______________________________________________________________________________

 

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

 

 

 

 

ROYALE ENERGY, INC.

(Exact name of registrant as specified in its charter)

 

 

 

 

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 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:

 

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 March 31, 2009, a total of 8,506,098 shares of registrant’s common stock were outstanding.

 

 

TABLE OF CONTENTS

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Item 1.  Financial Statements

 

 

 

 

 

 

See notes to unaudited financial statements

 

 

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See notes to unaudited financial statements

 

 

 

 

 

 

 

 

See notes to unaudited financial statements

 

 

 

 

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 three 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 three months ended March 31, 2009 and 2008, Royale Energy had dilutive securities of 26,392 and 28,708, respectively. These securities were not included in the dilutive loss per share due to their anti-dilutive nature.

 

 

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:

 

 

 

 

 

 

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 SFAS No. 123 (revised 2004) (“SFAS No. 123R”), Share-Based Payment, 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. SFAS No. 123R eliminates the ability to account for stock-based compensation transactions using the intrinsic value method under Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and instead generally requires that such transactions be accounted for using a fair-value-based method. The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards under SFAS No. 123R, consistent with that used for pro forma disclosures under SFAS No. 123, Accounting for Stock-Based Compensation. The Company has elected to use the modified prospective transition method as permitted by SFAS No. 123R and accordingly prior periods have not been restated to reflect the impact of SFAS No. 123R. The modified prospective transition method requires that stock-based compensation expense be recorded for all new and unvested stock options, restricted stock, restricted stock units, and employee stock purchase plan shares that are ultimately expected to vest as the requisite service is rendered beginning on January 1, 2006. Stock-based compensation expense for awards granted prior to January 1, 2006 is based on the grant-date fair-value as determined under the pro forma provisions of SFAS No. 123.

 

At the March 12, 2008 Board of Directors meeting, directors and executive officers of Royale Energy were each granted 45,000 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, the first 15,000 vested March 31, 2008, the second part vested on March 31, 2009, and the remaining 15,000 options will vest on March 31, 2010. The options were granted for a legal life of four years with a service period of three years. Royale Energy recorded compensation expense of $18,687 in first quarters of 2009 and 2008 relating to these options. The total income tax benefit recognized in the income statement for these option arrangements was $7,269 and $7,400 in 2009 and 2008, respectively.

 

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. The grant is to be vested in three parts, 31,667 or 63,334 shares, depending on Royale’s stock price, which will vest on November 30, 2009, 2010, and 2011. Royale has recognized share-based compensation expense of $20,688 and $8,048 as a tax benefit in the first quarter of 2009 relating to this grant.

 

 

NOTE 5 – RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

 

In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160 “Noncontrolling Interest in Consolidated Financial Statements – an Amendment of ARB 51” (SFAS 160). SFAS 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. It also requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest, and requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the noncontrolling interest. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited.

 

On December 12, 2007, the Financial Accounting Standards Board ratified the consensus reached by the Emerging Issues Task Force on Issue No. 07-01 “Accounting for Collaborative Arrangements”. This Issue will be effective for the fiscal year beginning January 1, 2009. This pronouncement is not expected to have a material impact on our financial statements.

 

In March 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 161 “Disclosures about Derivative Instruments and Hedging Activities – An Amendment of FASB Statement No. 133” (SFAS 161), that requires new and expanded disclosures regarding hedging activities. These disclosures include, but are not limited to, a proscribed tabular presentation of derivative data; financial statement presentation of fair values on a gross basis, including those that currently qualify for netting under FASB Interpretation No. 39; and specific footnote narrative regarding how and why derivatives are used. The disclosures are required in all interim and annual reports. SFAS 161 is effective for fiscal and interim periods beginning after November 15, 2008.

 

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. Early adoption is not permitted. We are currently assessing the impact that the adoption will have on our disclosures, operating results, financial position and cash flows.

 

 

 

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 March 31, 2009, and 2008:

 

 

 

 

 

 

 

Item 2.                Management's Discussion And Analysis Of Financial

 

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 first quarter of 2009, we had a net loss from operations of $891,056 compared to the net loss of $927,460 during the first quarter of 2008, a $36,404 difference. Total revenues for the first quarter in 2009 were $2,268,170, a decrease of $722,087 or 24.2% from the total revenues of $2,990,257 during the period in 2008. This decrease in revenues and the quarter’s net loss was the result of decreases in oil and natural gas commodity prices affecting our oil and natural gas production revenues.

 

In the first quarter of 2009, revenues from oil and gas production decreased $877,815 or 51.1% to $838,577 from the 2008 first quarter revenues of $1,716,392, due to lower prices received for our oil and natural gas production. The net sales volume of natural gas for the quarter ended March 31, 2009, was approximately 176,928 Mcf with an average price of $4.38 per Mcf, versus 175,822 Mcf with an average price of $8.22 per Mcf for the first quarter of 2008. This represents an increase in net sales volume of 1,107 Mcf or 0.6%. This slight increase was mainly due to new production brought online during the quarter , partially offset by the natural declines in production from existing wells. The net sales volume for oil and condensate (natural gas liquids) production was 2,002 barrels with an average price of $32.10 per barrel for the first three months of 2009, compared to 3,069 barrels at an average price of $88.44 per barrel for the three months in 2008. This represents a decrease in net sales volume of 1,067 barrels, or 34.8%.

 

Oil and natural gas lease operating expenses decreased by $237,124 or 34.7%, to $446,938 for the quarter ended March 31, 2009, from $684,062 for the quarter in 2008. This decrease was mainly due to lower workover costs during the period in 2009.

 

For the quarter ended March 31, 2009, turnkey drilling revenues increased $194,271 or 17.7% to $1,290,467 from $1,096,196 in the same quarter in 2008. We also had a $226,008 or 22.7% increase in turnkey drilling and development costs to $1,220,694 in 2009 from $994,686 in 2008. Turnkey drilling revenues and costs increased due to the drilling of two wells in California during the period in 2009, the Lonestar East #1, which went online in January and the Raptor #1, an exploratory dry hole. One well was drilled during the period in 2008. During the year to date in 2009, we processed the permits on several wells in California, and we expect to participate in

 

 

the drilling of up to seven wells during the third quarter 2009.

 

The aggregate of supervisory fees and other income was $139,126 for quarter ended March 31, 2009, a decrease of $38,543 (21.7%) from $177,669 during the period in 2008. This decrease was due to lower interest income received on our available cash and to lower cost recovery fees on facilities due to lower natural gas production.

 

Depreciation, depletion and amortization expense decreased to $542,775 from $854,844, a decrease of $312,069 (36.5%) for the quarter ended March 31, 2009, as compared to the same period in 2008. This decrease in depletion expense was mainly due to the decrease in our oil and gas assets from our 2008 impairments.

 

General and administrative expenses decreased by $71,557 or 7.2%, from $991,204 for the quarter ended March 31, 2008, to $919,647 for the period in 2009. This was primarily due to our cost control measures. Marketing expense for the quarter ended March 31, 2009, decreased $14,787, or 6.5%, to $212,707, compared to $227,494 for the period in 2008. 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 decreased to $366,511 for the period, compared to $531,650 for period in 2008, a $165,139 or 31.1% decrease. The decrease in legal and accounting expense was a result of lower legal fees due to litigation defending property rights, which culminated in a trial and a successful outcome for the Company in April 2008.

 

Interest expense decreased to $18,961 for the quarter ended March 31, 2009, from $83,423 for the same period in 2008, a $64,462, or 77.3% decrease. This was due to a decrease in the usage of our bank line of credit and lower interest rate on funds borrowed. For the first quarters in 2009 and 2008, we had income tax benefits of $569,007 and $477,469, respectively, due to net operating losses in both periods.

 

Capital Resources and Liquidity

 

At March 31, 2009, Royale Energy had current assets totaling $8,204,379 and current liabilities totaling $12,227,967, a $4,023,588 working capital deficit. We had cash and cash equivalents at March 31, 2009, of $3,044,316 compared to $1,330,739 at December 31, 2008.

 

During 2008, Royale Energy maintained a revolving credit agreement with Guaranty Bank, FSB, secured by all of our oil and gas properties, which at December 31, 2008, had outstanding indebtedness of $1,975,974. In February 2009, the Guaranty Bank loan was repaid and we entered into a new agreement with Texas Capital Bank, N.A. for a new revolving line of credit and letter of credit facility, also secured by our oil and gas properties, of up to $14,250,000 and separate letter of credit facility 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 March 31, 2008, we had outstanding indebtedness

 

 

on this loan of $4,454,181. Unused available credit from this revolving line of credit totaled approximately $270,819 at March 31, 2009.

 

At March 31, 2009, we were not in compliance with some financial covenants of our loan agreement with the bank, but we have obtained a temporary waiver from the terms of those loan covenants. We are not now, nor have we been, in default on any principal, interest or sinking fund payment.

 

At March 31, 2009, our accounts receivable totaled $2,157,689, compared to $3,750,557 at December 31, 2008, a $1,592,868 (42.5%) decrease, primarily due to lower receivables from an industry member participating in wells we drilled at the end of 2008. At March 31, 2009, our accounts payable and accrued expenses totaled $8,218,387, a decrease of $2,101,800 or 20.4% from the accounts payable at December 31, 2008, of $10,320,187, mainly due to applying prepaid drilling remittances to trade accounts payables.

 

We ordinarily fund our operations and cash needs from cash flows generated from operations. We believe that we have sufficient liquidity for the remainder of 2009 and do not foresee any liquidity demands that cannot be met from cash flow or financing activities.

 

Operating Activities. For the quarter ended March 31, 2009, cash used by operating activities totaled $565,680 compared to cash provided by operating activities of $746,608 for the same period in 2008, a $1,312,288 difference. This difference was due to decreases in accounts payables, accounts receivable, and prepaid expenses from the increased drilling activity during the period in 2009.

 

Investing Activities. Net cash used by investing activities, primarily in capital acquisitions of oil and gas properties, amounted to $198,950 for the period in 2009, compared to $1,482,015 used by investing activities for the same period in 2008, a $1,283,065 or 86.6% decrease in cash used.  This decrease capital acquisition was due to the timing of the wells drilled in 2009. The process to fund the necessary vendors working on the wells drilled in early January 2009 began in late December 2008, whereas the process to fund the one well drilling in the first quarter of 2008 began in the same quarter. The expense and costs for these wells in the first quarter of 2009 were recorded in the quarter, but the actual cash usage occurred in December 2008.

 

Financing Activities. For the three months ended March 31, 2009, cash provided by financing activities was $2,478,207 compared to cash used by financing activity of $400,000 for the same period in 2008. This difference was primarily due to the change from Guaranty Bank to Texas Capital Bank, and drawing down on our new credit line to fund continued drilling and corporate operations.

 

 

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 $3.97 per Mcf to a high of $5.36 per Mcf for the first three months of 2009. 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 March 31, 2009, 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 March 31, 2009.

 

No changes occurred in our internal control over financial reporting during the three months ended March 31, 2009, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

 

Item 1 Legal Proceedings

 

National Fuel Corporation (“NFC”) v. Royale Energy, Inc., No. 080800735, Uintah County, Utah. This lawsuit was filed on October 10, 2008, after the close of the third fiscal quarter. It arose from a dispute over jointly operated property in which Royale in the 75% owner and operator and NFC is a non-operator with a 25% ownership.  NFC disagrees with the Company’s operations and seeks to remove the Company as operator.  NFC also seeks unspecified damages. In an effort to bring this matter to a quick conclusion, Royale has agreed to non-binding mediation scheduled for May 19, 2009, in Denver, Colorado. The purpose of the mediation to place the litigation on hold prior to engaging in expensive discovery; allow the parties to state their respective cases; obtain a knowledgeable, third-party assessment of the strengths and weaknesses of each party’s case; and set the stage for settlement discussions.

 

Item 1A Risk Factors

 

Please review the risk factors contained in our Annual Report on Form 10-K for the year ended December 31, 2008. In addition, please note the following:

 

Risks Related to Our Common Stock

 

Failure to meet the continued listing standards of the NASDAQ Global Market could result in delisting of our common stock.

 

We currently do not meet the continued listing standards of the NASDAQ Global Market because our stockholders’ equity at December 31, 2008, was $7,394,467, which is less than the minimum requirement of $10 million in stockholders’ equity. We currently expect that additional operating losses in 2009 could further decrease our stockholders’ equity. We have submitted a plan to NASDAQ to regain compliance with this requirement but have not received

 

 

a response to our plan as of the date of this filing. We have filed a registration statement on Form S-3 with the SEC for the sale of shares of common stock to raise additional equity. The common stock offering is one element of our plan to regain compliance by increasing our stockholders’ equity. However, if we are unable to complete the rights offering successfully, or if we continue to experience significant losses, we may not achieve compliance with continued listing standards and NASDAQ could seek to delist our stock from the Global Market. In that event we would likely see to be listed on the NASDAQ Capital Market, but delisting may have a negative impact on the market price and liquidity of our common stock.

 

Item 6 Exhibits

 

31.1 Rule 13a-14(a)/15d-14(a) Certification

31.2 Rule 13a-14(a)/15d-14(a) Certification

32.1 18 U.S.C. § 1350 Certification

32.2 18 U.S.C. § 1350 Certification

 

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.