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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
 


FORM 10-Q
 


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2011
Commission File No. 000-22750
 
ROYALE ENERGY, INC.
(Exact name of registrant as specified in its charter)
 
California
33-0224120
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)

7676 Hazard Center Drive, Suite 1500
San Diego, CA 92108
(Address of principal executive offices) (Zip Code)
 
619-881-2800
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (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  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).              Yes x     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer  (as defined in Rule 12b-2 of the Exchange Act).  Check one:
 
Large accelerated filer  o
Accelerated filer  o
Non-accelerated filer  o
Smaller reporting company  x

Indicate by check mark whether the registrant is a blank check company (as defined in Rule 12b-2 of the Exchange Act).                  Yes  o    No  x

At June 30, 2011, a total of 10,762,099 shares of registrant’s common stock were outstanding.
 
 
TABLE OF CONTENTS


PART I
FINANCIAL INFORMATION
1
Item 1.
1
Item 2.
11
Item 3.
13
Item 4.
13
     
PART II
OTHER INFORMATION
14
Item 1.
14
Item 1A.
14
Item 6.
14
 
15







PART I.    FINANCIAL INFORMATION

Item 1.  Financial Statements
 
ROYALE ENERGY, INC.
BALANCE SHEETS
 
   
June 30, 2011
   
December 31, 2010
 
   
(Unaudited)
   
(Audited)
 
             
ASSETS
           
             
Current Assets
           
    Cash and Cash Equivalents
  $ 6,273,254     $ 4,630,722  
    Accounts Receivable, net
    2,574,013       2,451,047  
    Prepaid Expenses
    364,534       586,486  
    Deferred Tax Asset
    352,553       541,442  
    Inventory
    875,044       850,385  
                 
      Total Current Assets
    10,439,398       9,060,082  
                 
                 
Other Assets
    6,946       6,946  
Deferred Tax Asset-Noncurrent
    4,495,145       4,495,145  
                 
Oil and Gas Properties, at cost, (successful efforts basis),
    Equipment and Fixtures
    11,241,446       10,258,240  
                 
                 
Total Assets
  $ 26,182,935     $ 23,820,413  
 
See notes to unaudited financial statements
 
 
ROYALE ENERGY, INC.
BALANCE SHEETS
 
   
June 30, 2011
   
December 31, 2010
 
   
(Unaudited)
   
(Audited)
 
LIABILITIES AND STOCKHOLDERS' EQUITY
           
             
Current Liabilities:
           
    Accounts Payable and Accrued Expenses
  $ 4,229,310     $ 5,235,166  
    Deferred Revenue from Turnkey Drilling
    5,723,401       3,866,319  
                 
      Total Current Liabilities
    9,952,711       9,101,485  
                 
Noncurrent Liabilities:
               
    Asset Retirement Obligation
    586,897       580,568  
    Long-Term Debt, Net of Current Portion
    3,250,000       3,200,000  
                 
      Total Noncurrent Liabilities
    3,836,897       3,780,568  
                 
Total Liabilities
    13,789,608       12,882,053  
                 
Stockholders' Equity:
               
    Common Stock, no par value, authorized 20,000,000 shares, 
      10,794,718 and 10,307,350 shares issued; 10,762,099 and
      10,274,731 shares outstanding, respectively
    28,298,229       27,246,740  
    Convertible preferred stock, Series AA, no par value,
      147,500 shares authorized; 52,784 and 52,784 shares
      issued and outstanding, respectively
    154,014       154,014  
    Accumulated Deficit
    (16,471,224 )     (16,807,424 )
                 
    Total Paid in Capital and Accumulated Deficit
    11,981,019       10,593,330  
    Less Cost of Treasury Stock 32,619 and 32,619 shares
    (179,376 )     (179,376 )
    Additional Paid in Capital
    591,684       524,406  
                 
      Total Stockholders' Equity
    12,393,327       10,938,360  
                 
Total Liabilities and Stockholders' Equity
  $ 26,182,935     $ 23,820,413  

See notes to unaudited financial statements


ROYALE ENERGY, INC.
STATEMENTS OF OPERATIONS
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2011
   
2010
   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
   
(Unaudited)
 
                         
Revenues:
                       
    Sale of Oil and Gas
  $ 1,864,515     $ 634,630     $ 3,302,074     $ 1,425,411  
    Turnkey drilling
    1,311,320       3,253,736       2,507,191       3,978,564  
    Supervisory Fees and Other
    300,810       226,821       502,536       360,191  
                                 
      Total Revenues
    3,476,645       4,115,187       6,311,801       5,764,166  
                                 
Costs and Expenses:
                               
    General and Administrative
    993,596       1,008,763       2,041,390       1,949,808  
    Turnkey Drilling and Development
    474,963       649,518       1,425,977       1,103,604  
    Lease Operating
    493,943       336,600       800,051       595,009  
    Lease Impairment
    0       114,048       0       114,048  
    Geological and Geophysical Expense
    25,059       0       66,968       0  
    Legal and Accounting
    94,768       62,563       497,979       254,560  
    Marketing
    244,888       152,649       425,492       303,401  
    Depreciation, Depletion and Amortization
    717,114       238,937       1,246,561       478,622  
                                 
        Total Costs and Expenses
    3,044,331       2,563,078       6,504,418       4,799,052  
                                 
Gain on Sale of Assets
    8,024       0       793,156       0  
                                 
      Income From Operations
    440,338       1,552,109       600,539       965,114  
Other Income (Expense):
                               
    Interest Expense
    (37,232 )     (5,035 )     (75,450 )     (10,544 )
    Gain on Marketable Securities
    0       164,383       0       164,383  
                                 
Income Before Income Tax Expense
    403,106       1,711,457       525,089       1,118,953  
Income tax provision
    143,759       636,063       188,889       416,074  
                                 
Net Income
  $ 259,347     $ 1,075,394     $ 336,200     $ 702,879  
                                 
                                 
Basic Earnings Per Share
  $ 0.02     $ 0.11     $ 0.03     $ 0.07  
                                 
                                 
Diluted Earnings Per Share
  $ 0.02     $ 0.10     $ 0.03     $ 0.06  
                                 
                                 
Other Comprehensive Income
                               
    Unrealized Loss on Equity Securities
  $ 0     $ (611,512 )   $ 0     $ (455,032 )
    Less: Reclassification Adjustment for Gains Included in Net Income
    0       (164,383 )     0       (164,383 )
                                 
Other Comprehensive Loss, before tax
    0       (447,129 )     0       (290,649 )
Income Tax Benefit Related to Items of Other Comprehensive Income
    0       (165,175 )     0       (59,759 )
                                 
Other Comprehensive Loss, net of tax
    0       (281,954 )     0       (230,890 )
                                 
                                 
Comprehensive Income
  $ 259,347     $ 793,440     $ 336,200     $ 471,989  
 
See notes to unaudited financial statements
 
 
ROYALE ENERGY, INC.
STATEMENTS OF CASH FLOWS 
FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010

   
2011
   
2010
 
   
(Unaudited)
   
(Unaudited)
 
CASH FLOWS FROM OPERATING ACTIVITIES
           
    Net Income
  $ 336,200     $ 702,879  
    
               
    Adjustments to Reconcile Net Income to Net
      Cash Provided by Operating Activities:
               
        Depreciation, Depletion and Amortization
    1,246,561       478,622  
        Lease Impairment
    0       114,048  
        Gain on Sale of Assets
    (793,156 )     0  
        Realized Gain on Equity Securities
    0       (164,383 )
        Stock-Based Compensation, net of adjustments
    67,278       89,780  
     Decrease (Increase) in:
               
        Accounts Receivable
    (122,966 )     406,748  
        Prepaid Expenses and Other Assets
    197,293       10,433  
     Increase (Decrease) in:
               
        Accounts Payable and Accrued expenses
    (999,527 )     (272,839 )
        Deferred Revenues - DWI
    1,857,082       (1,625,927 )
        Deferred Income Tax expense
    188,889       416,074  
                 
   Net Cash Provided by Operating Activities
    1,977,654       155,435  
                 
CASH FLOWS FROM INVESTING ACTIVITIES
               
    Expenditures for Oil and Gas Properties and Other Capital Expenditures
    (2,242,964 )     (513,653 )
    Purchase of Equity Securities
    0       (4,159 )
    Sale of Equity Securities
    0       164,384  
    Proceeds from Sale of Assets
    806,353       0  
                 
   Net Cash Used by Investing Activities
    (1,436,611 )     (353,428 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES
               
    Proceeds from Long-Term Debt
    650,000       4,320,000  
    Principal Payments on Long-Term Debt
    (600,000 )     (4,747,500 )
    Proceeds from Stock Option and Warrant Exercises
    1,051,489       0  
                 
   Net Cash Provided (Used) by Financing Activities
    1,101,489       (427,500 )
                 
Net Increase (Decrease) in Cash and Cash Equivalents
    1,642,532       (625,493 )
                 
Cash at Beginning of Year
    4,630,722       3,835,282  
                 
Cash at End of Period
  $ 6,273,254     $ 3,209,789  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION:
         
  Cash Paid for Interest
  $ 75,775     $ 4,258  
                 
  Cash Paid for Taxes
  $ 2,522     $ 4,168  

See notes to unaudited financial statements
 
 
ROYALE ENERGY, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 1 – In the opinion of management, the accompanying unaudited financial statements include all adjustments, consisting only of normally recurring adjustments, necessary to present fairly the Company’s financial position and the results of its operations and cash flows for the periods presented.  The results of operations for the six month period are not, in management’s opinion, indicative of the results to be expected for a full year of operations.  It is suggested that these financial statements be read in conjunction with the financial statements and the notes thereto included in the Company’s latest annual report.

NOTE 2 – EARNINGS PER SHARE

Basic and diluted earnings (loss) per share are calculated as follows:

   
For the Six Months ended June 30, 2011
 
   
Income
(Numerator)
   
Shares
(Denominator)
   
Per-Share
Amount
 
Basic Earnings Per Share:
                 
   Net income available to common stock
  $  336,200       10,542,890     $ 0.03  
                         
Diluted Earnings Per Share:
                       
   Effect of dilutive securities and stock options
    0       354,266       0.00  
                         
Net income available to common stock
  $ 336,200       10,897,156     $ 0.03  
                         
   
For the Six Months ended June 30, 2010
 
   
Income
(Numerator)
   
Shares
(Denominator)
   
Per-Share
Amount
 
Basic Earnings Per Share:
                       
   Net income available to common stock
  $ 702,879       10,241,783     $ 0.07  
                         
Diluted Earnings Per Share:
                       
   Effect of dilutive securities and stock options
    0       954,159       (0.01
                         
Net income available to common stock
  $ 702,879       11,195,942     $ 0.06  
 
 
ROYALE ENERGY, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 3  – OIL AND GAS PROPERTIES, EQUIPMENT AND FIXTURES

Oil and gas properties, equipment and fixtures consist of the following:

   
June 30, 2011
   
December 31, 2010
 
Oil and Gas
           
  Producing properties, including drilling costs
  $ 26,442,399     $ 25,637,549  
  Undeveloped properties
    619,168       512,573  
  Lease and well equipment
    9,943,437       9,750,303  
      37,005,004       35,900,425  
  Accumulated depletion, depreciation & amortization
    (26,454,638 )     (26,333,243 )
      10,550,366       9,567,182  
Commercial and Other
               
  Real estate, including furniture and fixtures
  $ 502,344     $ 502,344  
  Vehicles
    151,669       158,250  
  Furniture and equipment
    1,303,992       1,285,744  
      1,958,005       1,946,338  
  Accumulated depreciation
    (1,266,925 )     (1,255,280 )
      691,080       691,058  
                 
    $ 11,241,446     $ 10,258,240  
 
The guidance set forth in the Continued Capitalization of Exploratory Well Costs paragraph of the Extractive Activities Topic of the FASB Accounting Standards Codification (ASC) requires that we evaluate all existing capitalized exploratory well costs and disclose the extent to which any such capitalized costs have become impaired and are expensed or reclassified during a fiscal period. We did not make any additions to capitalized exploratory well costs pending a determination of proved reserves during 2011 or 2010.

   
Six Months ended
June 30,
 
   
2011
   
2010
 
Beginning balance at January 1
  $ 0     $ 0  
Additions to capitalized exploratory well costs pending the
     determination of proved reserves
    0       433,220  
Reclassifications to wells, facilities, and equipment based on
     the determination of proved reserves
    (0 )     (433,220 )
Ending balance at June 30
  $ 0     $ 0  
 
 
ROYALE ENERGY, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 4 – STOCK BASED COMPENSATION

Royale Energy has a stock-based employee compensation plan.  Effective January 1, 2006, the Company adopted the Compensation – Stock Compensation Topic of the FASB ASC, which addresses the accounting for stock-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards, consistent with that used for pro forma disclosures under the Topic.

During the March 2008 Board of Directors meeting, directors and executive officers of Royale Energy were each granted 45,000 options, a total of 360,000 options, to purchase common stock at an exercise or base price of $3.50 per share.  These options are to be vested in three parts with 120,000 vesting on March 31, 2008, 2009, and 2010, respectively.  The options were granted for a legal life of four years with a service period of three years.  Royale Energy recorded compensation expense of $37,374 in the first six months of 2010 relating to these options. The total income tax benefits recognized in the income statement for these option arrangements were $13,903 in 2010.  No compensation cost or tax benefit was recognized in 2011 relating to this option grant.

In November 2008, the Board of Directors granted the directors and executive officers of Royale Energy 95,000 shares of restricted common stock.  The number of granted shares will double to 190,000 shares of common stock if Royale’s stock price reaches $15 a share during the period.  On November 30, 2009 and November 30, 2010, 31,665 shares vested, and the remaining 31,670 or 63,340, depending on Royale’s stock price, will vest on November 30, 2011.  Royale has recognized share-based compensation expense of $46,893 and $16,442 as a tax benefit in the first two quarters of 2011 relating to this grant.  During the same time period in 2010, Royale recognized $52,406 as compensation expense resulting in a $19,495 tax benefit relating to this stock grant.

During the Board of Directors meeting held in December 2010, directors and executive officers of Royale Energy were each granted 50,000 stock options, a total of 400,000 options, to purchase common stock at an exercise or base price of $3.25 per share.  These options are to vest in two parts; the first 200,000 options vested on January 1, 2011; the remaining 200,000 options will vest on January 1, 2012.  The options were granted with a legal life of five years, and a service period of two years beginning January 1, 2011.  During the first six months of 2011, Royale recognized compensation costs of $20,385 and a tax benefit of $7,147 relating to this option grant.
 
NOTE 5 – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

The Company has adopted the Subsequent Events Topic of the FASB Accounting Standards Codification. It establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. The Topic sets forth (1) The period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (2) The circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and (3) The disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The Topic is effective for interim or annual financial periods ending after June 15, 2009. The adoption of this standard did not have a significant impact on the Company’s interim financial information.

SEC Rulemaking

On December 31, 2008, the SEC published the final rules and interpretations updating its oil and gas reporting requirements. Many of the revisions are updates to definitions in the existing oil and gas rules to make them consistent with the petroleum resource management system, which is a widely accepted standard for the management of petroleum resources that was developed by several industry organizations. Key revisions include the ability to include nontraditional resources in reserves, the use of new technology for determining reserves, permitting disclosure of probable and possible reserves, and changes to the pricing used to determine reserves in that companies must use a 12-month average price. The average is calculated using the first-day-of-the-month price for each of the 12 months that make up the reporting period. The SEC will require companies to comply with the amended disclosure requirements for registration statements filed after January 1, 2010, and for annual reports for fiscal years ending on or after December 15, 2009. The adoption of this rule did not have a significant impact on the Company’s financial statements.
 
 
ROYALE ENERGY, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 6 – FINANCIAL INFORMATION RELATING TO INDUSTRY SEGMENTS

Royale Energy identifies reportable segments by product and country, although Royale Energy currently does not have foreign country segments. Royale Energy includes revenues from both external customers and revenues from transactions with other operating segments in its measure of segment profit or loss. Royale Energy also includes interest revenue and expense, DD&A, and other operating expenses in its measure of segment profit or loss.

Royale Energy's operations are classified into two principal industry segments. Following is a summary of segmented information for the three months ended June 30, 2011, and 2010:
 
   
Oil and Gas
             
   
Producing
   
Turnkey
       
   
and
   
Drilling
       
   
Exploration
   
Services
   
Total
 
                   
Six Months Ended June 30, 2011:
                 
Revenues from External Customers
  $ 3,302,074     $ 2,507,191     $ 5,809,265  
                         
Supervisory Fees
    486,931       0       486,931  
                         
Interest Revenue
    0       15,605       15,605  
                         
Interest Expense
    37,725       37,725       75,450  
                         
Operating Expenses for Segment Assets
    2,365,247       2,892,610       5,257,857  
                         
Depreciation, Depletion and Amortization
    1,184,233       62,328       1,246,561  
                         
Gain on Sale of Assets
    793,156       0       793,156  
                         
Income Tax Expense (Benefit)
    357,913       (169,024 )     188,889  
                         
Total Assets
  $ 24,873,788     $ 1,309,147     $ 26,182,935  
                         
Net Income (Loss)
  $ 637,043     $ (300,843 )   $ 336,200  
 
 
ROYALE ENERGY, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS

   
Oil and Gas
             
   
Producing
   
Turnkey
       
   
and
   
Drilling
       
   
Exploration
   
Services
   
Total
 
                   
Six Months Ended June 30, 2010:
                 
Revenues from External Customers
  $ 1,425,411     $ 3,978,564     $ 5,403,975  
                         
Supervisory Fees
    353,284       0       353,284  
                         
Interest Revenue
    0       6,907       6,907  
                         
Interest Expense
    5,272       5,272       10,544  
                         
Operating Expenses for Segment Assets
    1,895,586       2,310,796       4,206,382  
                         
Depreciation, Depletion and Amortization
    454,691       23,931       478,622  
Lease Impairment
    57,024       57,024       114,048  
                         
Gain on Marketable Securities
    0       164,383       164,383  
                         
Income Tax Expense (Benefit)
    (235,703 )     651,777       416,074  
                         
Total Assets
  $ 20,653,198     $ 1,087,010     $ 21,740,208  
                         
Net Income (Loss)
  $ (398,175 )   $ 1,101,054     $ 702,879  
 
 
ROYALE ENERGY, INC.
NOTES TO UNAUDITED FINANCIAL STATEMENTS

NOTE 7 – FAIR VALUE MEASUREMENTS

According to Fair Value Measurements and Disclosures Topic of the FASB Accounting Standards Codification, assets and liabilities that are measured at fair value on a recurring and nonrecurring basis in periods subsequent to initial recognition, the reporting entity shall disclose information that enable users of its financial statements to assess the inputs used to develop those measurements and for recurring fair value measurements using significant unobservable inputs, the effect of the measurements on earnings for the period.

In January 2000, Royale Energy received 96,000 shares (as adjusted for a later stock split) in a new start up company (the “Settlement Stock”) as part of a settlement in an action filed against a former consultant.  At the time of the settlement, the value of the Settlement Stock was undeterminable because there was no market for the start-up’s stock.  In September 2009, issuer of the Settlement Stock conducted an initial public offering of stock, and a market for its shares was established.  At June 30, 2010, the fair value of these shares was $710,830 and they were classified as available for sale securities.  The fair value was determined using the number of shares owned as of the last day of the reporting period multiplied by the market price of the Settlement Stock on that day.  For the six months ended June 30, 2010, an unrealized holding loss of $230,890 was recorded in the other comprehensive income (loss) section of the Statement of Operations. The unrealized holding loss included an income tax benefit of $59,759.  Royale also recognized a realized gain of $164,383 and a related income tax expense of $61,150 from the partial liquidation of the Settlement Stock for the period ending June 30, 2010.  By September 30, 2010, the Company had sold all remaining shares of the Settlement Stock.


Item 2.  Management's Discussion And Analysis Of Financial Condition And Results Of Operations

Forward Looking Statements
 
 In addition to historical information contained herein, this discussion contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995, subject to various risks and uncertainties that could cause our actual results to differ materially from those in the "forward-looking" statements. While we believe our forward looking statements are based upon reasonable assumptions, there are factors that are difficult to predict and that are influenced by economic and other conditions beyond our control. Investors are directed to consider such risks and other uncertainties discussed in documents filed by the Company with the Securities and Exchange Commission.

Results of Operations

For the six months ended June 30, 2011, we achieved net income of $336,200, a $366,679 decrease compared to the net income of $702,879 during the first six months of 2010.  Total revenues for the first six months of 2011 were $6,311,801, an increase of $547,635 or 9.5% from the total revenues of $5,764,166 received during the period in 2010.  This increase in revenues was mainly due to increased natural gas production during the period in 2011.  For the quarter ended June 30, 2011, our net income was $259,347, an $816,047 decrease compared to the net income of $1,075,394 achieved during the same period in 2010, mainly the result of higher turnkey drilling revenues during the quarter in 2010.

In the first six months of 2011, revenues from oil and gas production increased $1,876,663 or 131.7% to $3,302,074 from 2010 first half revenues of $1,425,411. This increase was due to higher natural gas production as three wells, two of which were drilled during the fourth quarter of 2010, were brought online during the period in 2011.  The net sales volume of natural gas for the six months ended June 30, 2011, was approximately 759,395 Mcf with an average price of $4.20 per Mcf, versus 249,152 Mcf with an average price of $4.75 per Mcf for the first six months of 2010.  This represents an increase in net sales volume of 510,243 Mcf or 204.8%.  For the quarter ended June 30, 2011, revenues from oil and gas increased to $1,864,515 from $634,630 received during the same period in 2010.  During the second quarter in 2011, we produced 417,303 Mcf with an average price of $4.33 per Mcf versus 123,326 Mcf produced during the same quarter in 2010 with an average price of $4.22 per Mcf, which represents a 293,977 Mcf or 238.4% increase in net sales volume.  The net sales volume for oil and condensate (natural gas liquids) was 1,233 barrels with an average price of $93.61 per barrel for the first six months of 2011, compared to 3,419 barrels with an average price of $70.85 per barrel for the first six months in 2010.  This represents a decrease in net sales volume of 2,186 barrels, or 64%.  For the second quarter of 2011, oil and condensate production decreased 988 barrels, or 62.5%, from 1,581 barrels produced in 2010 to 592 barrels produced in the same period in 2011.  This decrease was mainly due to the sale of several oil producing wells in February 2011 and the natural declines in production from existing oil and condensate wells.

Oil and natural gas lease operating expenses increased by $205,042 or 34.5%, to $800,051 for the six months ended June 30, 2011, from $595,009 for the same period in 2010.   This increase was mainly due to higher plugging and abandoning costs and higher transportation costs stemming from an increased production during the period in 2011.  For the second quarter of 2011, lease operating expenses increased $157,343 or 46.7% over the same period in 2010, also due to higher transportation and plugging costs.

For the six months ended June 30, 2011, turnkey drilling revenues were $2,507,191, a $1,471,373 or 37% decrease compared to revenues of $3,978,564 for the same period in 2010.  We also had a $322,373 or 29.2% increase in turnkey drilling and development costs to $1,425,977 in 2011 from $1,103,604 in 2010.  During the first six months in 2011 and 2010 we drilled three wells and five wells, respectively, leading to the decrease in turnkey revenues in 2011.  Since the three wells we drilled in the first six months of 2011 were deeper and more expensive than the wells we drilled during the same time period in 2010, our turnkey drilling and development costs increased.  In the second quarter of 2011, turnkey drilling revenues decreased $1,942,416 or 59.7% from $3,253,736 during the period in 2010 to $1,311,320 in 2011.  Also during the second quarter in 2011, our turnkey drilling costs decreased by $174,555 to $474,963 in 2011 from $649,518 during the period in 2010.  Turnkey drilling revenues and turnkey drilling and development costs decreased due to a reduction in drilling activity for the second quarter.  For the three months ended June 30, we drilled one well in 2011 and four wells in 2010.  We anticipate drilling activity to continue in the next quarter as we have processed permits for several new wells, and expect to drill three California wells during the third quarter of 2011.

We periodically review our proved properties for impairment on a field-by-field basis and charge impairments of value to the expense.  An impairment loss of $114,048 was recorded in the first six months of 2010.  This impairment was mainly due to various lease and land costs that were no longer viable.
 

The aggregate of supervisory fees and other income was $502,536 for the six months ended June 30, 2011, an increase of $142,345 (39.5%) from $360,191 during the same period in 2010.  Second quarter 2011 supervisory fees and other income increased $73,989, or 32.6%, to $300,810 from $226,821 in 2010.    These increases were the result of higher pipeline and compressors revenues generated from the increase in natural gas production.

Depreciation, depletion and amortization expense increased to $1,246,561 from $478,622, an increase of $767,939 (160.5%) for the six months ended June 30, 2011, as compared to the same period in 2010. This increase in depletion expense was mainly due to the increase in production resulting in an increased depletion rate of our oil and natural gas properties.   

General and administrative expenses increased by $91,582, or 4.7%, from $1,949,808 for the six months ended June 30, 2010, to $2,041,390 for the period in 2011.  This increase was primarily due to increased employee related costs.    Second quarter 2010 general and administrative expense decreased $15,167, or 1.5% from $1,008,763 in 2010 compared to $993,596 in 2011.

Marketing expense for the six months ended June 30, 2011, increased $122,091, or 40.2%, to $425,492 compared to $303,401 for the same period in 2010.  For the second quarter 2011, marketing expenses increased $92,239, or 60.43%, to $244,888 from $152,649 for the same period in 2010.   Marketing expense varies from period to period according to the number of marketing events attended by personnel and their associated costs.

Legal and accounting expense increased to $497,979 for the first six months of 2011, compared to $254,560 for same period in 2010, a $243,419 or 95.6% increase.  For the second quarter 2011, legal and accounting expenses increased by $32,205, or 51.5% from the same period last year.  The increase in legal and accounting expense was the result of higher legal fees in 2011 primarily related to the conclusion of the Mountain West litigation.

During the first six months of 2011, we sold our working interest in two separate non-core properties and other equipment resulting in a gain of $793,156.  The properties were located in Kern County, California and Gaines County, Texas.

Interest expense increased to $75,450 for the six months ended June 30, 2011, from $10,544 for the same period in 2010, a $64,906, or 615.6% increase. This was due to an increase in the usage of our bank line of credit.  For the six months ended June 30, 2011 and 2010, we had income tax expenses of $188,889 and $416,074, respectively, due to net operating profits.

During the second quarter of 2010, we received title to securities stemming from a litigation settlement received approximately 10 years ago; the securities, at that time, had an undeterminable value.  In June 2010, Royale began to liquidate its position and, by the end of July 2010, Royale had fully liquidated its position.  For the first six months of 2010, the Company has recognized a net unrealized holding loss of $230,890 in the other comprehensive income section of the Statement of Operations, and a realized gain of $164,383 from the partial liquidation of these securities in the other income section of the Statement of Operations.

Capital Resources and Liquidity

At June 30, 2011, Royale Energy had current assets totaling $10,439,398 and current liabilities totaling $9,952,711, a $486,687 working capital surplus.  We had cash and cash equivalents at June 30, 2011, of $6,273,254 compared to $4,630,722 at December 31, 2010.

In February 2009, we entered into a revolving credit agreement with Texas Capital Bank, N.A. secured by our oil and gas properties, of up to $14,250,000.  We also entered into a separate letter of credit facility with Texas Capital Bank of up to $750,000, for the purposes of refinancing Royale’s existing debt and to fund development, exploration and acquisition activities as well as other general corporate purposes.  Under the terms of the agreement, Royale Energy may borrow, repay, and reborrow funds as necessary.  At June 30, 2011, we had a current borrowing base of $3,250,000 and outstanding indebtedness on this loan of $3,250,000.

At June 30, 2011, we were in compliance with all financial covenants of our loan agreement with the bank, and we are not in default on any principal, interest or sinking fund payment.
 

At June 30, 2011, our accounts receivable totaled $2,574,013, compared to $2,451,047 at December 31, 2010, a $122,966 (5%) increase.  The increase in our accounts receivable during the first six months of 2011 was due to our increased oil and natural gas production.  At June 30, 2011, our accounts payable and accrued expenses totaled $4,229,310, a decrease of $1,005,856 or 19.2% from the accounts payable at December 31, 2010, of $5,235,166, mainly due to paying down our accounts payable.

Ordinarily, we fund our operations and cash needs from our available credit and cash flows generated from operations.  We believe that we have sufficient liquidity for the remainder of 2011 and do not foresee any liquidity demands that cannot be met from cash flow or financing activities.

Operating Activities.  For the six months ended June 30, 2011, cash provided by operating activities increased to $1,977,654 from $155,435 for the same time period in 2010, a difference of $1,822,219.  This difference was mainly due to an increase in Direct Working Interest sales.

Investing Activities.  Net cash used by investing activities, primarily in capital acquisitions of oil and gas properties, amounted to $1,436,611, and $353,428 for the six month period ended June 30, 2011 and 2010, respectively.  This rise in capital acquisition costs was the result of drilling fewer but deeper and more expensive wells during the period in 2011.  In the first two quarters of 2011, Royale also received proceeds of $806,353 relating to the sale of certain oil and natural gas properties in Kern County, California and Gaines County, Texas.  As part of the sale, Royale retained an overriding royalty interest in the acreage.

Financing Activities.  For the six months ended June 30, 2011, cash provided by financing activities amount to $1,101,489 compared to cash used by financing activities of $427,500 for the same period in 2010.  During the first six months of 2011, several warrants were exercised in exchange for shares of Royale’s common stock.  Royale received $1,051,489 and issued 468,928 shares of its common stock relating to these exercises.

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

Our major market risk exposure relates to pricing of oil and gas production.  The prices we receive for oil and gas are closely related to worldwide market prices for crude oil and local spot prices paid for natural gas production.  Prices have been volatile for the last several years, and we expect that volatility to continue.  Monthly average natural gas prices ranged from a low of $3.96 per Mcf to a high of $4.29 per Mcf for the first six months of 2011.  We have not entered into any hedging or derivative agreements to limit our exposure to changes in oil and gas prices or interest rates.

Item 4.  Controls and Procedures

As of June 30, 2011, an evaluation was performed under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of the design and operation of our disclosure controls and procedures.  These controls and procedures are based on the definition of disclosure controls and procedures in Rule 13a-15(e) and Rule 15d-15(e) promulgated under the Securities Exchange Act of 1934.  Based on that evaluation, our management, including the CEO and CFO, concluded that our disclosure controls and procedures were effective as of June 30, 2011.

No changes occurred in our internal control over financial reporting during the six months ended June 30, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 

PART II.    OTHER INFORMATION

Item 1.  Legal Proceedings

There were no material developments in any pending legal proceedings during the quarter ended June 30, 2011.  Please refer to Part II, Item 1 of our Report on Form 10-Q for the quarter ended March 31, 2011 for a description of pending legal proceedings.

Item 1A.  Risk Factors

Please review the risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2010.

Item 6.  Exhibits

31.1
31.2
32.1
32.2
101.INS**
XBRL Instance Document
101.SCH**
XBRL Taxonomy Extension Schema
101.CAL**
 XBRL Taxonomy Extension Calculation Linkbase
101.DEF**
 XBRL Taxonomy Extension Definition Linkbase
101.LAB**
 XBRL Taxonomy Extension Label Linkbase
101.PRE**
 XBRL Taxonomy Extension Presentation Linkbase
 
** Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to liability.
 

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:    July 29, 2011
/s/ Donald H. Hosmer
 
Donald H. Hosmer, Co-President and Co-Chief Executive Officer
   
Date:    July 29, 2011
/s/ Stephen M. Hosmer
 
Stephen M. Hosmer, Co-President, Co-Chief Executive Officer, and Chief Financial Officer