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, 1999 Commission 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: 619-881-2800
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, par value $.01 per share
(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. [X]
State issuer's revenues for its most recent fiscal year: $7,843,732
At March 29, 2000, there were 2,657,587 outstanding shares of registrant's
Common Stock held by non-affiliates, with an aggregate market value of
approximately $6,976,166, based on the closing Nasdaq price on that date.
At March 29, 2000, a total of 3,808,613 shares of registrant's Common Stock
were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE: None
Transitional Small Business Disclosure Format (check one):
Yes ; No X
----- -----
Exhibit Index appears on page 20.
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TABLE OF CONTENTS
PART I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .-1-
Item 1. Description of Business. . . . . . . . . . . . . .-1-
Item 2. Description of Property. . . . . . . . . . . . . .-4-
Item 3. Legal Proceedings. . . . . . . . . . . . . . . . .-8-
Item 4. Submission of Matters to a Vote of Security
Holders. . . . . . . . . . . . . . . . . . . . . .-8-
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. . . . . . . .-9-
Item 7. Financial Statements and Supplementary Data . . .-12-
Item 8. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure. . . . . . . -12-
PART III. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .-13-
Item 9. Directors, Executive Officers, Promoters and
Control Persons, Compliance with Section 16(a)
of the Exchange Act. . . . . . . . . . . . . . . -13-
Item 10. Executive Compensation. . . . . . . . . . . . . .-15-
Item 11. Security Ownership of Certain Beneficial
Owners and Management. . . . . . . . . . . . . . -17-
Item 12. Certain Relationships and Related Transactions. .-19-
Item 13. Exhibits, Lists, and Reports on Form 8-K. . . . .-20-
Signatures. . . . . . . . . . . . . . . . . . . . . . . . . . . . .-21-
FINANCIAL STATEMENTS. . . . . . . . . . . . . . . . . . . . . . . . . . -F-1-
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ROYALE ENERGY, INC.
PART I
Item 1. Description of Business
Royale Energy, Inc. (the "Company" or "Royale"), is an independent oil and
natural gas producer. The Company's principal lines of business are the
production and sale of natural gas, 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. It offers fractional working interests and seeks to minimize
the risks of oil and gas drilling by selling multiple well drilling ventures
that exclude the use of debt financing. Royale was incorporated in
California in 1986 and began operations in 1988. The Company's Common Stock
is traded on the Nasdaq National Market System (symbol ROYL). On March 29,
2000, Royale had 12 full time and 170 part time employees.
During the Company's last fiscal year ended December 31, 1999, the Company
continued to explore and develop natural gas properties in northern
California. The Company drilled twelve wells in 1999, choosing to complete
six as commercially productive wells. Five wells drilled in 1999 were plugged
and abandoned as dry holes, and the Company has not decided whether to
complete one of the wells. The Company's estimated total natural gas
reserves increased from approximately 15.2 Bcf at January 1, 1999 to 15.8
Bcf at December 31, 1999, and it has minimal crude oil reserves or
operations.
The Company reported gross revenues in connection with the drilling of wells
on a turnkey contract basis in the amount of $4,213,696 for the year ended
December 31, 1999, which represents 53.7% of its total revenues for the
year. In the year ended 1998, we reported $3,789,995 gross revenues for
the year, representing 45.3% of our total revenues for that year. These
amounts are offset by drilling expenses and development costs of $2,600,555
in 1999, and $1,541,624 in 1998. In addition to Royale's own engineering
staff, it hires independent contractors to drill, test, complete and equip
the wells that it drills.
38.3% of the Company's total revenue for the year ended December 31, 1999 was
made up of the $3,006,010 it earned from oil and natural gas sales from
production of its wells. In 1998, this amount was $4,101,553, which
represented 49.0% of the Company's total revenues.
Plan of Business
The Company acquires interests in oil and natural gas reserves by sponsoring
private joint ventures. Royale believes that its shareholders are better
served by diversification of its investments among individual drilling
projects. Through its participation in joint ventures, the Company can
acquire interests and develop oil and natural gas properties with limited
expense and risk and still receive an interest in the revenues and reserves
produced from these properties.
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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. The Company pays its proportionate share of the
actual cost of drilling, testing, and completing the project to the extent
that it retains all or any portion of the working interest.
Royale may also sell fractional interests in undeveloped wells to finance
part of the drilling cost. When the Company sells fractional interests to
raise capital to drill oil and natural gas wells, generally it 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
recognizes 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 greater than the
gross revenue which is recognized by the Company for its fractional interest
sales.
When Royale sells a turnkey drilling project, it uses a percentage of the
funds it receives from the purchasers of the project to prepay lease costs,
intangible drilling costs, and other costs as required so that the drilling
project can proceed. These funds are non-refundable once the purchase of the
turnkey project has been made. The non-refundable portion of the total
turnkey drilling project is based on a percentage calculated by estimating
the pre-drilling costs as a percentage of total drilling costs for a
particular project. On the Company's financial statements, it recognizes the
non-refundable portion of the total purchase price as revenue and it expenses
the related pre-drilling costs. The Company records the remaining funds from
the sale of working interests as income at the commencement of drilling, and
it carries as a current liability its obligation to expend the remaining
unexpended funds for drilling wells on behalf of the purchasers. See, Note
1 to the Company's Financial Statements on Page F-7. The Company maintains
internal records of the expenditure of each investor's funds for drilling
projects.
Royale generally operates the wells it completes. As operator, it receives
fees set by industry standards from the owners of fractional interests in the
wells and from expense reimbursements. For the year ended December 31, 1999,
the Company earned gross revenues from operation of the wells in the amount
of $624,026, representing 8.0% of its total revenues on a consolidated basis
for that year. In 1998, the amount was $473,582, which represented 5.7% of
the consolidated total revenues. As of December 31, 1999, the Company holds
working interests in 48 gas wells in California, with locations ranging from
Tehama County in the north to Kern County in the south. The Company also
holds a 20% working interest in a well being completed in Louisiana, plus
interests in two exploration wells in California which resulted in gas
discoveries. The California wells are currently waiting on installation of
gas sales pipelines.
The Company's business does not depend on a single customer or a few
customers and the Company's management does not believe this will change in
the foreseeable future. Oil and natural gas purchasers are readily available
in today's markets, and Royale does not believe that the loss of any customer
would materially affect its business or our ability to find ready purchasers
for its oil and gas production at current market prices.
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Natural gas demand and the prices paid for gas have been seasonal, but over
the past year or so the seasonality has changed. In past years, natural gas
demand in Northern California has increased during the winter. More
recently, natural gas demand and prices have decreased during the fall and
winter and risen in the spring and summer, reflecting increased electricity
consumption. The oil business is not generally seasonal in nature. Rather,
oil prices increase and decrease in response to worldwide supply and demand
trends. Oil price changes don't unusually materially affect the Company's
revenues.
Affiliated Entities
On December 31, 1999, Royale Petroleum Corporation ("RPC") owned 27.53% of
the Company's Common Stock (excluding rights to purchase shares pursuant to
warrants). RPC 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 on Page 17. RPC is a predecessor and affiliate of the
Company. RPC is a Delaware corporation formed in 1985.
The Company had no subsidiaries at December 31, 1999.
Competition, Markets and Regulation
Competition
The exploration and production of oil and natural gas is an intensely
competitive industry. The sale of interests in oil and gas projects, like
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, and
many of these companies are substantially larger than Royale is.
Markets
Market factors beyond the Company's control affect the quantities of oil and
natural gas production and the price the Company can obtain for the
production from its oil and natural gas properties. 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
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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. Royale can't assure that
the prices of oil and natural gas will not increase or decrease in the
future, resulting in an increase or decrease in the revenues that the Company
receives from its oil and natural gas sales.
Regulation
Federal and state laws and regulations affect, to some degree, the
production, transportation, and sale of oil and natural gas from the
Company's operations. Many states in which Royale operates have statutory
provisions regulating the production and sale of oil and natural gas,
including provisions regarding deliverability. These statutes, along with
the regulations interpreting the statutes, generally are 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 increase the cost of doing business. These laws and regulations
may require: the acquisition of a permit by operators before drilling
commences; the prohibition of drilling activities on certain lands lying
within wilderness areas or where pollution arises; and the imposition
of substantial liabilities for pollution resulting from drilling operations,
particularly operations in offshore waters or on submerged lands. The cost
of oil and natural gas development and production also may increase because of
the cost of compliance with such legislation and regulations, together
with any penalties resulting from failing to comply with the legislation and
regulations. Ultimately, the Company may bear some of these costs.
Presently, the Company does not anticipate that compliance with federal,
state and local environmental regulations will have a material adverse effect
on capital expenditures, earnings, or its competitive position in the oil
and natural gas industry; however, since these laws and regulations change
frequently, the Company can't predict the costs of its compliance with
existing and future environmental regulations.
The discussion in this section of the regulation of the oil and natural gas
industry is an overview. Royale does not intend for it to constitute a
complete discussion of the various statutes, rules, regulations or
governmental orders to which the Company's operations may be subject.
Item 2. Description of Property
Since 1993, Royale has concentrated on development of properties in the
Sacramento Basin of Northern California. In 1999, the Company drilled nine
wells in Northern California, five of which were commercially productive
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wells and three were dry holes. It has not yet determined whether to
complete one well drilled in 1999. Also in 1999, Royale participated in
drilling activities in and near Louisiana, resulting in one commercially
productive on-shore gas well which was completed and which produced only for
a short time and in one well resulting in a dry hole in the Gulf of Mexico,
near the coast of Louisiana. The Company owns a 20% working interest in that
gas well, which is a part of a redevelopment project located south of Baton
Rouge, Louisiana. As of December 31, 1999, the estimated gross reserves of
the Louisiana project are 1.7 Bcf of natural gas and 510,000 barrels of oil.
The Company holds interests in two exploration wells in California which
resulted in gas discoveries. As of December 31, 1999, the California wells
are waiting on installation of gas sales pipelines. The Company also owns
minor interests in properties in Texas and Oklahoma in connection with joint
ventures in which it is a participant, but 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 transferor. In these cases, Royale attempts to conduct due
diligence as to title before the acquisition, but it can't assure that
there will be no losses resulting 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, all of which are customary
within the oil and natural gas industry.
The Company has available a $5,050,000 revolving credit line from a major
commercial bank to use for working capital purposes, acquisitions, and
development of oil and gas properties. At December 31, 1999, $5,050,000 in
loans were outstanding under this credit line. All of the Company's oil and
gas properties are pledged to secure this credit line.
Following is a discussion of Royale's significant oil and natural gas
properties. Reserves at December 31, 1999, for each property discussed below,
have been determined by WZI, Inc., registered professional petroleum
engineers, in accordance with its report submitted to the Company on March 2,
2000 (the most recent report available).
Northern California
The Company owns lease interests in 29,187.88 gross (15,877.53 net) acres in
15 gas fields with locations ranging from Tehama County in the north to Kern
County in the south, in the Sacramento and San Joaquin Basins in Northern
California. At December 31, 1999, the Company operated 48 wells in Northern
California, and its estimated total gas reserves in Northern California were
approximately 7.0 Bcf, according to the Company's independently prepared
reserve report.
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Developed and Undeveloped Leasehold Acreage
As of December 31, 1999, the Company owned leasehold interests in the
following developed and undeveloped properties in both gross and net acreage.
Developed Undeveloped
Gross Net Gross Net
Acres Acres Acres Acres
----- ----- ----- -----
California 17,202.70 10,598.73 4721.48 3790.21
All other States 2,263.70 238.59 5000.00 1250.00
--------- --------- ------- -------
Total 19,466.40 10,837.32 9,721.48 5040.21
Drilling Activities
The following table sets forth Royale's drilling activities during the years
ended December 31, 1997, 1998, and 1999. All wells are located in the
Continental U.S., in California, Texas, and Oklahoma.
Gross Wells(b) Net Wells
Year Type of Well(a) ---------------------------------------------------
Total Producing(c) Dry(d) Producing(c) Dry(d)
1997 Exploratory 3 1 2 .4430 .6150
Developmental 10 8 2 3.1507 .7650
1998 Exploratory - - - - -
Developmental 8 2 6 .9727 2.9287
1999 Exploratory 3 1 2 .4320 .9653
Developmental 9(e) 6 2 1.8156 .6417
(a) An exploratory well is one that is drilled in search of new oil and
natural gas reservoirs, or to test the boundary limits of a
previously discovered reservoir. A developmental well is one drilled
on a previously known productive area of an oil and natural gas
reservoir with the objective of completing that reservoir.
(b) Gross wells represent the number of actual wells in which the Company
owns an interest. The Company's interest in these wells may range
from 1% to 100%.
(c) A producing well is one that is producing oil and/or natural gas that
is being purchased on the market.
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(d) A dry well is a well that is not deemed capable of producing
hydrocarbons in paying quantities.
(e) Royale has not yet determined whether to complete one developmental
well drilled in 1999.
As of December 31, 1999, the Company had 48 gross (27.49 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 Royale owns 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.
1999 1998 1997
---- ---- ----
NET VOLUME
Oil (Bbl) 2,215 1,238 679
Gas (Mcf) 1,331,887 1,773,294 1,365,562
Mcfe 1,354,037 1,785,674 1,376,334
AVERAGE SALES PRICE
Oil (Bbl) $16.30 $9.42 $14.42
Gas (Mcf) $2.34 $2.21 $2.26
Net Production
Costs & Taxes $673,793 $708,137 $460,768
Lifting Costs $0.49 $0.39 $0.34
Net Proved Oil and Natural Gas Reserves
As of December 31, 1999, Royale had proved developed reserves of 10,401,000
Mcf and total proved reserves of 15,842,000 Mcf of natural gas on all of the
properties Royale leases. For the same period, Royale also had proved
developed reserves of 80 Mbbl and total proved reserves of 80 Mbbl of oil on
the same properties. 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.
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Oil and gas reserve estimates and the discounted present value estimates
associated with the reserve estimates are based on numerous engineering,
geological and operational assumptions that generally are derived from
limited data. Common assumptions include such matters as the areal extant and
average thickness of a particular reservoir, the average porosity and
permeability of the reservoir, the anticipated future production from
existing and future wells, future development and production costs and the
ultimate hydrocarbon recovery percentage. As a result, oil and gas reserve
estimates and discounted present value estimates are frequently revised in
subsequent periods to reflect production data obtained after the date of the
original estimate. If the reserve estimates are inaccurate, production rates
may decline more rapidly than anticipated, and future production revenues may
be less than estimated.
Additional data relating to the Company's oil and natural gas properties is
disclosed in Supplemental Information About Oil and Gas Producing Activities
(Unaudited), attached to the Company's Financial Statements which are part of
this document and found on Page F-20. 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, 1999 and 1998,
prepared by the Company's independent reserve engineering consultants.
Item 3. Legal Proceedings
On December 10, 1999, a group of 16 investors in drilling projects sponsored
by Royale from 1994 to 1998 filed suit against Royale and certain of its
officers and former officers in U.S. District Court for the Northern District
of California, alleging fraud, negligent misrepresentation, breach of
fiduciary duties and other related claims in connection with the sales of
working interests in those projects. Buck, et al., v. Royale Energy, et al.,
No. C 99 5236. The suit seeks an unspecified amount of damages, restitution
of amounts the plaintiffs invested, and punitive damages. The Company
expects to file responsive motions in the case, which state that the
plaintiffs' pleadings are fatally defective and have been filed in the wrong
court. No discovery has been conducted in the case. The Company will contend
that the plaintiffs' claims are completely without merit and that the
plaintiffs' complaint fails to state a claim on which relief can be based.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of Royale's security holders during the
fourth quarter of fiscal year ended December 31,1999.
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PART II
Item 5. Market Price of the Company's Common Stock and Related
Stockholder Matters
Since February 25, 1997, the Company's Common Stock has been traded on the
Nasdaq National Market System under the symbol 'ROYL.' From October 1994
until February 24, 1997, the Company's Common Stock was traded on the Nasdaq
Small Cap Market. The following table reflects high and low quarterly sales
prices from January 1998 through December 1999.
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
High Low High Low High Low High Low
---- --- ---- --- ---- --- ---- ---
1998 4 1/2 3 3/8 5 1/4 4 4 1/4 2 13/16 4 5/8 3
1999 3 1/4 2 17/32 4 2 15/32 3 7/8 3 3 5/32 1 5/8
Dividends
The Company has not declared or paid any cash dividends to its common
shareholders. Its board of directors has discussed whether it may wish to
declare a dividend in the future. The future determination as to the payment
of dividends will depend on the Company's financial condition and other
factors deemed relevant by the Company's board of directors.
Item 6. Management's Discussion and Analysis of Financial Condition
and Results of Operations
The following discussion should be read in conjunction with the Company's
Financial Statements and Notes thereto and other financial information
relating to the Company included elsewhere in this document.
For the past six years, the Company has primarily acquired and developed
producing and non-producing natural gas properties in Northern California.
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 change in natural
gas reserves owned by the Company.
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Results of Operations for the Twelve Months Ended December 31, 1999, as
Compared to the Twelve Months Ended December 31, 1998
For the year ended December 31, 1999, Royale achieved a net profit of
$149,903, a $569,025 increase over the net loss before an extraordinary
income item (change in accounting principle) of $419,122 in 1998 but a
$624,503 or 80.6% decrease from the post change in accounting principle
profit in 1998 of $774,406. Royale's management attribute this decrease to
lower revenues from oil and gas sales due to delays in bringing some new
wells into production in 1999, resulting in lower production. Total
revenues for the year ended December 31, 1999 were $7,843,732, which was a
decrease of $521,398 or 6.2%, when compared to 1998. The decrease in total
revenues can be primarily attributed to the decrease in revenues from oil and
gas sales in 1999, compared to 1998.
Oil and gas revenues for the year ended December 31, 1999 were $3,006,010
compared to $4,101,553 for the same period in 1998, which represents a
$1,095,543 or 26.7% decrease. This decrease in revenues was mainly due to a
decrease in natural gas production from Royale's wells due to field delays in
bringing certain wells into production during the year in 1999. The net
sales volume for the year ended December 31, 1999, was 1,331,887 Mcf with an
average price of $2.34 per Mcf, versus 1,773,294 Mcf with an average price of
$2.21 per Mcf for 1998, which represents a decrease in net sales volume of
441,407 Mcf or 24.9%. The net sales volume for oil and condensate (natural
gas liquids) production was 2,215 barrels with an average price of $16.30 per
Bbl for the period ended December 31, 1999, compared to 1,238 barrels at an
average price of $9.42 per Bbl for the same period in 1998, which represents
an increase in net sales volume of 977 barrels or 78.9%.
Royale's oil and gas lease operating expenses decreased by $124,220,
or 12.2%, to $896,321 for the year ended December 31, 1999, from $1,020,541
for the same period in 1998. The higher costs in 1998 were due to the
installation of dehydrating equipment on many natural gas wells in 1998 to
increase efficiencies within the Company's transportation system. For 1999,
Royale's gross margins on oil and gas production (excluding drilling and
development costs) were 70.2%, compared to 75.1% in 1998. The decrease in
gross margin was due to a decrease in average natural gas production per
well during 1999 when compared to 1998.
For the year ended December 31, 1999, turnkey drilling revenues increased
$423,701, to $4,213,696 in 1999 from $3,789,995 in 1998, or 11.2% for the
year. Royale also experienced a $1,058,931 or 68.7% increase in drilling and
development costs from $1,541,624 in 1998 to $2,600,555 in 1999. This
increase in turnkey revenues and expenses was due to the Company's drilling
of twelve wells that were sold to outside parties in 1999, versus the
drilling of eight wells in 1998. Royale's gross margins, or profits, on
drilling depend on its 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.
Royale's gross margins on drilling were 38.3% and 59.3% for the years ended
December 31, 1999 and 1998, respectively.
The Company's aggregate of supervisory fees and other income was $624,026 for
the year ended December 31, 1999, an increase of $150,444 (31.8%) from
$473,582 during 1998. Supervisory fees are charged in accordance with the
Council for Petroleum Accountants Societies (COPAS) policy for reimbursement
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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 $26,156 or 8.3%, from $316,065 in 1998 to $342,221
in 1999. The overall increase in supervisory fees and other income was
mainly due to fees received in 1999 from new facilities placed in service
during the year in 1998.
Depreciation, depletion and amortization expense increased to $1,502,026 from
$1,461,511, an increase of $40,515 (2.8%) for 1999, compared to 1998. The
depletion rate is calculated using production as a percentage of reserves,
and the increase in depletion was mainly due to the increase in the number
of wells placed into production during 1999.
Royale 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 this assessment, $62,815 was recorded as a lease impairment in 1999 while
$465,520 was recorded as impaired in 1998.
Royale also reevaluated several of its geological lease and land costs, which
had been previously capitalized, in order to write off those prospects which
were no longer viable. As a result, $97,851 of previously capitalized costs
were written off and recorded as geological and geophysical expense during
1999 compared with $139,664 written off in 1998, a $41,813 or 29.9% decrease.
General and administration expenses decreased by $25,152, or 1.6%, from
$1,606,702 for the year ended December 31, 1998 to $1,581,550 for the same
period in 1999. Legal and accounting expense decreased to $180,941 for the
year, compared to $544,228 for 1998, a $363,287 (66.8%) decrease. The
decrease was due to lower litigation costs in 1999 as well as an increase in
the portion covered by insurance. Marketing expense for the year ended
December 31, 1999, decreased $36,819 or 8.7%, to $385,874, compared to
$422,693 for 1998. Royale's marketing expense varies from period to period
according to the number of marketing events attended by personnel and
associated travel costs.
During the year in 1998, the Company extended an existing credit line from
a major commercial bank. Because of borrowings pursuant to this credit
line, interest expense increased to $385,896 for the year ended December 31,
1999 from $335,373 for the same period in 1998, a $50,523 or 15.1% increase.
Capital Resources and Liquidity
At December 31, 1999, the Company had current assets totaling $3,183,771
and current liabilities totaling $5,318,774, a $2,135,003 working capital
deficit. The primary reason for this deficit is the Company's obligation
-11-
<PAGE>
to complete wells on behalf of investors who bought fractional working
interests from it. Royale records these obligations as deferred revenue from
turnkey drilling until the drilling projects are completed. For the
industry as a whole, a working capital deficit is not uncommon. Management
believes that Royale Energy has sufficient liquidity for the short term.
Operating Activities. For the year ended December 31, 1999, cash provided
by operating activities totaled $2,657,697 compared to $3,239,819 provided
by operations for 1998. This decrease in cash provided in 1999 can be
mainly attributed to increased drilling in 1999.
Investing Activities. Net cash used by investing activities, primarily in
capital acquisitions of oil and gas properties, amounted to $2,707,024 for
the period, compared to $4,942,652 used by investing activities for 1998.
The higher costs in 1998 can be primarily attributed to the installation of
pipeline and dehydrating equipment during the period.
Financing Activities. Net cash provided by financing activities for the year
ended December 31, 1999, was $50,000, compared to $687,138 provided by
financing activities for the same period in 1998. The decrease in net cash
provided in 1999 was mainly due to Royale's not having significantly
increased its credit line in 1999.
Year 2000 Compliance
In general, Year 2000 issues relate to the way that many computer programs
refer to dates and their ability to recognize dates after the end of 1999.
In 1999, the Company reviewed its information systems and non-information
based, automated systems for Year 2000 compliance. The Company upgraded
some software systems to resolve Year 2000 concerns at a total cost of about
$6,650. Neither Royale nor its suppliers or customers have had any Year 2000
problems to date.
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.
-12-
<PAGE>
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 Royale's current directors and
executive officers. 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.
First Became Director
Name Age or Executive Director Positions Held
---- --- --------------------- --------------
Harry E. Hosmer* 69 1986 Chairman of the Board.
Donald H. Hosmer+ 46 1986 President, Secretary and
Director. Chairman of the
Board and President of Royale
Petroleum Corporation ("RPC").
Stephen M. Hosmer+ 33 1991 Chief Financial Officer and
Director. Secretary and
Director of RPC.
Oscar A.
Hildebrandt*+ 64 1995 Director.
Gilbert C.L. Kemp 66 1998 Director.
Rodney Nahama+ 68 1994 Director.
George M.
Watters*+ 80 1991 Director.
* Member of the audit committee.
+ Member of the compensation committee.
Following is a summary of 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. He has served
as Chairman since the Company began in 1986, and from inception in 1986
until June 1995, he also served as President and Chief Executive Officer.
In October 1985, Mr. Hosmer and three of his sons founded Royale Petroleum
Corporation, an affiliate of the Company.
DONALD H. HOSMER is President, Chief Executive Officer, Secretary, and
Director of the Company. He has served as an executive officer and Director
of the Company since its inception in 1987, and in June 1995 he became
President and Chief Executive Officer. Prior to becoming President, he was
-13-
<PAGE>
Executive Vice President, responsible for marketing working interests in oil
and gas projects developed by the Company. He was also responsible for
investor relations and communications. Donald H. Hosmer is the son of Harry
E. Hosmer and brother of Stephen M. Hosmer.
STEPHEN M. HOSMER is Chief Financial Officer and Director of the Company.
Mr. Hosmer joined the Company as the Management Information Systems Manager in
May 1988, responsible for developing and maintaining the Company's
computer software. Mr. Hosmer developed programs and software systems used by
the Company. In 1996, he was elected to the board of directors of the
Company. Mr. Hosmer serves on the board of directors of Youth for Christ, a
charitable organization in San Diego, California. Stephen M. Hosmer is the son
of Harry E. Hosmer and brother of Donald H. Hosmer.
OSCAR 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.
GILBERT C. L. KEMP currently manages the California operations of Western
Atlas, Inc., a New York Stock Exchange company. Mr. Kemp was a founding
member of 3D Geophysical, Inc., where he served as Vice President from 1996
until March 1998. In March 1998 3-D Geophysical, whose stock had been listed
on the Nasdaq National Market System since February 1996, merged with Western
Atlas, Inc. During the years 1987 to 1995, Mr. Kemp served as President and
CEO of Kemp Geophysical Corporation, which owned and operated seismic crews
in the United States and Canada.
RODNEY NAHAMA, a Director of the Company, 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
Petroleum Association and the Independent Petroleum Association of America.
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
-14-
<PAGE>
investments. 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 file reports of ownership
and changes in ownership with the SEC and the NASD and furnish the Company
with copies of all such reports they file. Director Oscar A. Hildebrandt
failed to file one report of a purchase on time in 1999. Except for this
report, and based solely upon a review of the copies of the form furnished to
the Company, or written representations from certain reporting persons that
no reports were required, the Company believes that no other persons failed
to file required reports on a timely basis during or in respect of 1999.
Item 10. Executive Compensation
The following table summarizes the compensation of chief executive officer
and the other most highly compensated executive officers of the Company and
its subsidiaries during the past year.
Annual Compensation
-------------------------------------------------------
(a) (b) (c) (d) (e) (f)
Other Annual All Other
Name Year Salary Bonus Compensation Compensation
(1) (2)(3)
- --------------------------------------------------------------------
Donald H. Hosmer, 1999 $135,046 $415 $ 2,400
President 1998 $121,169 $10,000 $368 $53,350
1997 $103,974 $356
Stephen M. Hosmer, 1999 $112,539 $321 $ 3,300
Chief Financial 1998 $ 97,808 $10,000 $340 $37,269
Officer 1997 $ 75,995 $361
(1) Under the terms of a plan adopted by the board of directors in 1989,
each of the listed executives has elected to participate in wells
drilled by the Company. See, Certain Relationships and Related
Transactions on Page 19. The costs that they incurred 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 executives' actual cost and the cost incurred by
outside investors could be considered as additional compensation to
them. However, Royale's management does not believe that the amount of
such difference is significant. In addition, prior to June 1995,
Royale advanced funds to the executives to pay for their well
-15-
<PAGE>
participation interests. To the extent that the advances amount to
interest free loans, the executives could also be considered to have
received additional compensation. The Other Annual Compensation in the
foregoing table consists of the amounts which the management believes
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 Company used the imputed interest rate of 7% simple
interest per annum. In June 1995, Royale'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.
(2) Includes the amount received upon resale of stock options to the
Company in September 1998 by Donald Hosmer ($51,750) and Stephen Hosmer
($34,400). There were no stock options granted in 1999.
(3) Includes the Company's matching contribution in 1999 for Donald Hosmer
($2,400) and Stephen Hosmer ($3,300) to the Company's retirement savings
plan initiated in April 1998. For year ending 1998, includes matching
contribution for Donald Hosmer ($1,600) and Stephen Hosmer ($2,769).
No Stock Options Were Granted in 1999
The Company did not grant any stock options or stock appreciation rights to
its officers or employees during 1999.
Aggregated 1999 Option Exercises and Year-End Values
None of the executive officers named in the Summary Compensation Table
exercised any stock options or stock appreciation rights in 1999, 1998, or
1997. The following table summarizes the number and value of all unexercised
stock options held by those executive officers at the end of 1999.
(a) (b) (c) (d) (e)
Number of
Securities Value of
Underlying Unexercised
Number of Unexercised In-the-Money
Securities Options/SARS Options/SARS
Underlying at FY-End at FY-End
Options/
SARs Value Exercisable/ Exercisable/
Name Exercised Realized Unexercisable Unexercisable
- -----------------------------------------------------------------------------
Donald H. Hosmer - - 15,000/0 $37,500/0
Stephen M. Hosmer - - 10,000/0 $25,000/0
- 16 -
<PAGE>
1 Based on a fair market value of $2.50 per share, which was the closing
bid price of the Company's Common Stock in the Nasdaq National Market
System on December 31, 1999.
Compensation of Directors
Each director who is not an employee of the Company receives a quarterly fee
for his services, which in 1999 was set at $2,035. In addition, the Company
reimburses directors for the expenses they incur for their service No
directors received any stock options or stock appreciation rights in 1999.
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, 1999, by: (i) each person
the Company knows to own beneficially more than 5% of the outstanding shares
of each class of equity securities, (ii) each of Royale's directors, and iii)
all of Royale's directors and officers 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, 1999, 3,808,613 shares of the Company's Common Stock were
outstanding.
Shares Owned (1)
----------------
Shareholder (2) Number Percent
--------------- ------ -------
Royale Petroleum Corporation 1,274,076 (3), (4) 31.54%
Donald H. Hosmer 1,290,076 (3), (4) 31.96%
Harry E. Hosmer 45,000 (4) 1.17%
Oscar A. Hildebrandt 72,755 (5) 1.90%
Stephen M. Hosmer 1,285,236 (3), (4) 31.84%
Gilbert C. L. Kemp 5,000 Less than 1%
Owen LeTissier 400,000 (6) 10.50%
St. Peter Port
Guernsey, Channel Islands
Rodney Nahama 14,000 Less than 1%
George M. Watters 77,500 (7) 2.02%
All directors and officers as a
group(7 persons) 1,151,026 (3) 36.32%
-17-
<PAGE>
(1) Includes shares which the listed shareholder has the right to acquire
before March 1, 2000, from options or warrants, as follows: Royale
Petroleum Corporation 230,555, Donald H. Hosmer 15,000, Harry E. Hosmer
45,000, Stephen M. Hosmer 10,000, Oscar Hildebrandt 20,000, Rodney
Nahama 14,000, George M. Watters 30,000, and all officers and directors
as a group (excluding Royale Petroleum Corporation) 134,000.
(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, each of them may be deemed to be the
beneficial owner of all the Common Stock owned by RPC pursuant to Rule
13d-3 promulgated under the Securities Exchange Act of 1934, as
amended. Accordingly, the 1,274,076 shares of the Company RPC owns are
included in the number of shares both Donald and Stephen Hosmer own 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 Convertible Preferred Stock 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, 1999, there were 9,375 shares of Series
A and 43,750 shares of Series AA Convertible Preferred Stock outstanding. The
shares of each series of Preferred shares are convertible into shares of
Royale'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. To
the Company's knowledge, none of the Preferred shareholders would own more
than 1% of the Company's Common Stock, if their Preferred shares were
converted to Common shares.
Series A Series AA
-------- ---------
Shareholder Number % Number %
----------- ------ ----- ------ -----
Richard G. and Margaret E. Algire 3,125 33.3%
-18-
<PAGE>
Marjorie Carson 6,250 14.28%
June L. Ginnings 3,125 7.14%
Overland Bank 6,250 14.28%
Audrey Sanabria & B.G. Dienelt, Jr. 3,125 7.14%
George Singleton 6,250 14.28%
James S. Trowbridge 6,250 66.7%
William W. Well 6,250 14.28%
Jerome Winston 6,250 14.28%
Nim E. Wire 6,250 14.28%
All officers and directors as a group
(7 persons). 0 0.0% 0 0.0%
Item 12. Certain Relationships and Related Transactions
In 1989, the board of directors adopted a policy (the 1989 policy) that
permits each director and officer of the Company 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
Royale's actual pro rata cost of drilling and completion, 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, and Oscar
Hildebrandt at various times have elected under the 1989 policy to purchase
interests in certain wells the Company has drilled.
Under the 1989 policy, officers and directors may elect to participate in
wells at any time up until drilling of the prospect begins. Participants do
not pay a set, turnkey price (as do outside investors who purchase undivided
working interests from the Company), but they 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 similar to other oil and gas industry participants or
joint venturers. Participants are invoiced for their share of direct costs
of drilling and completion as the Company incurs expenses.
Officer and director participants under this program do not pay some expenses
paid by outside, 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, Royale's
management believes that its officers and directors who participate in wells
under the Board of Directors' policy do so 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
-19-
<PAGE>
under which outside investors purchase fractional undivided working interests
from the Company.
Donald and Stephen Hosmer each have participated individually in 47 wells
under the 1989 policy. Donald and Stephen Hosmer also have participated in 27
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 46 wells.
During 1999, RPC did not invest in any under the 1989 policy through Donald
and Stephen Hosmer.
Donald Hosmer's 1999 investments in wells under the 1989 policy totaled
$13,316 for 0.25% interests in 15 wells. In 1999, Stephen Hosmer purchased
0.125% interests in 15 wells under the 1989 policy, for a total investment of
$7,019.
The Hosmer Trust purchased 1.0% interests in 15 wells during 1999 for a total
investment of $52,783.
Prior to June 1995, Royale had advanced to the participants under the 1989
policy the funds with which to purchase their interests, and the funds would
be repaid from future production from the working interests and advances
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 income from all wells is credited. In June
1995, Royale changed its policy regarding the advancement of funds. Current
policy requires that all such purchases of interests in wells must be paid in
cash. At December 31, 1999, the following executive officers and their
affiliates owed the following amounts on advances for well participations:
Donald Hosmer $17,974; Stephen Hosmer $9,901; RPC $418; the Hosmer Trust
$64,577.
Royale's Chairman of the Board and former President, Harry E. Hosmer, renders
management consulting services to the Company on an ongoing basis. The
Company compensated Mr. Hosmer $120,000 annually for his consulting services
in 1999 and pays his medical insurance costs. Mr. Hosmer's consulting
services are in addition to his service on the board of directors, for which
he receives no compensation other than reimbursement of expenses to attend
meetings.
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.
-20-
<PAGE>
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 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
1999.
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
ROYALE ENERGY, INC.
Date: April 10, 2000 /s/ Donald H. Hosmer
-----------------------------
Donald H. Hosmer, President
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated.
Date: April 10, 2000 /s/ Harry E. Hosmer
-----------------------------
Harry E. Hosmer,
Chairman of the Board
Date: April 10, 2000 /s/ Donald H. Hosmer
-----------------------------
Donald H. Hosmer,
Chief Executive Officer,
President, Secretary, and
Director
Date: April 10, 2000 /s/ Stephen H. Hosmer
-----------------------------
Stephen M. Hosmer, Chief
Financial Officer and Director
Date: April 10, 2000 /s/ Oscar H. Hildebrandt
-----------------------------
Oscar A. Hildebrandt, Director
-21-
<PAGE>
Date: 2000
----------- ------------------------------
Gilbert C.L. Kemp, Director
Date: April 10, 2000 /s/ Rodney Namama
------------------------------
Rodney Namama, Director
Date: April 10, 2000 /s/ George M. Watters
-------------------------------
George M. Watters, Director
- 22 -
<PAGE>
ROYALE ENERGY, INC.
INDEX TO FINANCIAL STATEMENTS
AND SUPPLEMENTARY DATA
Index to Financial Statements...................................F-1
Report of Brown Armstrong Randall Reyes Paulden & McCown,
Independent Auditors...........................................F-2
Balance Sheets at December 31, 1999 and 1998....................F-3
Statements of Income for the Years Ended
December 31, 1999 and 1998.....................................F-4
Statements of Stockholders' Equity for the Years Ended
December 31, 1999 and 1998.....................................F-5
Statements of Cash Flows for the Years Ended December 31, 1999
and 1998.......................................................F-6
Notes to the Financial Statements...............................F-7
Supplemental Information About Oil and Gas Producing
Activities (Unaudited)........................................F-20
Financial statement schedules have been omitted since they are either not
required, are not applicable, or the required information is shown in the
financial statements and related notes.
- F-1 -
<PAGE>
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, 1999 and 1998, 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, 1999 and 1998, and the results of their operations and their
cash flows for the years then ended in conformity with generally accepted
accounting principles.
As discussed in Note 1 to the financial statements, during 1998, the Company
changed its method of evaluating its oil and gas properties for impairment.
BROWN ARMSTRONG RANDALL
REYES PAULDEN & McCOWN
ACCOUNTANCY CORPORATION
Bakersfield, California
March 2, 2000
- F-2 -
<PAGE>
ROYALE ENERGY, INC.
BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
ASSETS
1999 1998
---------------- ----------------
Current Assets
Cash and cash equivalents $ 1,016,979 $ 1,016,306
Accounts receivable 1,745,408 1,531,259
Receivables from related parties - 49,412
Note receivable 84,662 118,149
Other current assets 336,722 169,103
---------------- ----------------
Total Current Assets 3,183,771 2,884,229
---------------- ----------------
Oil and Gas Properties (successful efforts
basis), Equipment and Fixtures, net 13,049,079 11,597,827
---------------- ----------------
Other Assets
Other capitalized costs, net 618,139 927,208
Receivables from other related parties - 7,151
---------------- ----------------
Total Other Assets 618,139 934,359
---------------- ----------------
$ 16,850,989 $ 15,416,415
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities
Accounts payable and accrued expenses $ 3,854,159 $ 1,249,127
Deferred revenue from turnkey drilling 1,464,615 2,834,976
---------------- ----------------
Total Current Liabilities 5,318,774 4,084,103
---------------- ----------------
Long-Term Debt, net of current portion 5,050,000 5,000,000
---------------- ----------------
Redeemable Preferred Stock
Series A, convertible preferred stock,
no par value, 59,250 shares authorized;
9,375 shares issued and outstanding 19,100 19,100
---------------- ----------------
Stockholders' Equity
Common stock, no par value, 10,000,000
shares authorized; 3,808,613 shares
issued and outstanding 8,240,605 8,240,605
---------------- ----------------
Convertible preferred stock, Series AA,
no par value, 147,500 shares authorized;
43,750 shares issued and outstanding 175,000 175,000
Accumulated deficit (1,857,990) (2,007,893)
---------------- ----------------
Total paid in capital and accumulated
deficit 6,557,615 6,407,712
Less cost of treasury stock, 19,300
shares (94,500) (94,500)
---------------- ----------------
Total Stockholders' Equity 6,463,115 6,313,212
---------------- ----------------
$ 16,850,989 $ 15,416,415
================ ================
(The accompanying notes are an integral part of these financial statements.)
- F-3 -
<PAGE>
ROYALE ENERGY, INC.
STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
1999 1998
---------------- ----------------
Revenues
Sale of oil and gas $ 3,006,010 $ 4,101,553
Turnkey drilling 4,213,696 3,789,995
Supervisory fees and other 624,026 473,582
---------------- ----------------
Total Revenues 7,843,732 8,365,130
---------------- ----------------
Costs and Expenses
General and administrative 1,581,550 1,606,702
Geological and geophysical expense 97,851 139,664
Turnkey drilling and development 2,600,555 1,541,624
Lease operating 896,321 1,020,541
Lease impairment 62,815 465,520
Legal and accounting 180,941 544,228
Marketing 385,874 422,693
Depreciation, depletion and amortization 1,502,026 1,461,511
---------------- ----------------
Total Costs and Expenses 7,307,933 7,202,483
---------------- ----------------
Income from Operations 535,799 1,162,647
---------------- ----------------
Other (Expense)
Interest (385,896) (335,373)
---------------- ----------------
Income Before Income Tax Expense 149,903 827,274
---------------- ----------------
Income Tax Expense - 52,868
---------------- ----------------
Net Income $ 149,903 $ 774,406
================ ================
Basic Earnings per Common Share (See Note 1)
Net income per common share $ .04 $ 0.20
================ ================
Diluted earnings per common share
(See Note 1) $ .04 $ 0.19
================ ================
(The accompanying notes are an integral part of these financial statements.)
- F-4 -
<PAGE>
ROYALE ENERGY, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
Preferred Stock Series AA Treasury Stock
------------------------- --------------
Number Number Accumulated Number
of Shares Amount of Shares Amount Deficit of Shares Amount
--------- --------- ------- -------- ---------- ------- --------
Balance,
1/1/98 3,864,300 $8,676,273 50,000 $200,000 $(2,782,299) 37,500 $187,500
New shares
issued 18,060 - - - - - -
Shares issued in connection with
preferred stock Series A
conversion 3,750 30,000 - - - - -
Shares issued in connection with
preferred stock Series AAA
conversion 3,125 25,000 - - - - -
Stock options
repurchased - (86,250) - - - - -
Shares redeemed and
canceled (80,622) (404,418) (6,250) (25,000) - (18,200)(93,000)
Net income - - - - 774,406 - -
--------- --------- ------- -------- ---------- ------- -------
Balance,
12/31/98 3,808,613 8,240,605 43,750 175,000 (2,007,893) 19,300 94,500
Shares issued in connection with
preferred stock Series A
conversion - - - - - - -
Shares issued in connection with
preferred stock Series AAA
conversion - - - - - - -
Shares
purchased - - - - - - -
Shares redeemed and
canceled - - - - - - -
Net loss - - - - 149,903 - -
--------- --------- ------- -------- ---------- ------- -------
Balance,
12/31/99 3,808,613 $8,240,605 43,750 $ 175,000 $(1,857,990) 19,300 $94,500
========= ========= ====== ========== =========== ====== ========
(The accompanying notes are an integral part of these financial statements.)
- F-5 -
<PAGE>
ROYALE ENERGY, INC.
STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1999 AND 1998
1999 1998
------------ -----------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 149,903 $ 774,406
Adjustment to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation, depletion and amortization 1,502,026 1,461,511
Loss on lease impairment 62,815 465,520
(Increase) decrease in:
Accounts receivable (298,811) 292,129
Receivable from related parties 56,563 2,501
Prepaid expenses and other assets (167,619) (32,644)
Notes receivable 118,149 40,875
Increase (decrease) in:
Accounts payable and accrued expenses 2,605,032 (863,629)
Deferred revenues - DWI (1,370,361) 1,099,150
----------- ----------
Net Cash Provided by Operating Activities 2,657,697 3,239,819
----------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Expenditures for oil and gas properties (2,671,191) (4,817,413)
Other capital expenditures (35,833) (125,239)
----------- ----------
Net Cash Used by Investing Activities (2,707,024) (4,942,652)
----------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
(Increase) decrease in receivable from
related parties, net - (15,194)
Proceeds from line of credit 50,000 1,100,000
Common stock purchased and canceled - (397,668)
----------- ----------
Net Cash Provided by Financing Activities 50,000 687,138
----------- ----------
Net Decrease in Cash and Cash Equivalents 673 (1,015,695)
Cash at beginning of year 1,016,306 2,032,001
----------- ----------
Cash at end of year $ 1,016,979 $ 1,016,306
=========== ==========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $ 385,896
==========
Cash paid for taxes $ 800
==========
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS:
Series A preferred stock exchanged for
common stock $ - $ 30,000
============= ==========
Series AA stock exchanged for common stock $ - $ 25,000
============= ==========
Treasury stock reclassed to common stock $ - $ 93,000
============= ==========
(The accompanying notes are an integral part of these financial statements.)
- F-6 -
<PAGE>
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.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change
relate to the estimate of Company oil and gas reserves prepared by an
independent engineering consultant. Such estimates are subject to numerous
uncertainties inherent in the estimation of quantities of proved reserves.
Estimated reserves are used in the calculation of depletion, depreciation and
amortization as well as the Company's assessment of proved oil and gas
properties for impairment.
Revenue Recognition
The Company recognizes revenues from the sales of oil and gas in the period
of delivery.
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. A percentage
of total funds invested are 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. 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. Included in cash and cash equivalents are amounts for use in the
completion of Turnkey drilling programs in progress.
- F-7 -
<PAGE>
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Oil and Gas Property and Equipment (Successful Efforts)
The Company accounts for its oil and gas exploration and development costs
using the successful efforts method. Leasehold acquisition costs are
capitalized. If proved reserves are found on an undeveloped property,
leasehold cost is transferred to proved properties. Significant undeveloped
leases are reviewed periodically and a valuation allowance is provided for
any estimated decline in value. Cost of other undeveloped leases is expensed
over the estimated average life of the leases. Cost of exploratory drilling
is initially capitalized but is subsequently expensed if proved reserves are
not found. Other exploratory costs are charged to expense as incurred.
Development costs, including unsuccessful development wells, are capitalized.
Depletion, depreciation and amortization of oil and gas producing properties
are computed on an aggregate basis using the units-of-production method.
Financial Accounting Standards Board (FASB), 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", 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. Prior to 1998, the Company performed the impairment review on a field
by field basis. In 1998, management decided to perform the impairment review
on a region by region basis. According to management, regional aggregations
of fields are more consistent with the company's operations and identifiable
sources of cash flows. Regional aggregations of fields also correctly reflect
geological relationships between proved reserves.
Impairment loss for the year ended December 31, 1998 was $465,520. In 1999,
$62,815 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.
Other Capitalized Costs
Other capitalized costs are related to 3D seismic studies performed by an
outside Geophysical and Geological company on behalf of the Company. The cost
of this data is based on cost per square mile multiplied by the number of
squares analyzed. The data is used by the Company to enhance or evaluate
proposed developments of its proved and unproved fields, as well as held for
sale to outside parties. As the Company uses the data for its exploratory and
development projects, that portion of the capitalized costs used will be
reclassified as proved oil and gas properties or expensed. The portion of the
data library not used by the Company for its projects will be amortized over
a three-year period using the straight-line method. Amortization expense for
the year ended December 31, 1999 was $309,069.
As of the audit report date, the Company had not licensed and/or sold seismic
data to outside parties.
- F-8 -
<PAGE>
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 (Loss) 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.
Basic and diluted earnings (loss) per share are calculated as follows:
For the Year Ended 1999
----------------------------------------------------
Income Shares Pre-Share
(Numerator) (Denominator) Amount
----------- ------------- ----------
Basic Earnings Per Share:
Net income available to
common stock $ 149,903 3,808,613 $ .04
Diluted Earnings Per Share:
Effect of dilutive securities
and stock options - 2,288 -
----------- ------------- ----------
Net income available to
common stock $ 149,903 3,810,901 $ .04
========== =========== ==========
For the Year Ended 1998
----------------------------------------------------
Income Shares Pre-Share
(Numerator) (Denominator) Amount
----------- ------------- ----------
Basic Earnings Per Share:
Net income available to
common stock $ 774,406 3,839,127 $ .20
Diluted Earnings Per Share:
Effect of dilutive securities
and stock options - 294,883 (.01)
----------- ------------- ----------
Net income available to
common stock $ 774,406 4,134,010 $ 0.19
========== =========== ==========
- F-9 -
<PAGE>
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.
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 for December 31, 1999 and 1998 totaled $84,662 and $118,149,
respectively. Notes receivable at December 31, 1999 and 1998 consisted of
$79,629 and $103,116, respectively, 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 $5,033 and $15,033, respectively, secured
by Royale Covenant Security Corporation stock, bearing an interest rate of
prime plus 1.5%.
NOTE 3 - OIL AND GAS PROPERTIES, EQUIPMENT AND FIXTURES
Oil and gas properties, equipment and fixtures consist of the following at
December 31:
1999 1998
-------------- -------------
Oil and Gas
Producing properties, including
intangible drilling costs $ 10,684,610 $ 9,180,297
Undeveloped properties 2,051,572 1,444,942
Lease and well equipment 4,442,335 3,950,428
-------------- -------------
17,178,517 14,575,667
Accumulated depletion, depreciation
and amortization (4,255,798) (3,127,477)
-------------- -------------
12,922,719 11,448,190
-------------- -------------
- F-10 -
<PAGE>
NOTE 3 - OIL AND GAS PROPERTIES, EQUIPMENT AND FIXTURES (Continued)
1999 1998
-------------- -------------
Commercial and Other
Furniture and equipment 391,087 355,254
Accumulated depreciation (264,727) (205,617)
-------------- -------------
126,360 149,637
-------------- -------------
$ 13,049,079 $ 11,597,827
=============== ===============
Other Capitalized Cost
3D seismic data $ 927,208 $ 927,208
Accumulated amortization (309,069) -
-------------- -------------
$ 618,139 $ 927,208
=============== ===============
The following sets forth costs incurred for oil and gas property acquisition
and development activities, whether capitalized or expensed:
1999 1998
-------------- -------------
Acquisition $ 107,139 $ 979,068
Development $ 4,560,146 $ 4,048,896
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:
1999 1998
-------------- -------------
Oil and gas sales $ 3,006,010 $ 4,101,553
Production related costs (896,321) (1,020,541)
Geological and geophysical expense (97,851) (139,664)
Depreciation, depletion and amortization (1,442,916) (1,409,858)
-------------- -------------
Results of operations from producing and
exploration activities $ 568,922 $ 1,531,490
=============== ===============
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, 1999 and 1998, the
Company had recorded deferred turnkey drilling revenue associated with
undrilled wells of $1,464,615 and $2,834,976, respectively, as a
current liability.
- F-11 -
<PAGE>
NOTE 5 - FINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS
The Company adopted SFAS No. 131, Disclosure About Segments of an Enterprise
and Related Information 'SFAS 131' in 1998 which changes the way the
Company reports information about its operating segments.
The Company identifies reportable segments by product and country, although
the Company currently does not have foreign country segments. The
Company includes revenues from both external customers and revenues
from transactions with other operating segments in its measure of segment
profit or loss. The Company also includes interest revenue and expense, DD&A,
and other operating expenses in its measure of segment profit or loss.
The accounting policies of the reportable segments are the same as
those described in the Summary of Significant Accounting Principles (see Note
1).
The Company's operations are classified into two principal industry
segments. Following is a summary of segmented information for 1999 and 1998:
Oil and Gas
Producing Turnkey
and Drilling
Exploration Services Total
----------- --------- -----------
Year Ended December 31, 1999
Revenues from External
Customers $ 3,006,010 $4,213,696 $ 7,219,706
=========== ========== ===========
Interest Revenue $ 13,243 $ - $ 13,243
=========== ========== ===========
Interest Expense $ 192,948 $ 192,948 $ 385,896
=========== ========== ===========
Expenditures for Segment
Assets $ 1,323,744 $3,867,675 $ 5,191,419
=========== ========== ===========
Depreciation, Depletion,
and Amortization $ 1,442,916 $ - $ 1,442,916
=========== ========== ===========
Lease Impairment $ 31,408 $ 31,407 $ 62,815
=========== ========== ===========
Total Assets $16,850,989 $ - $16,850,989
=========== ========== ===========
Net Income $ 28,237 $ 121,666 $ 149,903
=========== ========== ===========
Oil and Gas
Producing Turnkey
and Drilling
Exploration Services Total
----------- --------- -----------
Year Ended December 31, 1998
Revenues from External
Customers $ 4,101,553 $ 3,789,995 $ 7,891,548
=========== ========== ===========
Interest Revenue $ 57,882 $ - $ 57,882
=========== ========== ===========
Interest Expense $ 167,686 $ 167,687 $ 335,373
=========== =========== ===========
Expenditures for Segment
Assets $ 1,924,491 $ 3,039,782 $ 4,964,273
=========== =========== ===========
Depreciation, Depletion,
and Amortization $ 1,409,858 $ - $ 1,409,858
=========== =========== ===========
Lease Impairment $ 232,760 $ 232,760 $ 465,520
=========== =========== ===========
Total Assets $15,416,415 $ - $15,416,415
=========== =========== ===========
Net Income $ 424,640 $ 349,766 $ 774,406
=========== =========== ===========
- F-12 -
<PAGE>
NOTE 6 - LONG-TERM DEBT
1999 1998
-------------- -------------
Revolving line of credit with a maximum
available of $5,050,000 for working
capital purposes, acquisitions, and
development of oil and gas properties.
Agreement was amended on November 24, 1999.
Interest at New York prime plus 75.0
and 137.5 basis points, resulting in rates
of 9.25% and 8.5% at December 31, 1999 and
1998, respectively. Principal and
interest payable monthly, with the
remaining outstanding principal due at
maturity on January 31, 2001. Secured by
property and assignment of production. $ 5,050,000 $ 5,000,000
============== ===============
Maturities of long-term debt for years subsequent to December 31, 1999 are
as follows:
Year Ended
December 31,
-----------
2001 $ 5,050,000
=============
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 1998.
NOTE 7 - INCOME TAXES
The provisions for income taxes for the years ended December 31, 1999 and
1998 represents minimum state taxes.
As of December 31, 1999, the Company had federal net operating loss
carryforwards as indicated:
Year Originated Year of Expiration Net Operating Loss
--------------- ------------------ ------------------
1990 2006 $ 516,785
1991 2007 970,101
1992 2008 227,241
1993 2009 1,654,713
-----------------
$ 3,368,840
=================
The components of the net deferred tax assets were as follows:
1999 1998
-------------- ---------------
Deferred Tax Assets:
Net operating loss
carryforwards $ 1,145,406 $ 1,240,946
Statutory depletion carryforwards 227,904 227,904
Accumulated depreciation 29,324 23,799
---------------- -----------------
Total Deferred Tax Assets 1,402,634 1,492,649
-------------- ---------------
Valuation Allowance (1,402,634) (1,492,649)
-------------- ---------------
Net Deferred Tax Assets $ - $ -
============== ===============
- F-13 -
<PAGE>
NOTE 7 - INCOME TAXES (Continued)
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, 1999 and 1998, respectively, to pretax income is as follows:
1999 1998
-------------- ---------------
Tax computed at 34%, respectively $ 50,967 $ 281,001
Increase (decrease) in taxes
resulting from:
Net operating loss carryforwards (51,767) (281,001)
State tax 800 52,868
-------------- ----------------
$ - $ 52,868
============== ================
Effective Tax Rate 0.0% 6.8%
============== ================
NOTE 8 - 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 1999 or 1998.
The Series A Convertible Preferred Stock is convertible any time at the
basic conversion rate of one share of common stock for two shares of Series A
Convertible Preferred Stock, subject to adjustment. The Company has the
option to call, at any time, the Series A Convertible Preferred Stock at
either the issue price of $4 per share plus 10%, if called within one year
after issuance, or $4 per share thereafter. (Subject to the holders'
conversion rights outlined above).
Upon the sale of 50% of the units of beneficial interest in Royal Energy
Income Trust, a holder of Series A Convertible Preferred Stock may require
the Company to redeem their Series A Convertible Preferred Stock at the issue
price of $4 per share plus accrued dividends, if any.
The Series A Convertible Preferred Stock has a liquidation preference to the
common stock equal to $4 per share plus accrued dividends. Holders of
Series A Convertible Preferred Stock shall have voting rights equal to the
number of shares of common stock into which the Series A Convertible
Preferred Stock may be converted.
On October 28, 1993, the Company's Series A Convertible Preferred Stock
shareholders were made a one time offer to convert their Series A
Convertible Preferred Stock to common stock. This conversion would be
at one share of common stock for each share of Series A Convertible
Preferred Stock, rather than at the original conversion price of $4 per
share. This conversion would not affect the shareholders' rights and
incentives in the Royale Energy Income Trust. As of December 31, 1999 and
1998, 224,875 shares of Series A Convertible Preferred Stock had been
converted to 198,625 shares of common stock.
- F-14 -
<PAGE>
NOTE 9 - 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, 1999 and 1998, there were 43,750 shares issued
and outstanding. The dividend has been paid on all shares outstanding at
December 31, 1999 and 1998.
NOTE 10 - COMMON STOCK
During 1998, 3,125 shares of common stock were issued for conversion of 6,250
Series AA Preferred Stock, and 3,750 common shares were issued for conversion
of 7,500 shares of Series A Preferred Stock. Also, in 1998, 12,200 shares
were canceled. Additionally, 62,422 shares of the Company's common stock
were repurchased and canceled. The Company's Board of Directors, at its
December 1997 meeting, authorized the repurchase and cancellation of up
to 15% of the outstanding common stock of the Company.
NOTE 11 - STOCK WARRANTS
Changes in the Company's common stock warrants were as follows at
December 31:
1999 1998
-------------- ---------------
Outstanding warrants at beginning
of period 230,555 230,555
Additional warrants issued
Exercise of stock warrants - -
Warrants expired or ineligible - -
-------------- ---------------
Outstanding warrants at end of period 230,555 230,555
============== ===============
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.
- F-15 -
<PAGE>
NOTE 12 - OPERATING LEASES
The Company leases office space under a sixty month noncancellable operating
lease, which expires in July 2000. The lease calls for monthly payments
ranging from $16,312 to $17,762. Future minimum lease obligations as of
December 31, 1999 is as follows:
Year Ended
December 31,
- ------------------
2000 $ 167,838
2001 197,563
2002 197,563
2003 201,912
2004 206,262
2005 210,612
------------
$ 1,181,750
============
Rental expense for the years ended December 31, 1999 and 1998, was $151,500
and $146,397, respectively.
NOTE 13 - RELATED PARTY TRANSACTIONS
Significant Ownership Interests
On December 31, 1999, 27.53% of the Company's common stock was owned by
Royale Petroleum Corporation (RPC). RPC 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 10.50% of the Company's
common stock at December 31, 1999. 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.
Stock Compensation Plan
On December 18, 1992, the Board of Directors granted the directors and
executive officers of the Company 30,000 options to purchase common stock at
an exercise or base price of $3.00 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.
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. The Company did not grant stock
options during 1999 or 1998.
- F-16 -
<PAGE>
NOTE 13 - RELATED PARTY TRANSACTIONS (Continued)
A summary of the status of the Company's stock option plan as of December 31,
1999 and 1998, and changes during the years ending on those dates is
presented below:
1999 1998
------------------- ----------------------
Weighted- Weighted-
Average Average
Exercise Exercise
Shares Price Shares Price
------- ----------- ------- ----------
Fixed Options
Outstanding at beginning of
year 134,000 $ 2.15 184,000 $ 2.15
Granted - -
Exercised - 50,000
------- --------
Outstanding at end of year 134,000 134,000
======= ========
Options exercisable at year
end 134,000 134,000
======= ========
Weighted-average fair value
of options granted during
the year $ - $ -
======== ========
The following table summarizes information about fixed stock options
outstanding at December 31, 1999:
Weighted- Weighted-
Number Average Weighted- Number Average
Range of Outstanding Remaining Average Outstanding Remaining
Exercise at December Contractual Exercise at December Contractual
Prices 31, 1999 Life (Years) Price 31, 1998 Life (Years)
- ---------- ----------- ------------ --------- ------------ ------------
$3.00 30,000 3.0 $3.00 30,000 4.0
$1.90 104,000 5.2 $1.90 104,000 6.2
-------- ----------
$1.90 to $1.90 to
$3.00 134,000 4.7 $3.00 134,000 5.7
======== =========
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 $73,118 and $24,811 for their interests for the
years ended December 31, 1999 and 1998, respectively.
NOTE 14 - ENVIRONMENTAL MATTERS
The Company has established procedures for the on-going evaluation of its
operations to identify potential environmental exposures and assure
compliance with regulatory policies and procedures. Management monitors
these laws and regulations and periodically assesses the propriety of its
operational and accounting policies related to environmental issues. The
nature of the Company's business requires routine day-to-day compliance with
environmental laws and regulations. The Company incurred no environmental
investigation, compliance and remediation costs in 1999 or 1998.
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.
- F-17 -
<PAGE>
NOTE 15 - 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, 1998, the Company had satisfied
their obligation under the agreement. At December 31, 1999, 18,900 of the
37,500 shares were in the process of being cancelled by the Company.
In May 1998, the Company settled its litigated issues with Lucille F. Biegel,
et al. To avoid further litigation on this matter, the Company agreed to re-
purchase the claimants oil and gas working interests. The re-purchase amount,
which is considered material to the financial statements, was capitalized as
an investment in the working interest acquired.
In December 1998, a former employee of Royale Energy, Inc. filed a lawsuit
against Royale Energy, Inc., and in May 1999 Royale Energy, Inc. filed a
cross-complaint. In December 1999, mediation was held and a settlement was
reached. The terms of the settlement are confidential but it did involve a
payment to Royale Energy, Inc. The settlement payment was made to Royale
Energy, Inc. in February 2000, and the case has been dismissed.
In April 1999, Royale Energy, Inc. filed an action against a former
consultant, Isles of June Consulting and its principal Robert Watts. In
October 1999, the defendants filed a cross-complaint against Royale Energy,
Inc. In January 2000, a settlement of $500,000 was reached in the favor of
Royale Energy, however, the judgment can be satisfied by defendant by making
certain payments totaling $150,000 and the transfer of certain stock to the
Company, as well as additional non-financial terms. As of the audit report
date, the total settlement amount had not been received.
NOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED)
Operating revenues, operating income, net income, and earnings per common
share by quarters from 1999 and 1998 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.
Basic Weighted-
Net Earnings Average
Total Income Per Common Shares
Quarter Ended Revenues Gross Profit (Loss) Share Outstanding
- ------------- -------- ------------ --------- ---------- -----------
December 31, 1999 $1,556,742 $ 1,004,870 $ 167,962 $ 0.04 3,808,613
1998 $2,115,378 $ 817,637 $(233,095) $ 0.00 3,839,127
September 30, 1999$2,335,352 $ 589,814 $ 57,896 $ 0.02 3,808,613
1998$1,732,662 $ 1,122,345 $ 333,262 $ 0.09 3,797,636
June 30, 1999 $2,062,062 $ 1,172,866 $(128,079)$ (0.03) 3,808,613
1998 $3,025,311 $ 1,484,204 $ 567,944 $ 0.15 3,832,629
March 31, 1999 $1,889,576 $ 77,280 $ 52,124 $ 0.01 3,808,613
1998 $1,491,779 $ 917,268 $ 106,295 $ 0.03 3,864,845
- F-18 -
<PAGE>
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, 1999 and 1998. 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.
Changes in Estimated Reserve Quantities
The net interest in estimated quantities of proved developed reserves of crude
oil and natural gas at December 31, 1999 and 1998 and changes in such
quantities during each of the years then ended, were as follows:
1999 1998
--------------------- ----------------------
Oil (BBL) Gas (MCF) Oil (BBL) Gas (MCF)
---------- --------- --------- ---------
Proved developed and undeveloped reserves:
Beginning of period - 15,248,000 4,698 16,882,699
Revisions of previous
estimates 5,728 1,582,851 (386) (2,153,290)
Production (820) (3,419,343) (4,312) (6,099,330)
Extensions, discoveries
and improved recovery 75,092 2,430,492 - 5,003,000
Purchase of minerals in
place - - - 1,614,921
------ ---------- -------- ----------
Proved reserves end of
period 80,000 15,842,000 - 15,248,000
====== ========== ======== ==========
Proved developed and
undeveloped reserves:
Beginning of period - 15,248,000 4,698 16,882,699
====== ========== ======== ===========
End of period 80,000 15,842,000 - 15,248,000
====== ========== ======== ===========
- F-19 -
<PAGE>
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, 1999.
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.
1999 1998
--------------- -------------
Future cash inflows $ 39,051,000 $ 36,230,000
Future production costs (12,304,000) (10,674,000)
Future development costs (3,232,000) (2,557,000)
Future income tax expenses (7,053,600) (6,899,700)
--------------- -------------
Future net cash flows 16,461,400 16,099,300
10% annual discount for estimated
timing of cash flows (6,957,879) (6,028,407)
Standardized measure of discounted
future net cash flows $ 9,503,521 $ 10,070,893
=============== ===============
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.
- F-20 -
<PAGE>
1999 1998
--------------- -----------------
Standardized measure - beginning
of year $ 10,070,893 $ 12,986,218
--------------- -----------------
Sales of oil and gas produced,
net of production costs (2,521,491) (6,824,289)
Purchase of minerals in place - 1,890,036
Revisions of estimates of reserves
provided in prior years:
Net changes in prices and production
costs (1,805,533) (4,330,121)
Extensions, discoveries and improved
recovery 3,487,024 5,057,000
Accretion of discount 29,469 42,624
Net change in income tax 243,159 1,249,425
--------------- -----------------
Net decrease (567,372) (2,915,325)
--------------- -----------------
Standardized measure - end of year $ 9,503,521 $ 10,070,893
=============== =================
- F-21 -
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> $ 1,016,979
<SECURITIES> $ 0
<RECEIVABLES> $ 1,830,070
<ALLOWANCES> $ 0
<INVENTORY> $ 0
<CURRENT-ASSETS> $ 3,183,171
<PP&E> $17,569,604
<DEPRECIATION> $ 4,520,525
<TOTAL-ASSETS> $16,850,989
<CURRENT-LIABILITIES> $ 5,318,774
<BONDS> $ 0
$ 19,100
$ 175,000
<COMMON> $ 8,240,605
<OTHER-SE> $(1,952,490)
<TOTAL-LIABILITY-AND-EQUITY> $16,850,989
<SALES> $ 7,219,706
<TOTAL-REVENUES> $ 7,843,732
<CGS> $ 3,496,876
<TOTAL-COSTS> $ 7,307,933
<OTHER-EXPENSES> $ 0
<LOSS-PROVISION> $ 0
<INTEREST-EXPENSE> $ 385,896
<INCOME-PRETAX> $ 149,903
<INCOME-TAX> $ 0
<INCOME-CONTINUING> $ 149,903
<DISCONTINUED> $ 0
<EXTRAORDINARY> $ 0
<CHANGES> $ 0
<NET-INCOME> $ 149,903
<EPS-BASIC> $ 0.04
<EPS-DILUTED> $ 0.04
</TABLE>
