summer of 1997. Marketing expense for the
year ended December 31, 1997 decreased $50,452 or 10.2%, to $443,740,
compared to $494,192 for the same period in 1996. 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.
The Company discontinued its gas marketing division at the end of 1996.
These marketing operations had contributed a large share of revenues and
expenses but a relatively insignificant net revenue. In 1997, the
Company recorded one brokered natural gas sale during 1997 of $46,925,
which was offset by cost of sales of $23,741. The Company regards the
1997 sale as only an isolated trade rather than a continuing marketing
effort, but the Company intends to take advantage of any such trading
opportunities, should they arise in the future.
During the first half of 1997, the Company obtained a credit line from a
major commercial bank, which it has used to purchase the California
assets of Vernon E. Faulconer, Inc. Because of borrowings pursuant to
this credit line, interest expense dramatically increased to $134,799 in
1997 from $14,296 in 1996.
Capital Resources and Liquidity:
At December 31, 1997, the Company had current assets totaling $4,185,090
and current liabilities totaling $3,848,582. The Company's working
capital surplus at December 31, 1997, was $336,508, compared to a
working capital surplus at December 31, 1996. of $1,429,449. The
decrease in working capital surplus in 1997 was due mainly to use of
working capital to purchase revenue generating assets and to better
manage interest expenses by reducing the Company's revolving line of
credit. In addition, the Company drew upon its revolving line of credit
for approximately $3,900,000 during 1997. Management believes that the
Company has sufficient liquidity for the
13
<PAGE> 16
short term.
Operating Activities. For the year ended December 31, 1996, cash
provided by operating activities totaled $2,998,779 compared to
$1,765,996 provided by operations for the same period in 1995. This
increase in cash provided can be mainly attributed to the decrease in
accounts receivable for the year in 1997 when compared to 1996.
Investing Activities. Net cash used by investing activities, primarily
in capital acquisitions of oil and gas properties, amounted to
$6,929,049 for the period, compared to $682,5889 used by investing
activities for the same period in 1996. The increase due to
expenditures of $6,929,049 for oil and gas properties in 1997, compared
to only $688,194 for property acquisition in 1996.
Financing Activities. For the year ended December 31, 1997, net cash
provided by financing activities was $3,434,179, compared to cash used
by financing activities for the period in 1996 of $104,823. The reason
for the increase in cash provided for financing in 1997 was the
Company's use of its credit line in 1997 to acquire oil and gas
properties.
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, Promoters and 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.
14
<PAGE> 17
<TABLE>
<CAPTION>
First Became Director
Name Age or Executive Officer Positions Held
- ---- --- ---------------------- --------------
<S> <C> <C> <C>
Harry E. Hosmer* 67 1987 Chairman of the Board.
Donald H. Hosmer 41 1987 President, Secretary and
Director. Chairman of
the Board and President
of Royale Petroleum
Corporation ("RPC").
Stephen M. Hosmer 31 1991 Chief Financial Officer
and Director. Secretary
and Director of RPC.
Oscar A.
Hildebrandt+ 62 1995 Director.
Rodney Nahama 66 1994 Director.
Henry C. Thorne*+ 67 1991 Director and Assistant
Secretary.
George M. Watters*+ 78 1991 Director.
</TABLE>
* Member of the audit committee.
+ 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 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 was 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
15
<PAGE> 18
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.
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.
16
<PAGE> 19
Mr. Watters received his Bachelor of Science
degree from Massachusetts Institute of Technology in 1942.
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. During 1997, the Company did not receive 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 1997.
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, 1997, 1996, and 1995.
17
<PAGE> 20
<TABLE>
<CAPTION>
Long Term
Annual Compensation Compensation
------------------- Awards
(a) (b) (c) (d) (e)
Name Period Covered Salary Compensation Underlying Options
- ----- -------------- ------- ------------- ------------------
<S> <S> <C> <C> <C>
Donald H. FYE 12/31/97 $103,974 $356
Hosmer, CEO FYE 12/31/96 $100,000 $703 -
FYE 12/31/95 $100,000 $785 30,000
Harry E.
Hosmer, FYE 12/31/97 $110,000 $299
Chairman FYE 12/31/96 $122,444 $882 -
FYE 12/31/95 $110,000 $1,295 30,000
</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 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.
In 1997, the Company did not maintain a retirement plan or "Section
401(k)" compensation plan on behalf of its employees.
18
<PAGE> 21
Stock Options Granted in 1997
No stock options were granted to officers, directors, or employees
during 1997.
Aggregated 1996 Option Exercises and Year-End Values
Neither of the Named Officers exercised any stock options or stock
appreciation rights in 1997, 1996, or 1995. The following table
summarizes the number and value of all unexercised stock options held by
the Named Officers at the end of 1997.
<TABLE>
<CAPTION>
(a) (b) (c)
Number of Securities Value of Unexercised In-the-
Underlying Unexercised Money Options/SARs at FY-
Options/SARs at FY-End (#) End ($) 1
Name Exercisable/Unexercisable 2 Exercisable/Unexercisable
- ------------------------------------------------------------------------------
<S> <C> <C>
Harry E. Hosmer 45,000/0 $182,700/0
Donald H. Hosmer 45,000/0 $182,700/0
</TABLE>
1 Based on a fair market value of $4.06 per share, which was the closing
bid price of the Company's Common Stock in the Nasdaq National Market
System on December 31, 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 1997. The following table sets forth information
regarding the cash compensation paid to directors, other than Named
Officers, in 1997.
<TABLE>
<CAPTION>
(a) (b)
Annual Retainer
Name Fees
<S> <C>
Oscar Hildebrandt $6,800
Rodney Nahama $6,800
Henry C. Thorne $6,800
George M. Watters $6,800
</TABLE>
19
<PAGE> 22
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, 1997,
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, 1997, 3,864,300 shares of the Company's Common Stock
were outstanding.
<TABLE>
<CAPTION>
Shares Owned (1)
----------------
Shareholder (2) Number Percent
--------------- ------ -------
<S> <C> <C>
Royale Petroleum Corporation 1,279,243 (3), (4) 31.24%
Donald H. Hosmer 1,325,243 (3), (4) 32.42%
Harry E. Hosmer 45,000 (4) 1.15%
Oscar A. Hildebrandt 62,422 (5) 1.61%
Stephen M. Hosmer 1,310,793 (3), (4) 32.04%
Owen LeTissier
St. Peter Port
Guernsey, Channel Islands 400,000 (6) 10.35%
Rodney Nahama 14,000 0.36%
Henry C. Thorne 33,472 0.86%
George M. Watters 77,500 (7) 1.99%
All directors and officers as a group
(7 persons) 1,588,887 (3) 36.87%
</TABLE>
(1) Includes shares which the listed shareholder has the right to acquire
before March 1,1998, from options or warrants, as follows: Royale
Petroleum Corporation 230,555, Donald H. Hosmer 45,000, Harry E. Hosmer
45,000, Stephen M. Hosmer 30,000, Oscar Hildebrandt 20,000, Rodney
Nahama 14,000, Henry C. Thorne 30,000, George M. Watters 30,000, and all
officers and directors as a group 214,000.
20
<PAGE> 23
(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 1,048,688 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 as the Trustee of two foreign charitable trusts.
(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, 1997, there were
16,875 shares of Series A and 50,000 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 % Number %
- --------------- ------ - ------ -
<S> <C> <C> <C> <C>
Richard G. and Margaret E. Algire 3,125 18.6%
Marjorie Carson 6,250 12.50%
June L. Ginnings 3,125 6.25%
Virginia L. Hoffman 7,500 44.4%
Overland Bank 6,250 12.50%
21
<PAGE> 24
Series A Series AA
------------- -------------
Shareholder (1) Number % Number %
- --------------- ------ - ------ -
Audrey Sanabria & B.G. Dienelt, Jr. 3,125 6.25%
George Singleton 6,250 12.50%
Charles Swaner 6,250 12.50%
James S. Trowbridge 6,250 37.0%
William W. Well 6,250 12.50%
Jerome Winston 6,250 12.50%
Nim E. Wire 6,250 12.50%
All officers and directors as a group
(7 persons). 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.
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,
22
<PAGE> 25
retail investors in working interests, such as sales commission, if any,
or marketing expenses. The 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 25
wells under the 1989 policy. Donald and Stephen Hosmer have also
participated in 26 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.
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 1994, 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 1996, Director Oscar 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 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
23
<PAGE> 24
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
$4,767 and $3,328.29 remained outstanding at December 31, 1996 and 1997,
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 $5,481 and $4,418.77 remained unpaid by
each of them at December 31, 1996 and 1997, 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 1996, 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
$1,864, calculated on approximately the same basis as that under which
directors could have participated in the well 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.
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
24
<PAGE> 27
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 no Reports on Form 8-K during the last fiscal quarter
of 1997.
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.
4/20/98 /s/ Donald H. Hosmer
Date:------------------ ------------------------------------
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.
4/20/98 /s/ Harry E. Hosmer
Date:------------------- ------------------------------------
Harry E. Hosmer, Chairman of the Board
4/20/98 /s/ Donald H. Hosmer
Date:------------------- -------------------------------------
Donald H. Hosmer, Chief Executive Officer,
President, Secretary, and Director
4/20/98 /s/ Stephen M. Hosmer
Date:------------------- -------------------------------------
Stephen M. Hosmer, Chief Financial Officer
and Director
Date:------------------- -------------------------------------
Oscar A. Hildebrandt, Director
Date:------------------- --------------------------------------
Rodney Nahama, Director
Date:------------------- --------------------------------------
Henry C. Thorne, Director
4/20/98 /s/ George M. Watters
Date:------------------- --------------------------------------
George M. Watters, Director
25
<PAGE> 28
<TABLE>
<CAPTION>
ROYALE ENERGY, INC.
INDEX TO FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
Page
----
<S> <C>
Index to Financial Statements . . . . . . . . . . . . . . . . . . . . . . . F-1
Report of Brown, Armstrong, Randall and Reyes, Independent Auditors . . . . F-2
Balance Sheets at December 31, 1997 and 1996. . . . . . . . . . . . . . . . F-3
Statements of Income for the Years Ended
December 31, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . . . . F-5
Statements of Stockholders' Equity for the
Years Ended December 31, 1997 and 1996 . . . . . . . . . . . . . . . . . F-6
Statements of Cash Flows for the Years
Ended December 31, 1997 and 1996 . . . . . . . . . . . . . . . . . . . . F-8
Notes to the Financial Statements . . . . . . . . . . . . . . . . . . . . . F-10
Supplemental Information About Oil and Gas Producing Activities (Unaudited) F-23
<FN>
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.
</TABLE>
F-1
<PAGE> 29
REPORT OF INDEPENDENT AUDITORS
Shareholders and Board of Directors
Royale Energy, Inc.
We have audited the accompanying balance sheets of Royale Energy, Inc. (a
California corporation) as of December 31, 1997 and 1996, and the related
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 audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly in all
material respects, the financial position of Royale Energy, Inc., as of December
31, 1997 and 1996, and the results of their operations and their cash flows for
the years then ended in conformity with generally accepted accounting
principles.
/S/ BROWN ARMSTRONG RANDALL & REYES
BROWN ARMSTRONG RANDALL & REYES
ACCOUNTANCY CORPORATION
Bakersfield, California
February 27, 1998
F-2
<PAGE> 30
<TABLE>
<CAPTION>
ROYALE ENERGY, INC.
BALANCE SHEETS
ASSETS
December 31,
-------------------------
1997 1996
------------- ----------
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents . . . . . . . . . $ 2,032,001 $2,595,444
Accounts receivable . . . . . . . . . . . . 1,823,388 1,928,472
Receivables from related parties. . . . . . 34,218 34,897
Note receivable . . . . . . . . . . . . . . 159,024 131,847
Other current assets. . . . . . . . . . . . 136,459 190,535
------------- ----------
Total Current Assets. . . . . . . . . . . 4,185,090 4,881,195
------------- ----------
OIL AND GAS PROPERTIES (SUCCESSFUL
EFFORTS BASIS), EQUIPMENT AND FIXTURES, NET 9,509,414 3,478,707
------------- ----------
OTHER ASSETS
Receivables from related parties, net . . . 9,652 3,535
------------- ----------
$ 13,704,156 $8,363,437
============= ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE> 31
<TABLE>
<CAPTION>
ROYALE ENERGY, INC.
BALANCE SHEETS
LIABILITIES AND STOCKHOLDERS' EQUITY
December 31,
----------------------------
1997 1996
-------------- ------------
<S> <C> <C>
CURRENT LIABILITIES
Accounts payable and accrued expenses . . . . . . . . $ 2,112,756 $ 1,947,705
Deferred revenue from turnkey drilling. . . . . . . . 1,735,826 1,504,041
-------------- ------------
Total Current Liabilities . . . . . . . . . . . . . 3,848,582 3,451,746
-------------- ------------
LONG-TERM DEBT, NET OF CURRENT PORTION. . . . . . . . . 3,900,000 300,000
-------------- ------------
REDEEMABLE PREFERRED STOCK
Series A, convertible preferred stock, no par value,
259,250 shares authorized; 16,875 and
24,375 shares, respectively, issued and outstanding 49,100 79,100
-------------- ------------
STOCKHOLDERS' EQUITY
Common stock, no par value, 10,000,000 shares
authorized; 3,864,300 and 3,834,049 shares,
respectively, issued and outstanding. . . . . . . . 8,676,273 8,386,273
Convertible preferred stock, Series AA, no par value,
147,500 shares authorized; 50,000 and 115,000
shares, respectively, issued and outstanding. . . . 200,000 460,000
Accumulated deficit . . . . . . . . . . . . . . . . . (2,782,299) (4,292,682)
-------------- ------------
Total paid in capital and accumulated deficit . . . 6,093,974 4,553,591
Less cost of treasury stock 37,500 and 4,200 shares,
respectively. . . . . . . . . . . . . . . . . . . . (187,500) (21,000)
-------------- ------------
Total Stockholders' Equity. . . . . . . . . . . . . 5,906,474 4,532,591
-------------- ------------
$ 13,704,156 $ 8,363,437
============== ============
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE> 32
<TABLE>
<CAPTION>
ROYALE ENERGY, INC.
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
Year Ended December 31,
------------------------
1997 1996
----------- -----------
<S> <C> <C>
REVENUES
Sale of oil and gas . . . . . . . . . . . $2,992,679 $1,267,919
Gas distribution. . . . . . . . . . . . . 46,925 3,625,103
Turnkey drilling. . . . . . . . . . . . . 5,638,437 4,775,175
Supervisory fees and other. . . . . . . . 388,085 329,397
----------- -----------
Total Revenues. . . . . . . . . . . . . 9,066,126 9,997,594
----------- -----------
COSTS AND EXPENSES
Cost of gas distribution sales. . . . . . 23,741 3,629,991
General and administrative. . . . . . . . 1,437,046 1,265,814
Turnkey drilling and development. . . . . 3,163,945 1,530,597
Lease operating . . . . . . . . . . . . . 611,437 340,331
Lease impairment. . . . . . . . . . . . . 300,000 215,000
Legal and accounting. . . . . . . . . . . 658,864 268,683
Marketing . . . . . . . . . . . . . . . . 443,740 494,192
Depreciation, depletion and amortization. 665,694 479,842
----------- -----------
Total Costs and Expenses. . . . . . . . 7,304,467 8,224,450
----------- -----------
INCOME FROM OPERATIONS. . . . . . . . . . . 1,761,659 1,773,144
----------- -----------
OTHER (EXPENSE)
Interest. . . . . . . . . . . . . . . . . (149,725) (14,926)
Loss on asset disposition . . . . . . . . - (357,811)
----------- -----------
Total Other (Expense) . . . . . . . . . (149,725) (372,737)
----------- -----------
INCOME BEFORE INCOME TAX EXPENSE. . . . . . 1,611,934 1,400,407
INCOME TAX EXPENSE. . . . . . . . . . . . . 101,551 1,600
----------- -----------
NET INCOME. . . . . . . . . . . . . . . . . $1,510,383 $1,398,807
=========== ===========
DILUTED EARNINGS PER SHARE. . . . . . . . . $ .37 $ .34
=========== ===========
BASIC EARNINGS PER SHARE. . . . . . . . . . $ .39 $ .36
=========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE> 33
<TABLE>
<CAPTION>
ROYALE ENERGY, INC.
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
canceled. . . . . . . . . (166,500) - - - - - -
Shares donation . . . . . . 10,000 16,875 - - - - -
Shares purchased. . . . . . - - - - - 4,200 21,000
Shares redeemed and
canceled. . . . . . . . . - - (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>
(Continued on next page)
F-6
<PAGE> 34
<TABLE>
<CAPTION>
ROYALE ENERGY, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
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, 1997. . 3,834,049 $8,386,273 115,000 $ 460,000 $(4,292,682) 4,200 $ 21,000
Shares issued in connection
with preferred stock
Series A Conversion . . . 3,750 30,000 - - - - -
Shares issued in connection
with preferred stock
Series AA conversion. . . 32,501 260,000 - - - - -
Shares purchased. . . . . . - - - - - 33,300 166,500
Shares redeemed and
canceled. . . . . . . . . (6,000) - (65,000) (260,000) - - -
Net income. . . . . . . . . - - - - 1,510,383 - -
------------ ---------- ------------ ---------- ------------ --------- --------
Balance,
December 31, 1997 . . . . 3,864,300 $8,676,273 50,000 $ 200,000 $(2,782,299) 37,500 $187,500
============ ========== ============ ========== ============ ========= ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-7
<PAGE> 35
<TABLE>
<CAPTION>
ROYALE ENERGY, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1997 AND 1996
Year Ended December 31,
--------------------------
1997 1996
------------ ------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income . . . . . . . . . . . . . . . . . . . . . . $ 1,510,383 $ 1,398,807
Adjustment to reconcile net income to net
cash provided by operating activities:
Depreciation, depletion and amortization . . . . . . 665,694 479,842
Loss on disposal of assets . . . . . . . . . . . . . - 357,811
Loss on lease impairment . . . . . . . . . . . . . . 300,000 215,000
Stock option compensation for officers and directors - -
(Increase) decrease in:
Accounts receivable. . . . . . . . . . . . . . . . 105,084 (1,049,307)
Receivable from related parties. . . . . . . . . . (6,117) (10,429)
Prepaid expenses and other assets. . . . . . . . . 54,076 (89,805)
Notes receivable . . . . . . . . . . . . . . . . . (27,177) (98,347)
Other. . . . . . . . . . . . . . . . . . . . . . . - 1,132
Increase(Decrease) in:
Accounts payable and accrued expenses. . . . . . . 165,051 (409,809)
Deferred revenues - DWI. . . . . . . . . . . . . . 231,785 971,101
------------ ------------
Net Cash Provided by Operating Activities. . . . . 2,998,779 1,765,996
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for oil and gas properties. . . . . . . . (6,929,049) (688,194)
Proceeds from sale of oil and gas properties . . . . . 7,307 51,374
Other capital expenditures . . . . . . . . . . . . . . (74,659) (45,769)
------------ ------------
Net Cash Used by Investing Activities. . . . . . . (6,996,401) (682,589)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
(Increase) decrease in receivable from
related parties, net . . . . . . . . . . . . . . . . 679 49,841
Proceeds from line of credit . . . . . . . . . . . . . 3,900,000 300,000
Principal payments on notes payable. . . . . . . . . . (300,000) (433,664)
Treasury stock purchased . . . . . . . . . . . . . . . (166,500) (21,000)
------------ ------------
Net Cash Provided (Used) by Financing Activities . 3,434,179 (104,823)
------------ ------------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS. . . . . . . . . . . . . . . . . . . (563,443) 978,584
CASH AT BEGINNING OF YEAR. . . . . . . . . . . . . . . . 2,595,444 1,616,860
------------ ------------
CASH AT END OF YEAR. . . . . . . . . . . . . . . . . . . $ 2,032,001 $ 2,595,444
============ ============
</TABLE>
(Continued on next page)
F-8
<PAGE> 36
<TABLE>
<CAPTION>
ROYALE ENERGY FUNDS, INC.
STATEMENTS OF CASH FLOWS
Year Ended December 31,
-----------------------
1997 1996
-------- -------
<S> <C> <C>
SUPPLEMENTAL INFORMATION:
Cash paid for interest. . . . . . . . . . . $149,725 $14,930
Cash paid for taxes . . . . . . . . . . . . 101,551 1,600
NONCASH TRANSACTIONS:
Series A preferred stock exchanged
for common stock. . . . . . . . . . . . . 30,000 50,000
Series AA stock exchanged for common stock. 260,000 30,000
Common stock issued for charitable donation - 16,875
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-9
<PAGE> 37
ROYALE ENERGY, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
----------------------------------------------
This summary of significant accounting policies of Royale Energy, Inc. (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 area of 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
- ----------------------
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 the remaining operations of Royale Natural Gas Marketing, Inc. were
absorbed by Royale Energy, Inc. The results of these actions eliminated all
subsidiaries of the Company and there was no material effect on these financial
statements from these actions.
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.
F-10
<PAGE> 38
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
----------------------------------------------
Revenue Recognition
- --------------------
The Company recognizes revenues from the sales of oil and gas in the period of
delivery.
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, along with the investors, receive an assignment of working
interests. 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 pay their share of the land 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. 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, and a suitable replacement well is not
found, the deferred funds received would be returned to the investors. Included
in cash and cash equivalents are amounts for use in the completion of Turnkey
drilling programs in progress.
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 field by field impairment review.
In 1997 and 1996, $300,000 and $215,000, 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.
F-11
<PAGE> 39
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
----------------------------------------------
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.
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.
Earnings Per Share (SFAS 128)
- --------------------
In February 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 128 (SFAS 128), "Earnings Per
Share", which was adopted by the Company for the year ended December 31, 1997.
SFAS 128 replaces the presentation of primary earnings per share with a
presentation of basic earnings per share based upon the weighted average number
of common shares for the period. It also requires dual presentation of basic
and diluted earnings per share for companies with complex structures.nds
invested to be used
Basic and diluted earnings per share are calculated as follows:
<TABLE>
<CAPTION>
For the Year Ended 1997
---------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------ ------------- ----------
<S> <C> <C> <C>
Basic EPS
Income available to common stockholders . . $ 1,510,391 3,861,589 $ .39
==========
Effect of dilutive securities stock options - 244,006
------------ -------------
Diluted EPS
Income available to common stockholders . . $ 1,510,391 4,105,595 $ .37
============ ============= ==========
</TABLE>
<TABLE>
<CAPTION>
For the Year Ended 1996
---------------------------------------
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------ ------------- ----------
<S> <C> <C> <C>
Basic EPS
Income available to common stockholders . . $ 1,398,807 3,909,277 $ .36
==========
Effect of dilutive securities stock options - 254,206
------------ -------------
Diluted EPS
Income available to common stockholders . . $ 1,398,807 4,163,483 $ .34
============ ============= ==========
</TABLE>
F-12
<PAGE> 40
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
----------------------------------------------
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.
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 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.
New Accounting Pronouncements
- -------------------------------
In June 1997, the FASB issued Statement of Financial Accounting Standards No.
130 (SFAS 130), Reporting Comprehensive Income. This statement requires that
all items that are required to be recognized under accounting standards as
components of comprehensive income be reported in a financial statement that is
displayed with the same prominence as other financial statements. SFAS 130 will
be adopted by the Company for the year ended December 31, 1998. Prior period
financial statements provided for comparative purposes will be reclassified, as
required. Upon adoption, the Company does not expect SFAS 130 to have a
material affect upon the Company's financial condition or results of operations.
In June 1997, the FASB issued Statements of Financial Accounting Standards No.
131 (SFAS 131), Disclosures about Segments of an Enterprise and Related
Information. The statement requires the Company to report income/loss, revenue,
expense and assets by business segment including information regarding the
revenues derived from specific products and services and about the countries in
which the Company is operating. The Statement also requires that the Company
report descriptive information about the way that operating segments were
determined, the products and services provided by the operating segments,
differences between the measurements used in reporting segment information and
those used in the Company's general-purpose financial statements, and changes in
the measurement of segment amounts from period to period. SFAS 131 will be
adopted by the Company for the year ended December 31, 1998. This statement has
no affect on financial statements traditionally presented by the Company, but
increases required disclosures.
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, 1997 consist of $136,155 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 $22,869 secured
by Royale Covenant Security Corporation stock, bearing an interest rate of prime
plus 1.5%.
F-13
<PAGE> 41
NOTE 3 - OIL AND GAS PROPERTIES, EQUIPMENT AND FIXTURES
----------------------------------------------------
Oil and gas properties, equipment and fixtures consist of the following at
December 31:
Oil and Gas
- -------------
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Proved properties:
Producing properties, including intangible
drilling costs . . . . . . . . . . . . . . . . . $ 9,384,604 $ 2,866,941
Lease and well equipment . . . . . . . . . . . . . 2,442,696 2,030,728
------------ ------------
11,827,300 4,897,669
Accumulated depletion, depreciation and amortization (1,717,620) (1,086,487)
Reserve for lease impairment . . . . . . . . . . . . (728,938) (428,938)
------------ ------------
9,380,742 3,382,244
------------ ------------
Commercial and Other
- ------------------------------------------------------
Furniture and equipment. . . . . . . . . . . . . . . 282,153 214,800
Accumulated depreciation . . . . . . . . . . . . . . (153,481) 118,337
------------ ------------
128,672 96,463
------------ ------------
$ 9,509,414 $ 3,478,707
============ ============
</TABLE>
The following sets forth costs incurred for oil and gas property acquisition and
development activities, whether capitalized or expensed:
<TABLE>
<CAPTION>
1997 1996
---------- --------
<S> <C> <C>
Acquisition $3,999,087 $138,409
Development $5,150,617 $592,806
</TABLE>
In July 1997, the Company acquired additional working interests in producing
wells and properties with development potential. In exchange for these working
interests and properties, the Company gave consideration of cash by utilizing
their credit line and cash in the bank.
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>
1997 1996
----------- -----------
<S> <C> <C>
Oil and gas sales. . . . . . . . . . . . $2,992,679 $1,267,919
Production related costs . . . . . . . . (611,437) (340,331)
Depreciation, depletion and amortization (631,133) (458,951)
----------- -----------
Results of operations from producing
and exploration activities . . . . . . $1,750,109 $ 468,637
=========== ===========
</TABLE>
F-14
<PAGE> 42
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, 1997 and 1996, the Company had
recorded deferred turnkey drilling revenue associated with undrilled wells of
$1,735,826 and $1,504,041, respectively, as a current liability.
NOTE 5 - LONG-TERM DEBT
---------------
<TABLE>
<CAPTION>
1997 1996
---------- --------
<S> <C> <C>
Revolving line of credit with a maximum available
of $5,000,000 for working capital purposes,
acquisitions, and development of oil and gas
properties. Interest at New York prime plus 137.5
and 150 basis points, resulting in rates of 9.875%
and 9.75% at December 31, 1997 and 1996, respectively.
Interest payable monthly, with the outstanding
principal due at maturity on May 30, 1999. Secured
by property and assignment of production. . . . . . . . $3,900,000 $300,000
Less current portion. . . . . . . . . . . . . . . . . . - -
---------- --------
$3,900,000 $300,000
========== ========
</TABLE>
Maturities of long-term debt for years subsequent to December 31, 1997 are as
follows:
<TABLE>
<CAPTION>
December 31,
- ------------
<S> <C>
1999 $3,900,000
==========
</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
and 1997.
NOTE 6 - INCOME TAXES
-------------
The provisions for income taxes for the years ended December 31, 1997 and 1996
represents minimum state taxes.
As of December 31, 1997, the Company had federal net operating loss
carryforwards as indicated:
<TABLE>
<CAPTION>
Year Year of Net Operating
Originated Expiration Loss
- ----------- --------------
<S> <C> <C>
1988. . . . 2004 $ 127,792
1989. . . . 2005 885,795
1990. . . . 2006 970,101
1991. . . . 2007 1,654,713
1992. . . . 2008 227,241
--------------
3,865,642
==============
</TABLE>
F-15
<PAGE> 43
NOTE 6 - INCOME TAXES (Continued)
---------------
The components of the net deferred tax assets were as follows:
<TABLE>
<CAPTION>
1997 1996
------------ ------------
<S> <C> <C>
Deferred Tax Assets:
Net operating loss carryforwards. $ 1,314,318 $ 1,288,197
Statutory depletion carryforwards 182,622 182,622
Accumulated depreciation. . . . . 94,487 94,487
------------ ------------
Total Deferred Tax Assets . . . . . 1,591,427 1,565,306
------------ ------------
Valuation Allowance . . . . . . . . (1,591,427) (1,565,306)
------------ ------------
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.
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, 1997 and 1996, respectively, to pretax income is as follows:
<TABLE>
<CAPTION>
1997 1996
---------- ----------
<S> <C> <C>
Tax computed at 34%, respectively. . . . . . $ 513,533 $ 476,138
Increase (decrease) in taxes resulting from:
Net operating loss carryforwards . . . . . (513,533) (476,138)
State taxes. . . . . . . . . . . . . . . . 101,551 1,600
---------- ----------
$ 101,551 $ 1,600
========== ==========
Effective Tax Rate . . . . . . . . . . . . . 5.6% 0.1%
========== ==========
</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 1996 or 1997.
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).
F-16
<PAGE> 44
NOTE 7 - REDEEMABLE PREFERRED STOCK (Continued)
------------------------------
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, 1997, 217,375 shares of Series A Convertible
Preferred Stock had been converted to 194,875 shares of common stock.
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. The Series AA Convertible Preferred Stock
does not have the right of redemption at the shareholders' option. As of
December 31, 1997 and 1996, there were 50,000 and 115,000 shares issued and
outstanding, respectively. The dividend has been paid on all shares outstanding
at December 31, 1997.
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 canceled. Additionally
in 1996, 10,000 shares were issued and donated to a charitable organization.
During 1997, 32,501 shares of common stock were issued for conversion of 65,000
Series AA Preferred Stock, and 3,750 common shares were issued for conversion of
7,500 shares of Series A Preferred Stock. Also, in 1997, 6,000 shares were
canceled as a result of a settlement agreement executed in 1996. This
settlement agreement was not material to the Company as a whole.
NOTE 10 - STOCK WARRANTS
---------------
Changes in the Company's common stock warrants were as follows:
<TABLE>
<CAPTION>
Year Ended Year Ended
December 31, December 31,
1997 1996
------------ ------------
<S> <C> <C>
Outstanding warrants at beginning of period 230,555 480,555
Additional warrants issued
- Exercise of stock warrants . . . . . . - -
- Warrants expired or ineligible . . . . - 250,000
------------ ------------
Outstanding warrants at end of period . . . 230,555 230,555
============ ============
</TABLE>
F-17
<PAGE> 45
NOTE 10 - STOCK WARRANTS (Continued)
---------------
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. The expiration date to purchase the remaining 55,555
additional shares pursuant to this grant has been extended through December 31,
2002.
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. The expiration
date of this grant has been extended through December 31, 2002.
NOTE 11 - OPERATING LEASES
-----------------
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, 1997 are as follows:
<TABLE>
<CAPTION>
Year Ended December 31,
- -----------------------
<S> <C>
1998 $141,013
1999 145,359
2000 86,275
--------
372,647
========
</TABLE>
Rental expense for the years ended December 31, 1997 and 1996, was $138,664 and
$132,911, respectively.
NOTE 12- RELATED PARTY TRANSACTIONS
----------------------------
Significant Ownership Interests
- ---------------------------------
On December 31, 1997, 27.14% 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.
Harry E. Hosmer, the Company's former president and former chief executive
officer, is principal adviser to trusts which own 10.35% of the Company's common
stock at December 31, 1997. 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.
Related Party Receivables
- ---------------------------
Amounts due from officers were $34,218 and $34,897 at December 31, 1997 and
1996, respectively. Receivables from other related parties amounted to $9,652
and $3,535 on December 31, 1997 and 1996, respectively.
F-18
<PAGE> 46
NOTE 12- RELATED PARTY TRANSACTIONS (Continued)
----------------------------
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 and
contractors based on performance. The full authorization of 15,000 shares have
been awarded to Jack Conley.
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. The Company did not
grant stock options during 1997 or 1996.
A summary of the status of the Company's stock option plan as of December 31,
1997 and 1996, and changes during the years ending on those dates is presented
below:
<TABLE>
<CAPTION>
1997 1996
------------------------- ------------------------
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
-------- --------------- ------- ---------------
<S> <C> <C> <C> <C>
Fixed Options
Outstanding at beginning
of year. . . . . . . . 214,000 $ 1.79 214,000 $ 1.79
Granted. . . . . . . . . - -
Exercised. . . . . . . . - -
-------- -------
Outstanding at end of year 214,000 214,000
======== =======
Options exercisable at
year end . . . . . . . . 214,000 60,000
======== ======
Weighted-average fair
value of options granted
during the year. . . . . $ - $ -
</TABLE>
The following table summarizes information about fixed stock options outstanding
at December 31, 1997:
<TABLE>
<CAPTION>
1997 1996
---- ----
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
-------- --------------- ------- ---------------
<S> <C> <C> <C> <C>
Fixed Options
Outstanding at beginning
of year. . . . . . . . 214,000 $ 1.79 214,000 $ 1.79
Granted. . . . . . . . . - -
Exercised. . . . . . . . - -
-------- ---------------
Outstanding at end of year 214,000 214,000
======== ===============
Options exercisable at
year end . . . . . . . . 214,000 60,000
======== ===============
Weighted-average fair
value of options granted
during the year. . . . . $ - $ -
</TABLE>
The following table summarizes information about fixed stock options outstanding
at December 31, 1997:
<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 1997 Life (Years) Exercise Price 1996 Exercise Price
- --------- -------------------- -------------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C> <C>
$ 1.50 60,000 5.0 $ 1.50 60,000 6.0
$ 1.90 154,000 7.2 $ 1.90 154,000 8.2
-------------------- ---------------
1.50 to
$ 1.90 214,000 6.6 $1.50 to $1.90 214,000 7.6
==================== ===============
F-19
<PAGE> 47
NOTE 12 - RELATED PARTY TRANSACTIONS (Continued)
----------------------------
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 actual
cost, up to one percent of a fractional interest in any well to be drilled by
the Company. Current and former officers and directors received as compensation
or were billed $35,475 and $21,774 for their interests for the years ended
December 31, 1997 and 1996, respectively.
NOTE 13 - 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 1997 or 1996.
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 14 - COMMITMENTS AND CONTINGENCIES
---------------------------------
In 1996, the Company agreed to purchase 37,500 shares of its common stock from
an investor as part of a mediated settlement of litigation. The stock was
purchased at a total price of $187,500 with 4,200 shares purchased in December
of 1996 for $21,000 and the remaining 33,300 shares purchased for $166,500
during 1997. As of December 31, 1997, the Company had satisfied their
obligation under the agreement, however, 18,900 or the 37,500 shares had not
been received by the Company from the investor.
In October 1997, the Company settled its litigated issues with Stanley L.
Worthington. To avoid further litigation on this matter, the Company agreed to
re-purchase Mr. Worthington's oil and gas working interests. The re-purchase
amount, although material to the financial statements, remains confidentially
sealed in the court approved agreement.
On or about May 21, 1997 an action was brought against the Company by Lucille F.
Biegel, et al., San Diego Superior Court Case 710630. In the action thirteen
present or former shareholders of the Company and direct working interest owners
in various Royale Energy drilling programs from 1989 through 1994 have alleged
breach of contract and fraud, among other claims, in connection with their
purchase of stock and direct working interests. At present there are
twenty-seven defendants including Royale Energy, Inc.
It is anticipated that the case may be scheduled for trial in October or
November of 1998. Management has and will continue to vigorously contest this
case. No settlement discussions are occurring at this time. Based on the
advice of legal counsel, management is unable to predict the likelihood of an
unfavorable outcome and a range of potential loss, if any. Additionally, the
Company believes that the defendants have one or more defense actions, including
but not limited to, the statute of limitations.
F-20
<PAGE> 48
NOTE 15 - QUARTERLY FINANCIAL DATA (UNAUDITED)
---------------------------------------
Operating revenues, operating income, net income, and earnings per common share
by quarters from 1997 and 1996 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>
<TABLE>
<CAPTION>
Basic Weighted-
Net Earnings Average
Income Per Common Shares
Quarter Ended Net Sales Gross Profit (Loss) Share Outstanding
- -------------------- ---------- ------------- ----------- ------- -----------
<S> <C> <C> <C> <C> <C>
December 31, 1997. $2,687,906 $ 1,316,638 $ 471,094 0.12 3,861,589
1996 3,008,221 1,299,194 538,377 0.14 3,909,277
September 30, 1997 2,314,392 1,366,755 522,926 0.13 3,853,569
1996 2,860,866 1,029,360 440,803 0.11 3,962,359
June 30, 1997 2,520,193 1,258,232 448,332 0.12 3,845,062
1996 2,333,053 1,215,756 382,653 0.10 3,960,299
March 31, 1997 1,543,635 659,684 68,039 0.02 3,837,555
1996 1,795,454 496,414 36,974 0.01 3,982,570
</TABLE>
F-21
<PAGE> 49
F-22
<PAGE> 50
ROYALE ENERGY, INC.
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, 1997 and
1996. 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-23
<PAGE> 51
Changes in Estimated Reserve Quantities
- -------------------------------------------
The net interest in estimated quantities of proved developed reserves of crude
oil and natural gas at December 31, 1997 and 1996 and changes in such quantities
during each of the years then ended, were as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------- ---------------------
Oil Gas Oil Gas
(BBL) (MCF) (BBL) (MCF)
------- ----------- -------- -----------
<S> <C> <C> <C> <C>
Proved developed and
undeveloped reserves:
Beginning of period. . . . . . . 1,647 12,909,322 22,401 9,383,850
Revisions of previous estimates. 3,730 (5,522,625) (20,732) 2,071,879
Production . . . . . . . . . . . (679) (1,365,562) (22) (672,383)
Extensions, discoveries and
improved recovery. . . . . . . - 8,087,987 - 2,125,976
Purchase of minerals in place. . - 2,773,577 - -
Sale of minerals in place. . . . - - - -
------- ----------- -------- -----------
Proved reserves end of period . . . 4,698 16,882,699 1,647 12,909,322
======= =========== ======== ===========
Gas equivalent reserve. . . . . . . 46,980 16,470
======= ========
Proved developed reserves:
Beginning of period . . . . . . . 1,647 6,978,805 1,852 4,121,616
======= =========== ======== ===========
End of period . . . . . . . . . . 4,698 8,606,456 1,647 6,978,805
======= =========== ======== ===========
</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, 1997.
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-24
<PAGE> 52
<TABLE>
<CAPTION>
1997 1996
------------ -------------
<S> <C> <C>
Future cash inflows . . . . . . . . . . . . . . . . . . $37,322,465 $ 45,882,082
Future production costs . . . . . . . . . . . . . . . . (8,721,586) (11,985,243)
Future development costs. . . . . . . . . . . . . . . . (2,706,685) (2,263,988)
Future income tax expenses. . . . . . . . . . . . . . . (7,782,165) (9,489,856)
------------ -------------
Future net cash flows . . . . . . . . . . . . . . . . . 18,112,029 22,142,995
10% annual discount for estimated timing of cash flows. (5,125,811) (10,121,742)
------------ -------------
Standardized measure of discounted future net cash flow $12,986,218 $ 12,021,253
============ =============
</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>
1997 1996
------------ ------------
<S> <C> <C>
Standardized measure - beginning of year. . . $12,021,253 $ 2,697,415
------------ ------------
Sales of oil and gas produced,
net of production costs . . . . . . . . . . (1,515,072) (970,483)
Purchase of minerals in place . . . . . . . . 2,662,529 -
Revisions of estimates of reserves provided
in prior years:
Net changes in prices and production costs. (9,799,460) 10,634,281
Sales of minerals in place. . . . . . . . . . - -
Extensions, discoveries and improved recovery 10,422,897 3,722,480
Accretion of discount . . . . . . . . . . . . (392,373) (57,512)
Net change in income taxes. . . . . . . . . . (413,556) (4,004,928)
------------ ------------
Net increase. . . . . . . . . . . . . . . . . 964,965 9,323,838
------------ ------------
Standardized measure - end of year. . . . . . $12,986,218 $12,021,253
============ ============
</TABLE>
F-25
<PAGE> 53
<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>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 2,032,001
<SECURITIES> 0
<RECEIVABLES> 2,016,630
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 4,185,090
<PP&E> 12,109,453
<DEPRECIATION> 1,871,101
<TOTAL-ASSETS> 13,704,156
<CURRENT-LIABILITIES> 3,848,582
<BONDS> 0
49,100
200,000
<COMMON> 8,676,273
<OTHER-SE> (2,969,799)
<TOTAL-LIABILITY-AND-EQUITY> 13,704,156
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</TABLE>
