Attached files

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EX-21.1 - LIST OF SUBSIDIARIES - DUNE ENERGY INCdex211.htm
EX-99.1 - RESERVE REPORT OF INDEPENDENT ENGINEER - DUNE ENERGY INCdex991.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - DUNE ENERGY INCdex322.htm
EX-23.1 - CONSENT OF DEGOLYER AND MACNAUGHTON, INDEPENDENT PETROLEUM ENGINEERS - DUNE ENERGY INCdex231.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - DUNE ENERGY INCdex321.htm
EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - DUNE ENERGY INCdex311.htm
EX-10.17 - THIRD AMENDMENT TO CREDIT AGREEMENT - DUNE ENERGY INCdex1017.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - DUNE ENERGY INCdex312.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 001-32497

 

 

DUNE ENERGY, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   95-4737507

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

Two Shell Plaza, 777 Walker Street,

Suite 2300 Houston, Texas

  77002
(Address of principal executive offices)   (Zip Code)

(713) 229-6300

Registrant’s telephone number, including area code

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

  

Name of each exchange on which registered

Common Stock, $0.001 par value    NYSE AMEX

Securities registered pursuant to section 12(g) of the Act: None (Title of class)

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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  ¨

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  ¨   Accelerated filer  ¨
Non-accelerated filer  ¨    (Do not check if a smaller reporting company)       Smaller reporting company  x

 

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

As of June 30, 2009, the aggregate market value of the common stock of the registrant held by non-affiliates (excluding shares held by directors, officers and other holding more than 5% of the outstanding shares of the class) was $11,421,720, based upon a closing sale price of $0.14.

As of March 19, 2010, the registrant had outstanding 40,506,775 shares of common stock.

DOCUMENTS INCORPORATED BY REFERENCE

The information required by Part III will be incorporated by reference into this Form 10-K from the Registrant’s Definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the Registrant’s fiscal year covered by this Form 10-K.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

Cautionary Notice Regarding Forward-Looking Statements

   1

PART I

   2

Item 1. and Item 2. Business and Properties

   2

Item 1A. Risk Factors

   14

Item 1B. Unresolved Staff Comments

   24

Item 3. Legal Proceedings

   24

Item 4. Reserved

   24

PART II

   25

Item  5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   25

Item 6. Selected Financial Data

  

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

   28

Item 7A. Qualitative and Quantitative Disclosures About Market Risk

  

Item 8. Financial Statements and Supplementary Data

   37

Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

   37

Item 9A. Controls and Procedures

   37

Item 9B. Other Information

   40

PART III

   40

Item 10. Directors, Executive Officers and Corporate Governance

  

Item 11. Executive Compensation

  

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

  

Item 13. Certain Relationships and Related Transactions, and Director Independence

  

Item 14. Principal Accountant Fees and Services

  

PART IV

   41

Item 15. Exhibits and Financial Statement Schedules

   41

List of Subsidiaries

  

Consent of DeGolyer and MacNaughton, independent petroleum engineers

  

Certification of CEO Pursuant to Section 302

  

Certification of CFO Pursuant to Section 302

  

Certification of CEO Pursuant to Section 906

  

Certification of CFO Pursuant to Section 906

  

Summary of Reserve Report

  


Table of Contents

Cautionary Notice Regarding Forward Looking Statements

Dune Energy, Inc. (referred to herein as “Dune”, “we” or the “Company”) desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. This report contains a number of forward-looking statements that reflect management’s current views and expectations with respect to our business, strategies, future results and events and financial performance. All statements made in this Annual Report other than statements of historical fact, including statements that address operating performance, events or developments that management expects or anticipates will or may occur in the future, including statements related to revenues, cash flow, profitability, adequacy of funds from operations, statements expressing general optimism about future operating results and non-historical information, are forward looking statements. In particular, the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “may,” “will,” variations of such words, and similar expressions identify forward-looking statements, but are not the exclusive means of identifying such statements and their absence does not mean that the statement is not forward-looking. These forward-looking statements are subject to certain risks and uncertainties, including those discussed below. Our actual results, performance or achievements could differ materially from historical results as well as those expressed in, anticipated or implied by these forward-looking statements.

Readers should not place undue reliance on these forward-looking statements, which are based on management’s current expectations and projections about future events, are not guarantees of future performance, are subject to risks, uncertainties and assumptions (including those described below) and apply only as of the date of this report. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below in “Risk Factors” as well as those discussed elsewhere in this report, and the risks discussed in our press releases and other communications to stockholders issued by us from time to time which attempt to advise interested parties of the risks and factors that may affect our business. Except as may be required under the federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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PART I

Items 1 and 2.    Business and Properties.

Overview

Dune Energy, Inc. (“Dune, the “Company” or “we”) is an independent energy company based in Houston, Texas. Since May of 2004, we have been engaged in the exploration, development, acquisition and exploitation of natural gas and crude oil properties, with interests along the Louisiana/Texas Gulf Coast. Our properties cover over 90,000 gross acres across 27 producing oil and natural gas fields.

Our total proved reserves as of December 31, 2009 were 105.5 Bcfe, consisting of 62.4 Bcf of natural gas and 7.2 Mmbbls of oil. The PV-10 of our proved reserves at year end was $212.3 million based on the average of the beginning of each month prices for 2009 of $58.05/bbl and $4.14/mcf. During 2009, we added 5.5 Bcfe through extensions and discoveries, sold 2.2 Bcfe and produced 9.5 Bcfe. In addition, we experienced a downward revision of (21.3) Bcfe largely as a result of well performance at our Chocolate Bayou field (8.3) Bcfe and deletion of proved undeveloped locations at our North Broussard field (10.6) Bcfe due to mapping from 3-D seismic data.

Employees

As of December 31, 2009, we had 48 full time employees. We are not a party to any collective bargaining agreements and have not experienced any strikes or work stoppages. We believe our relationships with our employees are good. From time to time, we utilize the services of independent contractors to perform various field and other services.

Our Business Strategy

We intend to use our competitive strengths to continue increasing reserves, production and cash flow in order to maximize value for stockholders. The following are key elements of this strategy:

Grow Through Exploitation, Development and Exploration of Our Properties. Our primary focus will continue to be the development and exploration efforts in our Gulf Coast properties. We believe that our properties and acreage position will allow us to grow organically through low risk drilling in the near term, as this property set continues to present attractive opportunities to expand our reserve base through workovers and recompletions, field extensions, delineating deeper formations within existing fields and higher risk/higher reward exploratory drilling. In addition, we will constantly review, rationalize and “high-grade” our properties in order to optimize our existing asset base.

Actively Manage the Risks and Rewards of Our Drilling Program. Our strategy is to increase our oil and gas reserves and production while keeping our finding and development costs and operating costs (on a per Mcf equivalent (Mcfe) basis) competitive with our industry peers. We will implement this strategy through drilling exploratory and development wells from our inventory of available prospects that we have evaluated for geologic and mechanical risk and future reserve or resource potential. Our drilling program will contain some higher risk/higher reserve potential opportunities as well as some lower risk/lower reserve potential opportunities in order to achieve a balanced program of reserve and production growth.

Maintain and Utilize State of the Art Technological Expertise. We expect to maintain and utilize our technical and operations teams’ knowledge of salt-dome structures and multiple stacked producing zones common in the Gulf Coast to enhance our growth prospects and reserve potential. We employ technical advancements, including 3-D seismic data and Pre-stack depth and Reverse-Time migration to identify and exploit new opportunities in our asset base. We also employ the latest directional drilling, completion and fracturing technology in our wells to enhance recoverability and accelerate cash flows.

 

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Pursue Opportunistic Acquisitions of Underdeveloped Properties. We continually review opportunities to acquire producing properties, leasehold acreage and drilling prospects that are in core operating areas. We are seeking to acquire operational control of properties that we believe have a solid proved reserves base coupled with significant exploitation and exploration potential. We intend to continue to evaluate acquisition opportunities and make acquisitions that we believe will further enhance our operations and reserves in a cost effective manner.

2010 Budget. For 2010 we have targeted a capital budget of between $20 million and $22 million. While we will focus primarily on our development drilling program, we also intend to exploit certain exploration opportunities. Our capital budget will be revised as necessary to stay within our available cash, cash flow and line of credit.

Offices

Our headquarters are located at Two Shell Plaza, 777 Walker Street, Suite 2300, Houston, Texas 77002. Our telephone number is (713) 229-6300.

Core Areas of Operation and Certain Key Properties

As of December 31, 2009, our proved oil and gas reserves were concentrated in 26 producing fields along the Texas and Louisiana Gulf Coast. Almost all fields are characterized as legacy fields discovered by major companies in the mid 1900’s. The fields tend to have stacked multiple producing horizons with production typically between 4,000 and 13,000 feet. Most fields have numerous available wellbores capable of providing workover and recompletion opportunities. Additionally, new 3-D seismic allows definition of numerous updip proved undeveloped locations throughout the fields. The characteristics of these fields allow the Company to record significant proved behind pipe and proved undeveloped reserves in the annual year-end reserve report. At year end 2009, our proved developed producing (PDP) reserves of 40.9 Bcfe were 38.7% of our total oil and gas reserves, the proved developed non-producing (PDNP) of 31.3 Bcfe were 29.7% of the total oil and gas reserves and the proved undeveloped (PUD) of 33.3 Bcfe were 31.6% of the total proved reserves.

Three of our fields, Garden Island Bay, Leeville and Bateman Lake have large acreage positions surrounding piercement salt domes. These fields account for 32% of our total proved oil and gas reserves. We maintain an active workover and recompletion program in each of these fields and have drilled several development wells in the fields since we acquired them. These workovers, recompletions and development wells are designed to maintain or enhance the production rates in each of the fields. Most of these fields have had minimal drilling below 15,000 feet or below the salt layers which provides significant exploratory upside for the Company. 3-D seismic technology and directional drilling techniques perfected in the offshore shelf and deep water environments is providing the Company with several high reserve potential opportunities to drill in 2010 and beyond.

At Garden Island Bay, we completed a new Kirchoff Depth and Reverse Time migration project and depth converted our 3-D seismic data. The Company is seeking partners to participate in drilling an exploratory test well below the salt in this high reserve potential area along with seeking partners for several shallow wells to enhance the field’s near term production and reserves.

At Leeville and Bateman Lake fields, we have formed and maintained private company partnerships to drill new wells in which Dune can elect to participate at varied working interests or be carried for the full cost of the well and maintain an overriding royalty in the resultant production. The deeper potential at Leeville is relatively unexplored and we intend to develop partnerships to explore this potential in the next year or two.

The Chocolate Bayou, South Florence, Comite, North Broussard and Live Oak fields consist of 43% of our total reserves and are characterized as fields with fewer wellbores than the salt dome fields but numerous

 

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opportunities for new fault blocks containing unproved reserves that have been identified with new 3-D seismic data. As of December 31, 2009, approximately 43% of our proved undeveloped reserves (PUDs) requiring new wellbores are contained in these fields.

The remaining 18 fields contain approximately 25% of our total proved oil and gas reserves and are characterized by occasional new drilling wells and workovers, but typically do not have the upside opportunities demonstrated in the other fields.

Natural Gas and Oil Reserves.

Due to the inherent uncertainties and the limited nature of reservoir data, proved reserves are subject to change as additional information becomes available. The estimates of reserves, future cash flows and present value are based on various assumptions, including those prescribed by the Securities and Exchange Commission (“SEC”), and are inherently imprecise. Although we believe these estimates are reasonable, actual future production, cash flows, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves may vary substantially from these estimates. Also, the use of a 10% discount factor for reporting purposes may not necessarily represent the most appropriate discount factor, given actual interest rates and risks to which our business or the oil and natural gas industry in general are subject.

These calculations were prepared using standard geological and engineering methods generally accepted by the petroleum industry and in accordance with SEC financial accounting and reporting standards. The estimated present value of proved reserves does not include indirect expenses such as general and administrative expenses, debt service, future income tax expense or depletion, depreciation, and amortization.

In accordance with applicable financial accounting and reporting standards of the SEC, the estimates of our proved reserves and the present value of proved reserves set forth herein are made using the average of oil and natural gas sales prices on the first day of each of the twelve months during 2009. Estimated quantities of proved reserves and their present value are affected by changes in oil and natural gas prices. The average prices utilized for the purpose of estimating our proved reserves and the present value of proved reserves as of December 31, 2009 were $$58.05 per barrel of oil and $4.13 per Mcf of natural gas.

 

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The following table sets forth our estimated net total oil and natural gas reserves and the PV-10 value of such reserves as of December 31, 2009. The reserve data and the present value as of December 31, 2009 were prepared by DeGolyer and MacNaughton, independent petroleum engineers. For further information concerning our independent engineer’s estimates of our proved reserves as of December 31, 2009, see the reserve report filed as Exhibit 99.1 to this Annual Report on Form 10-K. The PV-10 value is not intended to represent the current market value of the estimated oil and natural gas reserves owned by us. For further information concerning the present value of future net revenues from these reserves, see Note 12 of Notes to Consolidated Financial Statements.

 

     Oil    Natural
Gas
   Undiscounted
Future Net
Revenue
   Present
value of
Proved
Reserves
Discounted
at
10% (1)
     Mbbl    Mmcf    $ thousands    $ thousands

Proved:

           

Developed Producing

   2,803.5    24,040.0    116,111.8    88,575.0

Developed Nonproducing

   2,136.9    18,463.5    100,318.8    52,412.9

Proved Undeveloped

   2,246.3    19,851.6    119,549.4    71,313.5
                   

Total Proved

   7,186.7    62,335.1    335,980.0    212,301.4
                   

Probable:

           

Developed Producing

   4.6    990.7    3,192.3    2,568.4

Developed Nonproducing

   72.8    1,947.5    4,897.7    2,303.7

Undeveloped

   347.2    1,102.5    15,003.5    10,813.8
                   

Total Probable

   424.6    4,040.7    23,093.5    15,685.9
                   

Possible:

           

Undeveloped

   44.0    6,779.5    15,218.0    7,463.8
                   

Total Possible

   44.0    6,779.5    15,218.0    7,463.8
                   

 

(1) Management believes that the presentation of PV-10 may be considered a non-GAAP financial measure as defined in Item 10(e) of Regulation S-K. Therefore we have included a reconciliation of the measure to the most directly comparable GAAP financial measure (standardized measure of discounted future net cash flows in the table immediately below). Management believes that the presentation of PV-10 value provides useful information to investors because it is widely used by professional analysts and sophisticated investors in evaluating oil and gas companies. Because many factors that are unique to each individual company may impact the amount of future income taxes to be paid, the use of the pre-tax measure provides greater comparability when evaluating companies. It is relevant and useful to investors for evaluating the relative monetary significance of our natural gas and oil properties. Further, investors may utilize the measure as a basis for comparison of the relative size and value of our reserves to other companies. Management also uses this pre-tax measure when assessing the potential return on investment related to its oil and gas properties and in evaluating acquisition candidates. The PV-10 value is not a measure of financial or operating performance under GAAP, nor is it intended to represent the current market value of the estimated oil and natural gas reserves owned by us. PV-10 should not be considered in isolation or as a substitute for the standardized measure of discounted future net cash flows as defined under GAAP.

 

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The table below provides a reconciliation of PV-10 to the standardized measure of discounted future net cash flows:

 

     As of
December 31,
2009
     (dollars in
thousands)

PV-10

   $ 212,301

Future income taxes, discounted at 10%

     —  
      

Standardized income of discounted future net cash flows

   $ 212,301
      

Oil and Natural Gas Volumes, Prices and Operating Expense

The following tables set forth certain information regarding the production volumes, revenue, average prices received and average production costs associated with our sale of oil and natural gas from continuing operations for the three years ended December 31, 2009 and 2008.

 

     Year Ended December 31,
     2009    2008

Net Production:

     

Oil (Bbl)

     724,139      884,213

Natural Gas (Mcf)

     5,177,317      6,060,093
             

Natural Gas Equivalent (Mcfe)

     9,522,151      11,365,371

Oil and Natural Gas Sales (dollars in thousands):

     

Oil

   $ 42,383    $ 88,306

Natural Gas

     22,490      58,294
             

Total

   $ 64,873    $ 146,600

Average Sales Price:

     

Oil ($ per Bbl)

   $ 58.53    $ 99.87

Natural Gas ($ per Mcf)

     4.34      9.62
             

Natural Gas Equivalent ($ per Mcfe)

   $ 6.81    $ 12.90

Oil and Natural Gas Costs (dollars in thousands):

     

Lease operating expenses

   $ 21,083    $ 24,830

Production taxes

     5,260      10,710

Average production cost per Mcfe

   $ 2.77    $ 3.13

 

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Exploration, Development and Acquisition Capital Expenditures

The following table sets forth certain information regarding the gross costs incurred in the purchase of proved and unproved properties and in development and exploration activities.

 

     Year Ended December 31,
     2009    2008
     (in thousands)

Property acquisition costs

   $ —      $ —  

Unproved prospects

     477      1,571

Exploration costs

     —        115

Development costs

     13,543      51,064

ARO costs

     594      1,209
             

Total consolidated operations

     14,614      53,959
             

Asset Retirement Obligation (non-cash)

   $ 1,256    $ 7,403
             

Drilling Activity

The following table sets forth our drilling activity during the twelve month periods ended December 31, 2009 and 2008 (excluding wells in progress at the end of the period). In the table, “gross” refers to the total number of wells in which we have a working interest and “net” refers to gross wells multiplied by our working interest therein.

 

     Year Ended December 31,
     2009    2008
     Gross    Net    Gross    Net

Development wells

           

Productive

   1    0.5    10.0    7.6

Non-productive

   —      —      —      —  

Exploratory wells

           

Productive

   1    0.825    1.0    0.3

Non-productive

   —      —      —      —  

Productive Wells

The following table sets forth the number of productive oil and natural gas wells in which we owned an interest as of December 31, 2009. Productive wells are wells that are capable of producing natural gas or oil.

 

    

Company Operated

   Non-operated    Total
     Gross    Net    Gross    Net    Gross    Net

Oil

   94    59.9    5    1.1    99    61.0

Natural Gas

   41    23.1    148    1.2    189    24.3
                             

Total

   135    83.0    153    2.3    288    85.3
                             

 

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Acreage Data

The following table summarizes our gross and net developed and undeveloped oil and natural gas acreage under lease as of December 31, 2009.

 

     Developed acres    Undeveloped acres
     Gross    Net    Gross    Net

Gulf Coast Properties (1)

   90,028    66,019.1    3,984    2,513.2

Other (2)

   —      —      14,250    4,275.0
                   

Total

   90,028    66,019.1    18,234    6,788.2
                   

 

(1) Undeveloped acreage includes State Lease #19246 at Bayou Couba and rental tracts at Broussard South.
(2) Other includes Delaware Deep acreage in Sweetwater County, Wyoming.

As is customary in the oil and natural gas industry, we can generally retain our interest in undeveloped acreage by drilling activity that establishes commercial production sufficient to maintain the leases or by paying delay rentals during the remaining primary term of leases. The oil and natural gas leases in which we have an interest are for varying primary terms, and if production under a lease continues from our developed lease acreage beyond the primary term, we are entitled to hold the lease for as long as oil or natural gas is produced.

Our oil and natural gas properties consist primarily of oil and natural gas wells and our interests in leasehold acreage, both developed and undeveloped.

Major Customers

The Company sold oil and natural gas production representing more than 10% of its oil and natural gas revenues as follows:

 

2009:

  

Texon LP

   64.06

Upstream Energy Services

   15.47

2008:

  

Texon LP

   50.42

Upstream Energy Services

   17.42

Because alternate purchasers of natural gas and oil are readily available, we believe that the loss of any of our purchasers would not have a material adverse effect on our financial results.

Competition

We encounter competition from other natural gas and oil companies in all areas of our operations, including the acquisition of exploratory prospects and proven properties. Many of our competitors are large, well-established companies that have been engaged in the natural gas and oil business for much longer than we have and possess substantially larger operating staffs and greater capital resources than we do. Our ability to explore for oil and natural gas reserves and to acquire additional properties in the future will be dependent upon our ability to conduct our operations, to evaluate and select suitable properties and to consummate transactions in this highly competitive environment. We believe that our technological expertise, our exploration, land, drilling and production capabilities and the experience of our management generally enable us to compete effectively.

 

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Marketing

Our production is marketed to third parties consistent with industry practices. Typically, oil is sold at the wellhead at field-posted prices plus a bonus and natural gas is sold under contract at a negotiated price based upon factors normally considered in the industry, such as distance from the well to the pipeline, well pressure, estimated reserves, quality of natural gas and prevailing supply and demand conditions.

Our marketing objective is to receive the highest possible wellhead price for our product. We are aided by the presence of multiple outlets near our production in Texas and Louisiana onshore Gulf Coast area. We take an active role in determining the available pipeline alternatives for each property based on historical pricing, capacity, pressure, market relationships, seasonal variances and long-term viability.

Regulation of the Oil and Natural Gas Industry

Regulation of Transportation and Sale of Oil

Sales of crude oil, condensate and natural gas liquids are not currently regulated and are made at negotiated prices. Nevertheless, Congress could reenact price controls in the future.

Our sales of crude oil are affected by the availability, terms and cost of transportation. The transportation of oil in common carrier pipelines is also subject to rate regulation. The Federal Energy Regulatory Commission, or the FERC, regulates interstate oil pipeline transportation rates under the Interstate Commerce Act. In general, interstate oil pipeline rates must be cost-based, although settlement rates agreed to by all shippers are permitted and market-based rates may be permitted in certain circumstances. Intrastate oil pipeline transportation rates are subject to regulation by state regulatory commissions. The basis for intrastate oil pipeline regulation, and the degree of regulatory oversight and scrutiny given to intrastate oil pipeline rates, varies from state to state. Insofar as effective interstate and intrastate rates are equally applicable to all comparable shippers, we believe that the regulation of oil transportation rates will not affect our operations in any way that is of material difference from those of our competitors.

Further, interstate and intrastate common carrier oil pipelines must provide service on a non-discriminatory basis. Under this open access standard, common carriers must offer service to all similarly situated shippers requesting service on the same terms and under the same rates. When oil pipelines operate at full capacity, access is governed by prorationing provisions set forth in the pipelines’ published tariffs. Accordingly, we believe that access to oil pipeline transportation services generally will be available to us to the same extent as to our competitors.

Regulation of Transportation and Sale of Natural Gas

Historically, the transportation and sale for resale of natural gas in interstate commerce have been regulated pursuant to the Natural Gas Act of 1938, the Natural Gas Policy Act of 1978 and regulations issued under those Acts by the FERC. In the past, the federal government has regulated the prices at which natural gas could be sold. While sales by producers of natural gas can currently be made at uncontrolled market prices, Congress could reenact price controls in the future.

FERC regulates interstate natural gas transportation rates and service conditions, which affects the marketing of natural gas that we produce, as well as the revenues we receive for sales of our natural gas. Since 1985, the FERC has endeavored to make natural gas transportation more accessible to natural gas buyers and sellers. The interstate pipelines’ traditional role as wholesalers of natural gas has been eliminated and replaced by a structure under which pipelines provide transportation and storage service on an open access basis to others who buy and sell natural gas. Although the FERC’s orders do not directly regulate natural gas producers, they are intended to foster increased competition within all phases of the natural gas industry.

We cannot accurately predict whether the FERC’s actions will achieve the goal of increasing competition in markets in which our natural gas is sold. Additional proposals and proceedings that might affect the natural gas

 

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industry are pending before the FERC and the courts. The natural gas industry historically has been very heavily regulated. Therefore, we cannot provide any assurance that the less stringent regulatory approach recently established by the FERC will continue. However, we do not believe that any action taken will affect us in a way that materially differs from the way it affects other natural gas producers.

Gathering service, which occurs upstream of jurisdictional transmission services, is regulated by the states on shore and in state waters. Although its policy is still in flux, FERC has reclassified certain jurisdictional transmission facilities as non-jurisdictional gathering facilities, which has the tendency to increase our costs of getting natural gas to point of sale locations.

Intrastate natural gas transportation is also subject to regulation by state regulatory agencies. The basis for intrastate regulation of natural gas transportation and the degree of regulatory oversight and scrutiny given to intrastate natural gas pipeline rates and services varies from state to state. Insofar as such regulation within a particular state will generally affect all intrastate natural gas shippers within the state on a comparable basis, we believe that the regulation of similarly situated intrastate natural gas transportation in any states in which we operate and ship natural gas on an intrastate basis will not affect our operations in any way that is of material difference from those of our competitors. Like the regulation of interstate transportation rates, the regulation of intrastate transportation rates affects the marketing of natural gas that we produce, as well as the revenues we receive for sales of our natural gas.

Regulation of Production

The production of oil and natural gas is subject to regulation under a wide range of local, state and federal statutes, rules, orders and regulations. Federal, state and local statutes and regulations require permits for drilling operations, drilling bonds and reports concerning operations. All of the states in which we own and operate properties have regulations governing conservation matters, including provisions for the unitization or pooling of oil and natural gas properties, the establishment of maximum allowable rates of production from oil and natural gas wells, the regulation of well spacing, and plugging and abandonment of wells. The effect of these regulations is to limit the amount of oil and natural gas that we can produce from our wells and to limit the number of wells or the locations at which we can drill, although we can apply for exceptions to such regulations or to have reductions in well spacing. Moreover, each state generally imposes a production or severance tax with respect to the production and sale of oil, natural gas and natural gas liquids within its jurisdiction.

The failure to comply with these rules and regulations can result in substantial penalties. Our competitors in the oil and natural gas industry are subject to the same regulatory requirements and restrictions that affect our operations.

Environmental Matters and Other Regulation

General

Our operations are subject to stringent and complex federal, state and local laws and regulations governing environmental protection as well as the discharge of materials into the environment. These laws and regulations may, among other things:

 

   

require the acquisition of various permits before drilling commences;

 

   

restrict the types, quantities and concentration of various substances that can be released into the environment in connection with oil and natural gas drilling and production activities;

 

   

limit or prohibit drilling activities on certain lands lying within wilderness, wetlands and other protected areas; and

 

   

require remedial measures to mitigate pollution from former and ongoing operations, such as requirements to close pits and plug abandoned wells.

 

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These laws and regulations may also restrict the rate of oil and natural gas production below the rate that would otherwise be possible. The regulatory burden on the oil and gas industry increases the cost of doing business in the industry and consequently affects profitability. Additionally, Congress and federal and state agencies frequently revise environmental laws and regulations, and any changes that result in more stringent and costly waste handling, disposal and cleanup requirements for the oil and gas industry could have a significant impact on our operating costs.

The following is a summary of some of the existing laws, rules and regulations to which our business operations are subject.

Waste Handling

The Resource Conservation and Recovery Act, or RCRA, and comparable state statutes, regulate the generation, transportation, treatment, storage, disposal and cleanup of hazardous and non-hazardous wastes. Under the auspices of the federal Environmental Protection Agency, or EPA, the individual states administer some or all of the provisions of RCRA, sometimes in conjunction with their own, more stringent requirements. Drilling fluids, produced waters and most of the other wastes associated with the exploration, development and production of crude oil or natural gas are currently regulated under RCRA or state non-hazardous waste provisions. Releases or spills of these regulated materials may result in remediation liabilities under these statutes. It is possible that certain oil and natural gas exploration and production wastes now classified as non-hazardous could be classified as hazardous wastes in the future. Any such change could result in an increase in our costs to manage and dispose of wastes, which could have a material adverse effect on our results of operations and financial position.

Comprehensive Environmental Response, Compensation, and Liability Act

The Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, also known as the Superfund Law, imposes joint and several liability, without regard to fault or legality of conduct, on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include the current or former owner or operator of the site where the release occurred and anyone who disposed or arranged for the disposal of a hazardous substance released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment.

In the course of our operations, we generate wastes that may fall within CERCLA’s definition of hazardous substances. Further, we currently own, lease or operate properties that have been used for oil and natural gas exploration and production for many years. Hazardous substances or petroleum may have been released on, at or under the properties owned, leased or operated by us, or on, at or under other locations, including off-site locations, where such hazardous substances or other wastes have been taken for disposal. In addition, some of our properties have been operated by third parties or by previous owners or operators whose handling, treatment and disposal of hazardous substances, petroleum, or other materials or wastes were not under our control. These properties and the substances or materials disposed or released on, at or under them may be subject to CERCLA, RCRA or analogous or other state laws. Under such laws, we could be required to remove previously disposed substances and wastes or released petroleum, remediate contaminated property or perform remedial plugging or pit closure operations to prevent future contamination.

Water Discharges

The Federal Water Pollution Control Act, or the Clean Water Act, and analogous state laws, impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and

 

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other substances into waters of the United States or state waters. Under these laws, the discharge of pollutants into regulated waters is prohibited except in accordance with the terms of a permit issued by EPA or an analogous state agency. Federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with discharge permits or other requirements of the Clean Water Act and analogous state laws and regulations.

The Oil Pollution Act of 1990, or OPA, which amends and augments the Clean Water Act, establishes strict liability for owners and operators of facilities that are the site of a release of oil into waters of the United States. In addition, OPA and regulations promulgated pursuant thereto impose a variety of regulations on responsible parties related to the prevention of oil spills and liability for damages resulting from such spills. OPA also requires certain oil and natural gas operators to develop, implement and maintain facility response plans, conduct annual spill training for certain employees and provide varying degrees of financial assurance.

In connection with the acquisition of Goldking, the Company inherited an environmental contingency which after conducting its due diligence and subsequent testing believes is the responsibility of third parties. However, federal and sate regulators have determined Dune is the responsible party for clean up of this area. Dune had maintained a passive maintenance of this site since it was first discovered after Hurricane Katrina. Costs to date of approximately $800,000 have been covered by the Company’s insurance minus the standard deductibles. The Company still feels other parties have the primary responsibility for this occurrence but is committed to working with various state and federal authorities on resolution of this issue. At this time no estimate of the final cost of remediation or the method of remediation preferred of this site can be determined. The Company’s insurance will continue to cover clean up costs up to $1 million total. At this time the Company can not be certain insurance will cover costs above this level or if the Company can be successful in proving the other parties should be primarily responsible for the cost of remediation.

Air Emissions

The Federal Clean Air Act and comparable state laws regulate emissions of various air pollutants through air emissions permitting programs and the imposition of other requirements. In addition, EPA has developed and continues to develop stringent regulations governing emissions of toxic air pollutants at specified sources. Federal and state regulatory agencies can impose administrative, civil and criminal penalties for non-compliance with air permits or other requirements of the Federal Clean Air Act and associated state laws and regulations. Oil and gas operations may in certain circumstances and locations be subject to permits and restrictions under these statutes for emissions of air pollutants, including volatile organic compounds, nitrous oxides, and hydrogen sulfide.

National Environmental Policy Act

Oil and natural gas exploration and production activities on federal lands are subject to the National Environmental Policy Act, or NEPA. NEPA requires federal agencies, including the Department of Interior, to evaluate major agency actions that have the potential to significantly impact the environment. In the course of such evaluations, an agency will prepare an Environmental Assessment that assesses the potential direct, indirect and cumulative impacts of a proposed project and, if necessary, will prepare a more detailed Environmental Impact Statement that may be made available for public review and comment. All of our current exploration and production activities, as well as proposed exploration and development plans, on federal lands require governmental permits that are subject to the requirements of NEPA. This process has the potential to delay the development of oil and natural gas projects.

Endangered Species, Wetlands and Damages to Natural Resources

Various state and federal statutes prohibit certain actions that adversely affect endangered or threatened species and their habitat, migratory birds, wetlands, and natural resources. These statutes include the Endangered

 

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Species Act, the Migratory Bird Treaty Act, the Clean Water Act and CERCLA. Where takings of or harm to species or damages to wetlands, habitat, or natural resources occur or may occur, government entities or at times private parties may act to prevent oil and gas exploration or production or seek damages to species, habitat, or natural resources resulting from filling or construction or releases of oil, wastes, hazardous substances or other regulated materials.

OSHA and Other Laws and Regulations

We are subject to the requirements of the federal Occupational Safety and Health Act (OSHA) and comparable state statutes. The OSHA hazard communication standard, the Emergency Planning and Community Right to Know Act and similar state statutes require that we organize and/or disclose information about hazardous materials stored, used or produced in our operations.

Recent studies have indicated that emissions of certain gases may be contributing to warming of the Earth’s atmosphere. In response to these studies, many nations have agreed to limit emissions of “greenhouse gases” pursuant to the United Nations Framework Convention on Climate Change, also known as the “Kyoto Protocol.” Methane, a primary component of natural gas, and carbon dioxide, a byproduct of the burning of oil and natural gas, and refined petroleum products, are “greenhouse gases” regulated by the Kyoto Protocol. Although the United States is not participating in the Kyoto Protocol, several states have adopted legislation and regulations to reduce emissions of greenhouse gases. Restrictions on emissions of methane or carbon dioxide that may be imposed in various states could adversely affect our operations and demand for our products. Additionally, the U.S. Supreme Court has ruled, in Massachusetts, et al. v. EPA, that the U.S. Environmental Protection Agency abused its discretion under the Clean Air Act by refusing to regulate carbon dioxide emissions from mobile sources. This Supreme Court decision could result in federal regulation of carbon dioxide emissions and other greenhouse gases, and may affect the outcome of other climate change lawsuits pending in U.S. federal courts in a manner unfavorable to our industry. Currently, our operations are not adversely impacted by existing state and local climate change initiatives and, at this time, it is not possible to accurately estimate how potential future laws or regulations addressing greenhouse gas emissions would impact our business.

Private Lawsuits

In addition to claims arising under state and federal statutes, where a release or spill of hazardous substances, oil and gas or oil and gas wastes have occurred, private parties or landowners may bring lawsuits against oil and gas companies under state law. The plaintiffs may seek property damages, personal injury damages, remediation costs or injunctions to require remediation or restoration of contaminated property, soil, groundwater or surface water. In some cases, oil and gas operations are located near populated areas and emissions or accidental releases could affect the surrounding properties and population.

 

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Item 1A. Risk Factors

You should carefully consider each of the risks described below, together with all of the other information contained in this report, before deciding to invest in our securities. If any of the following risks develop into actual events, our business, financial condition or results of operations could be materially adversely affected and you may lose all or part of your investment.

We have had operating losses and limited revenues to date.

We have operated at a loss each year since inception. Net losses applicable to common shareholders for the fiscal years ended December 31, 2008 and 2009 were $241.7 million and $95.9 million, respectively. Our loss in the fiscal year ended December 31, 2008 was largely attributable to a decrease in commodity prices and proved property impairment expense which was also a result of a drop in commodity prices from the fiscal year ended 2007 to 2008. Our revenues for the fiscal years ended December 31, 2008 and 2009 were $146.6 million and $64.9 million, respectively. We may not be able to generate significant revenues in the future. In addition, we expect to incur substantial operating expenses in connection with our natural gas and oil exploration and development activities. As a result, we may continue to experience negative cash flow for at least the foreseeable future and cannot predict when, or even if, we might become profitable.

Our leverage and debt service obligations may adversely affect our cash flow.

We have a substantial amount of debt. As of December 31, 2009, we had total debt of $316.3 million, primarily consisting of $292.3 million of our 10-1/2% senior secured notes due 2012 (the “Senior Notes”). There were borrowings of $24.0 million under our $40 million revolving credit facility (“May 2007 Credit Facility”) at year-end, plus $8.5 million of letters of credit were issued against the commitment. Our substantial level of indebtedness could have important consequences to you, including the following:

 

   

it may make it difficult for us to satisfy our obligations under our indebtedness and contractual and commercial commitments;

 

   

we must use a substantial portion of our cash flow from operations to pay interest on our indebtedness, which will reduce the funds available to us for other purposes;

 

   

our ability to obtain additional debt financing in the future for working capital, capital expenditures, acquisitions or general corporate purposes may be limited;

 

   

our flexibility in reacting to changes in the industry may be limited and we could be more vulnerable to adverse changes in our business or economic conditions in general; and

 

   

we may be at a competitive disadvantage to those of our competitors who operate on a less leveraged basis.

Furthermore, all of our borrowings under our May 2007 Credit Facility will bear interest at variable rates. If these rates were to increase significantly, our ability to borrow additional funds may be reduced, our interest expense would significantly increase and the risks related to our substantial indebtedness would intensify.

 

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Any failure to meet our debt obligations could harm our business, financial condition, results of operations or cash flows.

If our cash flow and capital resources are insufficient to fund our debt obligations, we may be forced to sell assets, seek additional equity or debt capital or restructure our debt. In addition, any failure to make scheduled payments of interest and principal on our outstanding indebtedness would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness on acceptable terms. Our cash flow and capital resources may be insufficient for payment of interest on and principal of our debt in the future and any such alternative measures may be unsuccessful or may not permit us to meet scheduled debt service obligations, which could cause us to default on our obligations and impair our liquidity.

The indenture governing the Senior Notes, the certificate of designations relating to our 10% Senior Redeemable Convertible Preferred Stock and our May 2007 Credit Facility impose significant operating and financial restrictions on us that may prevent us from pursuing certain business opportunities and restrict our ability to operate our business.

The indenture governing the Senior Notes, the certificate of designations relating to the our 10% senior redeemable convertible preferred stock and our May 2007 Credit Facility each contain covenants that restrict our ability and the ability of certain of our subsidiaries to take various actions, such as:

 

   

incurring or generating additional indebtedness or issuing certain preferred stock;

 

   

paying dividends on our capital stock or redeeming, repurchasing or retiring our capital stock or subordinated indebtedness or making other restricted payments;

 

   

entering into certain transactions with affiliates;

 

   

creating or incurring liens on our assets;

 

   

transferring or selling assets;

 

   

incurring dividend or other payment restrictions affecting certain of our existing and future subsidiaries; and

 

   

consummating a merger, consolidation or sale of all or substantially all of our assets.

In addition, our May 2007 Credit Facility contains customary representations and warranties by the Company as well as typical restrictive covenants whereby Dune has agreed, among other things, to limitations to incurrence of additional indebtedness, declaration of dividends, issuance of capital stock, sale of assets and corporate reorganizations.

The restrictions contained in the indenture governing the Senior Notes, the certificate of designations relating to the preferred stock and our May 2007 Credit Facility could:

 

   

limit our ability to plan for or react to market conditions or meet capital needs or otherwise restrict our activities or business plans; and

 

   

adversely affect our ability to finance our operations, strategic acquisitions, investments or alliances or other capital needs or to engage in other business activities that would be in our interest.

A breach of any of the restrictive covenants could result in a default under our May 2007 Credit Facility.

If a default occurs, the lenders under our May 2007 Credit Facility may elect to:

 

   

declare all borrowings outstanding thereunder, together with accrued interest and other fees, to be immediately due and payable;

 

   

or prevent us from making payments on the Senior Notes;

 

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either of which (after the expiration of any applicable grace periods) would result in an event of default under the indenture governing the Senior Notes and could result in a cross default under our other debt instruments. The lenders would also have the right in these circumstances to terminate any commitments they have to provide us with further borrowings. If the borrowings under our May 2007 Credit Facility and the Senior Notes were to be accelerated, we cannot assure you that we would be able to repay in full the Senior Notes.

We may not be able to generate sufficient cash flow to meet our debt service and other obligations due to events beyond our control.

Our ability to generate cash flows from operations and to make scheduled payments on our indebtedness, including the Senior Notes, will depend on our future financial performance. Our future performance will be affected by a range of economic, competitive, legislative, operating and other business factors, many of which we cannot control, such as general economic and financial conditions in our industry or the economy at large. A significant reduction in operating cash flows resulting from changes in economic conditions, increased competition, or other events could increase the need for additional or alternative sources of liquidity and could have a material adverse effect on our business, financial condition, results of operations and prospects and our ability to service our debt, including the Senior Notes, and other obligations. If we are unable to service our indebtedness, we will be forced to adopt an alternative strategy that may include actions such as reducing or delaying acquisitions and capital expenditures, selling assets, restructuring or refinancing our indebtedness or seeking equity capital. We cannot assure you that any of these alternative strategies could be affected on satisfactory terms, if at all, or that they would yield sufficient funds to make required payments on the Senior Notes and our other indebtedness.

We have substantial capital requirements that, if not met, may hinder operations.

We have and expect to continue to have substantial capital needs as a result of our active exploration, development, and acquisition programs. We expect that additional external financing will be required in the future to fund our growth. We may not be able to obtain additional financing, and financing under existing or new credit facilities may not be available in the future. Without additional capital resources, we may be forced to limit or defer our planned natural gas and oil exploration and development program and this will adversely affect the recoverability and ultimate value of our natural gas and oil properties, in turn negatively affecting our business, financial condition, and results of operations.

Recent economic conditions in the credit market may adversely affect our financial condition.

The disruption experienced in U.S. and global credit markets since the latter half of 2008 has resulted in projected decreases in demand for oil and natural gas, resulting in a sharp drop in energy prices, and has affected the availability and cost of capital. In addition, capital and credit markets have experienced unprecedented volatility and disruption and continue to be unpredictable. Given the current levels of market volatility and disruption, the availability of funds from those markets has diminished substantially. Prolonged negative changes in domestic and global economic conditions or disruptions of either or both of the financial and credit markets may have a material adverse effect on our results from operations, financial condition and liquidity. At this time, it is unclear whether and to what extent the actions taken by the U.S. government will mitigate the effects of the financial market turmoil. The impact of the current difficult conditions on our ability to obtain, and the cost and terms of, any financing in the future is equally unclear. Any inability to obtain adequate financing under our existing credit facility or to fund on acceptable terms could deter or prevent us from meeting our future capital needs to finance our development program, adversely affect the satisfaction or replacement of our debt obligations and result in a deterioration of our financial condition.

Natural gas and oil prices are highly volatile, and lower prices will negatively affect our financial results.

Our revenue, profitability, cash flow, oil and natural gas reserves value, future growth, and ability to borrow funds or obtain additional capital, as well as the carrying value of our properties, are substantially dependent on

 

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prevailing prices of natural gas and oil. Historically, the markets for natural gas and oil have been volatile, and those markets are likely to continue to be volatile in the future. It is impossible to predict future natural gas and oil price movements with certainty. Prices for natural gas and oil are subject to wide fluctuations in response to relatively minor changes in the supply of and demand for natural gas and oil, market uncertainty, and a variety of additional factors beyond our control. These factors include:

 

   

the level of consumer product demand;

 

   

the domestic and foreign supply of oil and natural gas;

 

   

overall economic conditions;

 

   

weather conditions;

 

   

domestic and foreign governmental regulations and taxes;

 

   

the price and availability of alternative fuels;

 

   

political conditions in or affecting oil and natural gas producing regions;

 

   

the level and price of foreign imports of oil and liquefied natural gas; and

 

   

the ability of the members of the Organization of Petroleum Exporting Countries and other state controlled oil companies to agree upon and maintain oil price and production controls.

Declines in natural gas and oil prices may materially adversely affect our financial condition, liquidity, and ability to finance planned capital expenditures and results of operations and may reduce the amount of oil and natural gas that we can produce economically.

Drilling for natural gas and oil is a speculative activity and involves numerous risks and substantial and uncertain costs that could adversely affect us.

Our success will be largely dependent upon the success of our drilling program. Our prospects are in various stages of evaluation, ranging from prospects that are ready to drill to prospects that will require substantial additional seismic data processing and interpretation and other types of technical evaluation. There is no way to predict in advance of drilling and testing whether any particular prospect will yield oil or natural gas in sufficient quantities to recover drilling or completion costs or to be economically viable. The use of seismic data and other technologies and the study of producing fields in the same area will not enable us to know conclusively prior to drilling whether oil or natural gas will be present or, if present, whether oil or natural gas will be present in commercial quantities. We cannot assure you that the analogies we draw from available data from other wells, more fully explored prospects or producing fields will be applicable to our drilling prospects. Drilling for natural gas and oil involves numerous risks, including the risk that no commercially productive natural gas or oil reservoirs will be discovered. The cost of drilling, completing, and operating wells is substantial and uncertain, and drilling operations may be curtailed, delayed, or canceled as a result of a variety of factors beyond our control, including:

 

   

unexpected or adverse drilling conditions;

 

   

elevated pressure or irregularities in geologic formations;

 

   

equipment failures or accidents;

 

   

adverse weather conditions;

 

   

compliance with governmental requirements; and

 

   

shortages or delays in the availability of drilling rigs, crews, and equipment.

Even if drilled, our completed wells may not produce reserves of natural gas or oil that are economically viable or that meet our earlier estimates of economically recoverable reserves. A productive well may become

 

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uneconomic if water or other deleterious substances are encountered, which impair or prevent the production of oil and/or natural gas from the well. Our overall drilling success rate or our drilling success rate for activity within a particular project area may decline. Unsuccessful drilling activities could result in a significant decline in our production and revenues and materially harm our operations and financial condition by reducing our available cash and resources. Because of the risks and uncertainties of our business, our future performance in exploration and drilling may not be comparable to our historical performance.

We depend on successful exploration, development and acquisitions to maintain reserves and revenue in the future.

In general, the volume of production from natural gas and oil properties declines as reserves are depleted, with the rate of decline depending on reservoir characteristics. Except to the extent that we conduct successful exploration and development activities or acquire properties containing proved reserves, or both, our proved reserves will decline as reserves are produced. Our future natural gas and oil production is, therefore, highly dependent on our level of success in finding or acquiring additional reserves. Additionally, the business of exploring for, developing, or acquiring reserves is capital intensive. Recovery of our reserves, particularly undeveloped reserves, will require significant additional capital expenditures and successful drilling operations. To the extent cash flow from operations is reduced and external sources of capital become limited or unavailable, our ability to make the necessary capital investment to maintain or expand our asset base of natural gas and oil reserves would be impaired. In addition, we are dependent on finding partners for our exploratory activity. To the extent that others in the industry do not have the financial resources or choose not to participate in our exploration activities, we will be adversely affected.

Reserve estimates depend on many assumptions that may turn out to be inaccurate. Any material inaccuracies in these reserve estimates or underlying assumptions could materially affect the quantities and present values of our reserves.

The process of estimating natural gas and oil reserves is complex. It requires interpretations of available technical data and various assumptions, including assumptions relating to economic factors. Any significant inaccuracies in these interpretations or assumptions could materially affect the estimated quantities and present value of reserves shown in our petroleum engineering reserve reports. In order to prepare these estimates, we must project production rates and timing of development expenditures. We must also analyze available geological, geophysical, production and engineering data, and the extent, quality and reliability of this data can vary. The process also requires economic assumptions relating to matters such as oil and natural gas prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. Therefore, estimates of oil and natural gas reserves are inherently imprecise.

Actual future production, oil and natural gas prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil and natural gas reserves most likely will vary from our estimates. A significant variance could materially affect the estimated quantities and pre-tax present value of the reserves shown in our petroleum engineering reserve reports. In addition, the 10% discount factor we use to calculate the net present value of future net cash flows for reporting purposes may not necessarily be the most appropriate discount factor. Further, we may adjust estimates of proved reserves to reflect production history, results of exploration and development, prevailing oil and natural gas prices and other factors, many of which are beyond our control.

A substantial percentage of our proved reserves consist of undeveloped reserves.

As of the end of our 2009 fiscal year, approximately 31% of our proved reserves were classified as proved undeveloped reserves. These reserves may not ultimately be developed or produced. As a result, we may not find commercially viable quantities of oil and natural gas, which in turn may have a material adverse effect on our results of operations.

 

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Seismic studies do not guarantee that hydrocarbons are present or if present will produce in economic quantities.

We rely on seismic studies to assist us with assessing prospective drilling opportunities on our properties, as well as on properties that we may acquire. Such seismic studies are merely an interpretive tool and do not necessarily guarantee that hydrocarbons are present or if present will produce in economic quantities.

We may experience difficulty in achieving and managing future growth.

Future growth may place strains on our resources and cause us to rely more on project partners and independent contractors, possibly negatively affecting our financial condition and results of operations. Our ability to grow will depend on a number of factors, including:

 

   

our ability to obtain leases or options on properties for which we have 3-D seismic data;

 

   

our ability to acquire additional 3-D seismic data;

 

   

our ability to identify and acquire new exploratory prospects;

 

   

our ability to develop existing prospects;

 

   

our ability to continue to retain and attract skilled personnel;

 

   

our ability to maintain or enter into new relationships with project partners and independent contractors;

 

   

the results of our drilling program;

 

   

hydrocarbon prices; and

 

   

our access to capital.

We may not be successful in upgrading our technical, operations, and administrative resources or in increasing our ability to internally provide certain of the services currently provided by outside sources, and we may not be able to maintain or enter into new relationships with project partners and independent contractors. Our inability to achieve or manage growth may adversely affect our financial condition and results of operations.

Our business may suffer if we lose key personnel.

We depend to a large extent on the services of certain key management personnel, including James A. Watt, our President and Chief Executive Officer, Frank T. Smith, Jr., our Senior Vice President and Chief Financial Officer and our other executive officers and key employees. These individuals have extensive experience and expertise in evaluating and analyzing producing oil and natural gas properties and drilling prospects, maximizing production from oil and natural gas properties, marketing oil and natural gas production and developing and executing financing and hedging strategies. The loss of any of these individuals could have a material adverse effect on our operations. We do not maintain key-man life insurance with respect to any of our employees. Our success will be dependent on our ability to continue to employ and retain skilled technical personnel.

We face strong competition from other natural gas and oil companies.

We encounter competition from other natural gas and oil companies in all areas of our operations, including the acquisition of exploratory prospects and proved properties. Our competitors include major integrated natural gas and oil companies and numerous independent natural gas and oil companies, individuals, and drilling and income programs. Many of our competitors are large, well-established companies that have been engaged in the natural gas and oil business much longer than we have and possess substantially larger operating staffs and greater capital resources than we do. These companies may be able to pay more for exploratory projects and productive natural gas and oil properties and may be able to define, evaluate, bid for, and purchase a greater

number of properties and prospects than our financial or human resources permit. In addition, these companies

 

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may be able to expend greater resources on the existing and changing technologies that we believe are and will be increasingly important to attaining success in the industry. We may not be able to conduct our operations, evaluate, and select suitable properties and consummate transactions successfully in this highly competitive environment.

We may not be able to keep pace with technological developments in our industry.

The natural gas and oil industry is characterized by rapid and significant technological advancements and introductions of new products and services using new technologies. As others use or develop new technologies, we may be placed at a competitive disadvantage or competitive pressures may force us to implement those new technologies at substantial costs. In addition, other natural gas and oil companies may have greater financial, technical, and personnel resources that allow them to enjoy technological advantages and may in the future allow them to implement new technologies before we can. We may not be able to respond to these competitive pressures and implement new technologies on a timely basis or at an acceptable cost. If one or more of the technologies we use now or in the future were to become obsolete or if we are unable to use the most advanced commercially available technology, our business, financial condition, and results of operations could be materially adversely affected.

Governmental regulation and liability for environmental matters may adversely affect our business, financial condition and results of operations.

Natural gas and oil operations are subject to various federal, state, and local government regulations that may change from time to time. Matters subject to regulation include discharge permits for drilling operations, plug and abandonment bonds, reports concerning operations, the spacing of wells, unitization and pooling of properties, and taxation. From time to time, regulatory agencies have imposed price controls and limitations on production by restricting the rate of flow of natural gas and oil wells below actual production capacity in order to conserve supplies of natural gas and oil. Other federal, state, and local laws and regulations relating primarily to the protection of human health and the environment apply to the development, production, handling, storage, transportation, and disposal of natural gas and oil, by-products thereof, and other substances and materials produced or used in connection with natural gas and oil operations. In addition, we may be liable for environmental damages caused by previous owners of property we purchase or lease. Some environmental laws provide for joint and several strict liability for remediation of releases of hazardous substances, rendering a person liable for environmental damage without regard to negligence or fault on the part of such person. In addition, we may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances such as oil and natural gas related products. As a result, we may incur substantial liabilities to third parities or governmental entities and may be required to incur substantial remediation costs. We also are subject to changing and extensive tax laws, the effects of which cannot be predicted. Compliance with existing, new, or modified laws and regulations could have a material adverse effect on our business, financial condition, and results of operations.

We may not have enough insurance to cover all of the risks we face and operators of prospects in which we participate may not maintain or may fail to obtain adequate insurance.

In accordance with customary industry practices, we maintain insurance coverage against some, but not all, potential losses in order to protect against the risks we face. We do not carry business interruption insurance. We may elect not to carry insurance if our management believes that the cost of available insurance is excessive relative to the risks presented. In addition, we cannot insure fully against pollution and environmental risks. The occurrence of an event not fully covered by insurance could have a material adverse effect on our financial condition and results of operations. The impact of recent hurricanes has resulted in escalating insurance costs and less favorable coverage terms.

Oil and natural gas operations are subject to particular hazards incident to the drilling and production of oil and natural gas, such as blowouts, cratering, explosions, uncontrollable flows of oil, natural gas or well fluids,

 

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fires and pollution and other environmental risks. These hazards can cause personal injury and loss of life, severe damage to and destruction of property and equipment, pollution or environmental damage and suspension of operation. We do not operate all of the properties in which we have an interest. In the projects in which we own a non-operating interest directly or own an equity interest in a limited partnership which in turn owns a non- operating interest, the operator for the prospect maintains insurance of various types to cover our operations with policy limits and retention liability customary in the industry. We believe the coverage and types of insurance are adequate. The occurrence of a significant adverse event that is not fully covered by insurance could result in the loss of our total investment in a particular prospect which could have a material adverse effect on our financial condition and results of operations.

The financial condition of our operators could negatively impact our ability to collect revenues from operations.

We do not operate all of the properties in which we have working interests. In the event that an operator of our properties experiences financial difficulties, this may negatively impact our ability to receive payments for our share of net production that we are entitled to under our contractual arrangements with such operator. While we seek to minimize such risk by structuring our contractual arrangements to provide for production payments to be made directly to us by first purchasers of the hydrocarbons, there can be no assurances that we can do so in all situations covering our non-operated properties.

We hedge the price risks associated with our production. Our hedge transactions may result in our making cash payments or prevent us from benefiting to the fullest extent possible from increases in prices for natural gas and oil.

Because natural gas and oil prices are unstable, we have entered into price-risk-management transactions such as swaps, collars, futures, and options to reduce our exposure to price declines associated with a portion of our natural gas and oil production and thereby to achieve a more predictable cash flow. The use of these arrangements will limit our ability to benefit from increases in the prices of natural gas and oil. Our hedging arrangements may apply to only a portion of our production, thereby providing only partial protection against declines in natural gas and oil prices. These arrangements could expose us to the risk of financial loss in certain circumstances, including instances in which production is less than expected, our customers fail to purchase contracted quantities of natural gas and oil, or a sudden, unexpected event materially impacts natural gas or oil prices.

If oil and natural gas prices decrease, we may be required to take write-downs of the carrying values of our oil and natural gas properties.

Certain accounting rules may require us to write down the carrying value of our properties when oil and natural gas prices decrease or when we have substantial downward adjustments of our estimated proved reserves, increases in our estimates of development costs or deterioration in our exploration results. Once incurred, a write-down of our oil and natural gas properties is not reversible at a later date. Any write-down would constitute a non-cash charge to earnings and could have a material adverse effect on our results of operations for the periods in which such charges are taken. For example, for the year ended December 31, 2008, we incurred a proved property impairment expense of $125.7 million, which reduced the carrying value of the properties, due to a drop in commodity prices from year end 2007 to year end 2008.

Our producing properties are located in regions which make us vulnerable to risks associated with operating in one major contiguous geographic area, including the risk of damage or business interruptions from hurricanes.

Our properties are located onshore and in state waters along the Texas and Louisiana Gulf Coast region of the United States. As a result of this geographic concentration, we are disproportionately affected by any delays or interruptions in production or transportation in these areas caused by governmental regulation, transportation

 

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capacity constraints, natural disasters, regional price fluctuations or other factors. This is particularly true of our inland water drilling and offshore operations, which are susceptible to hurricanes and other tropical weather disturbances. Such disturbances have in the past and will in the future have any or all of the following adverse effects on our business:

 

   

interruptions to our operations as we suspend production in advance of an approaching storm;

 

   

damage to our facilities and equipment, including damage that disrupts or delays our production;

 

   

disruption to the transportation systems we rely upon to deliver our products to our customers; and

 

   

damage to or disruption of our customers’ facilities that prevents us from taking delivery of our products.

Our identified drilling locations are scheduled out over several years, making them susceptible to uncertainties that could materially alter the occurrence or timing of their drilling.

Our management has specifically identified and scheduled drilling locations as an estimation of our future multi-year drilling activities on our existing acreage. These scheduled drilling locations represent a significant component of our growth strategy. Our ability to drill and develop these locations depends on a number of uncertainties, including oil and natural gas prices, the availability of capital, costs, drilling results, regulatory approvals and other factors. Because of these uncertainties, we do not know if the potential drilling locations we have identified will ever be drilled or if we will be able to produce oil or natural gas from these or any other potential drilling locations. As such, our actual drilling activities may materially differ from those presently identified, which could adversely affect our business.

Market conditions or operational impediments may hinder our access to oil and natural gas markets or delay our production.

Market conditions or the unavailability of satisfactory oil and natural gas transportation arrangements may hinder our access to oil and natural gas markets or delay our production. The availability of a ready market for our oil and natural gas production depends on a number of factors, including the demand for and supply of oil and natural gas and the proximity of our reserves to pipelines and terminal facilities. Our ability to market our production depends in substantial part on the availability and capacity of transport vessels, gathering systems, pipelines and processing facilities owned and operated by third parties under interruptible or short-term transportation agreements. Under the interruptible transportation agreements, the transportation of our natural gas may be interrupted due to capacity constraints on the applicable system, for maintenance or repair of the system, or for other reasons as dictated by the particular agreements. Our failure to obtain such services on acceptable terms could materially harm our business. We may be required to shut in wells due to lack of a market or the inadequacy or unavailability of natural gas pipeline or gathering system capacity. If that were to occur, we would be unable to realize revenue from those wells unless and until we made arrangements for delivery of their production to market.

Terrorist attacks aimed at our energy operations could adversely affect our business.

The continued threat of terrorism and the impact of military and other government action has led and may lead to further increased volatility in prices for oil and natural gas and could affect these commodity markets or the financial markets used by us. In addition, the U.S. government has issued warnings that energy assets may be a future target of terrorist organizations. These developments have subjected our oil and natural gas operations to increased risks. Any future terrorist attack on our facilities, those of our customers, the infrastructure we depend on for transportation of our products, and, in some cases, those of other energy companies, could have a material adverse effect on our business.

 

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Conversion of shares of our 10% Senior Redeemable Convertible Preferred Stock prior to June 1, 2010, will require us to make certain make-whole payments, which payments may consist of shares of our common stock, resulting in the dilution of the equity ownership of holders of our common stock.

In the event a holder of our 10% senior redeemable convertible preferred stock elects to convert such shares prior to June 1, 2010, then such holder shall be entitled to a make whole premium consisting of the present value of all dividends on the preferred stock as if paid in cash from the date of conversion through June 10, 2010, computed using a discount rate equal to the Reinvestment Yield. Should we elect to pay this amount in shares of our common stock, the equity ownership of holders of our common stock could be significantly diluted.

The market price of our common stock may be volatile.

The trading price of our common stock and the price at which we may sell common stock in the future are subject to large fluctuations in response to any of the following:

 

   

limited trading volume in our common stock;

 

   

quarterly variations in operating results;

 

   

our involvement in litigation;

 

   

general financial market conditions;

 

   

the prices of natural gas and oil;

 

   

announcements by us and our competitors;

 

   

our liquidity;

 

   

our ability to raise additional funds;

 

   

changes in government regulations; and

 

   

other events.

Sales of substantial amounts of shares of our common stock could cause the price of our common stock to decrease.

We have registered for resale a substantial number of shares of our common stock issuable upon conversion of our 10% senior redeemable convertible preferred stock and certain other securities convertible into or exercisable for shares of our common stock. Our stock price may decrease due to the additional amount of shares available in the market.

We do not intend to pay dividends on our common stock and our ability to pay dividends on our common stock is restricted.

We have not historically paid a dividend on our common stock, cash or otherwise, and do not intend to in the foreseeable future. We are currently restricted from paying dividends on common stock by the indenture governing our Senior Notes, the agreement relating to our existing credit facility and, in some circumstances, by the terms of our 10% senior redeemable convertible preferred stock. Any future dividends also may be restricted by our then-existing debt agreements.

Provisions of Delaware law and our charter and bylaws may delay or prevent transactions that would benefit stockholders.

Our certificate of incorporation and bylaws and the Delaware General Corporation Law contain provisions that may have the effect of delaying, deferring or preventing a change of control of the company. These provisions, among other things, provide for a classified Board of Directors with staggered terms, restrict the ability of stockholders to take action by written consent, authorize the Board of Directors to set the terms of preferred stock and restrict our ability to engage in transactions with stockholders with 15% or more of outstanding voting stock.

 

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Because of these provisions, persons considering unsolicited tender offers or other unilateral takeover proposals may be more likely to negotiate with our board of directors rather than pursue non-negotiated takeover attempts. As a result, these provisions may make it more difficult for our stockholders to benefit from transactions that are opposed by an incumbent board of directors.

 

Item 1B. Unresolved Staff Comments.

None.

 

Item 3. Legal Proceedings.

From time to time, we are party to certain legal actions and claims arising in the ordinary course of business. While the outcome of these events cannot be predicted with certainty, management does not expect these matters to have a materially adverse effect on our financial position or results of operations.

 

Item 4. [Reserved].

 

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PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market for Our Common Stock

Since May 9, 2005, our common stock has been traded on the NYSE AMEX (“The Exchange”) under the symbol “DNE”. The following table sets forth, for the periods indicated, the high and low sales prices of our common stock on The Exchange. Except with respect to the quarter ended December 31, 2009, prices set forth below have not been adjusted for the 1-for-5 reverse split that was effective on December 2, 2009.

 

2009:

   High    Low

Quarter ended December 31, 2009

   $ 0.45    $ 0.07

Quarter ended September 30, 2009

   $ 0.25    $ 0.10

Quarter ended June 30, 2009

   $ 0.25    $ 0.11

Quarter ended March 31, 2009

   $ 0.32    $ 0.11

2008:

   High    Low

Quarter ended December 31, 2008

   $ 0.75    $ 0.12

Quarter ended September 30, 2008

   $ 1.11    $ 0.57

Quarter ended June 30, 2008

   $ 1.85    $ 0.94

Quarter ended March 31, 2008

   $ 2.05    $ 1.40

The last sales price of our common stock on The Exchange on December 31, 2009 was $0.23 per share. As of February 22, 2010, the closing sale price of a share of our common stock was $0.17. As of February 22, 2010, there were approximately 369 holders of record of our common stock.

On December 28, 2009, we received notice from The Exchange indicating that the Company was not in compliance with certain conditions of The Exchange’s continued listing standards under Section 1003 of the Company Guide. Specifically, The Exchange noted the Company’s failure to comply with (a) Section 1003(a)(i) of the Company Guide relating to stockholders’ equity of less than $2,000,000 and losses from continuing operations and net losses in two out of its three most recent fiscal years; (b) Section 1003(a)(ii) of the Company Guide relating to stockholders’ equity of less than $4,000,000 and losses from continuing operations and net losses in three out of its four most recent fiscal years; and (c) Section 1003(a)(iii) of the Company Guide relating to stockholders’ equity of less than $6,000,000 and losses from continuing operations and net losses in its five most recent fiscal years. As a result, we may be subject to delisting proceedings by the Exchange. We have had communications with the Exchange regarding a plan to achieve compliance but there can be no assurances that the Exchange will grant our request and/or that our common stock will remain listed on The Exchange.

We have not paid any cash dividends to date, and have no intention of paying any cash dividends on our common stock in the foreseeable future. The declaration and payment of dividends is subject to the discretion of our Board of Directors and to certain limitations imposed under Delaware corporation law. The timing, amount and form of dividends, if any, will depend on, among other things, our results of operations, financial condition, cash requirements and other factors deemed relevant by our Board of Directors. The agreements and instruments that we entered into in 2007 in connection with our note and preferred stock financings, as well as our credit facility, contain significant restrictions on our ability to pay dividends on our common stock.

There were no repurchases of securities during the fourth quarter of 2009.

During the fourth quarter of 2009, the Company awarded a total of 1,023,780 shares of Restricted Stock to employees and non-employee directors of the Company, pursuant to the Dune Energy, Inc. 2007 Stock Incentive Plan (the “Plan”). In addition, three non-employee directors received a total of 216,665 shares of common stock in lieu of cash compensation for their service as directors during the fourth quarter of 2009.

 

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Securities Authorized for Issuance Under Equity Compensation Plans

The following table provides information as of December 31, 2009 about our equity compensation plans and arrangements.

Equity Compensation Plan Information—December 31, 2009

 

Plan category

   (a)
Number of securities
to be issued upon
exercise of
outstanding options,
warrants and rights
    (b)
Weighted-average
exercise price of
outstanding options,
warrants and rights
   (c)
Number of securities remaining
available for future issuance under
equity compensation plans
(excluding securities reflected in
column (a))
 

Equity compensation plans approved by security holders

   120,000 (1)(2)    $ 10.73    1,479,517 (3) 

Equity compensation plans not approved by security holders

   787,500 (4)(5)    $ 10.46    200,000 (6) 
           

Total

     $ 10.50   
           

 

(*) The number of shares and any exercise prices with respect to awards and equity issuances made prior to December 1, 2009 have been adjusted to give effect to the 1-for-5 reverse stock split adopted, effective as of December 2, 2009.
(1) Consists of options issued to our directors pursuant to our 2005 Non-Employee Director Incentive Plan (the “2005 Plan”) (i) on October 28, 2005 to purchase up to 60,000 shares of our common stock at an exercise price of $11.75 per share and (ii) on January 24, 2007 to purchase up to 60,000 shares of our common stock at an exercise price of $9.70 per share. The 2005 Plan, which authorized the issuance of up to 400,000 shares in stock awards and options, was approved by stockholders on May 30, 2006.
(2) Excludes the following shares of restricted stock awarded pursuant to our 2007 Stock Incentive Plan, as amended on December 1, 2009 (as amended, the “2007 Plan”): (i) 248,591 shares of restricted stock awarded to employees during fiscal year 2007, which shares vest over the three years from grant date; (ii) 622,700 shares of restricted stock awarded to employees during fiscal year 2008, which shares vest over the three years from grant date; (iii) 105,412 shares of restricted stock awarded in fiscal year 2008 to certain officers having elected to receive shares in lieu of cash for a portion of their respective bonuses, which shares vest one year from grant date; (iv) 573,780 shares of restricted stock awarded to employees, officers and non-employee consultants during fiscal year 2009, which shares vest over the three years from grant date; and (v) 450,000 shares of restricted stock awarded to certain executive officers during fiscal year 2009, of which 301,500 shares vest over the three years from grant date and 148,500 shares vest in accordance with certain performance-based criteria. The amendment to the 2007 Plan was approved by stockholders on November 30, 2009 and authorizes the issuance of up to 3,200,000 shares in stock awards and options. The initial 2007 Plan was approved by stockholders on May 30, 2006.
(3) Includes 280,000 shares available under the 2005 Plan and 1,199,518 shares available under our 2007 Plan. The following shares may return to the 2007 Plan or the 2005 Plan, as the case may be, and be available for issuance in connection with a future award: (i) shares covered by an award that expires or otherwise terminates without having been exercised in full; (ii) shares that are forfeited or repurchased by us prior to becoming fully vested; (iii) shares covered by an award that is settled in cash; (iv) shares withheld to cover payment of an exercise price or cover applicable tax withholding obligations; (v) shares tendered to cover payment of an exercise price; and (vi) shares that are cancelled pursuant to an exchange or repricing program.
(4) Consists of warrants and options granted to our employees, officers, directors and consultants, to the extent vested and exercisable (within the meaning of Rule 13d-3(d)(1) promulgated by the Commission under the Securities and Exchange Act of 1934, as amended) as of December 31, 2009.
(5) Excludes 407,702 shares of restricted stock awarded in fiscal year 2009 to non-employee directors having elected to receive shares in lieu of cash for a portion of their annual retainer and fees.
(6) Consists of 200,000 shares of restricted stock awarded pursuant to Restricted Stock Agreement dated April 17, 2007 entered into with one of our executive officers, which shares vest on April 17, 2010.

 

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Set forth below is a description of the individual compensation arrangements or equity compensation plans that were not required to be approved by our security holders pursuant to which the 787,500 shares of our Common Stock included in the chart above were issuable as of December 31, 2009:

 

   

Option granted February 15, 2005 to a former officer and director in consideration of services performed on our behalf, which option expires February 14, 2010 and is currently exercisable to purchase up to 50,000 shares of our Common Stock at an exercise price of $6.25 per share;

 

   

Option granted May 12, 2005 to an officer and director in consideration of services performed on our behalf, which option expires May 11, 2010 and is currently exercisable to purchase up to an aggregate of 125,000 shares of our Common Stock at an exercise price of $12.20 per share;

 

   

Option granted May 12, 2005 to a former officer in consideration of services performed on our behalf, which option expires May 11, 2010 and is currently exercisable to purchase up to an aggregate of 100,000 shares of our Common Stock at an exercise price of $12.20 per share;

 

   

Option granted August 3, 2005 to employee in consideration of services performed on our behalf, which option expires August 2, 2010 and is currently exercisable to purchase up to 6,000 shares of our Common Stock at an exercise price of $12.70 per share;

 

   

Warrant issued September 30, 2005 to consultant in consideration of services performed on our behalf, which warrant expires September 29, 2010 and is currently exercisable to purchase up to 64,865 shares of our Common Stock at an warrant exercise price of $9.25 per share;

 

   

Warrant issued February 1, 2006 to consultant in consideration of services performed on our behalf, which warrant expires January 31, 2011 and is currently exercisable to purchase up to 180,000 shares of our Common Stock at an warrant exercise price of $13.25 per share;

 

   

Option granted August 28, 2006 to employee in consideration of services performed on our behalf, which option expires April 27, 2011 and is currently exercisable to purchase up to an aggregate of 10,000 shares of our Common Stock at an exercise price of $7.50 per share;

 

   

Warrant issued September 26, 2006 to consultant in consideration of services performed on our behalf, which warrant expires September 25, 2015 and is currently exercisable to purchase up to 100,000 shares of our Common Stock at a warrant exercise price of $6.75 per share;

 

   

Option granted January 24, 2007 to a former officer in consideration of services performed on our behalf, which option expires January 23, 2012 and is currently exercisable to purchase up to an aggregate of 40,000 shares of our Common Stock at an exercise price of $9.70 per share;

 

   

Options granted April 12, 2007 to consultants in consideration of services performed on our behalf, which options expire April 11, 2012 and are currently exercisable to purchase up to 100,000 shares of our Common Stock at an exercise price of $9.35 per share; and

 

   

Warrants issued April 17, 2007 to our former lender in accordance with anti-dilutive protection contained in the September 26, 2006 warrant agreement with our former lender, resulting in the issuance of additional warrants expiring in September 25, 2015 and exercisable to purchase up to 11,635 shares of our Common Stock at a warrant exercise price of $6.75 per share.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion will assist you in understanding our financial position, liquidity and results of operations. The information below should be read in conjunction with the consolidated financial statements and the related notes to consolidated financial statements. Our discussion contains both historical and forward-looking information. We assess the risks and uncertainties about our business, long-term strategy and financial condition before we make any forward-looking statements but we cannot guarantee that our assessment is accurate or that our goals and projections can or will be met. Statements concerning results of future exploration, exploitation, development and acquisition expenditures as well as expense and reserve levels are forward-looking statements. We make assumptions about commodity prices, drilling results, production costs, administrative expenses and interest costs that we believe are reasonable based on currently available information.

Critical Estimates and Accounting Policies

We prepare our consolidated financial statements in this report using accounting principles that are generally accepted in the United States (“GAAP”). GAAP represents a comprehensive set of accounting and disclosure rules and requirements. We must make judgments, estimates, and in certain circumstances, choices between acceptable GAAP alternatives as we apply these rules and requirements. The most critical estimate we make is the engineering estimate of total oil and gas reserves. This estimate affects the application of the successful efforts method of accounting, the calculation of depreciation, depletion, and amortization of oil and gas properties and the estimate of the impairment of our oil and gas properties. It also affects the estimated lives used to determine asset retirement obligations. In addition, the estimates of proved oil and gas reserves are the basis for the related standardized measure of discounted future net cash flows.

Estimated total oil and gas reserves

The evaluation of our oil and gas reserves is critical to management of our operations and ultimately our economic success. Decisions such as whether development of a property should proceed and what technical methods are available for development are based on an evaluation of reserves. These oil and gas reserve quantities are also used as the basis of calculating the unit-of-production rates for depreciation, evaluating impairment and estimating the life of our producing oil and gas properties in our asset retirement obligations. Our total reserves are classified as proved, possible and probable. Proved reserves are classified as either proved developed or proved undeveloped. Proved developed reserves are those reserves which can be expected to be recovered through existing wells with existing equipment and operating methods. Proved undeveloped reserves include reserves expected to be recovered from new wells from undrilled proven reservoirs or from existing wells where a significant major expenditure is required for completion and production. Probable reserves are those additional reserves that are less certain to be recovered than proved reserves and when probabilistic methods are used, there should be at least a 50% probability that the actual quantities recovered will equal or exceed the proved plus probable estimates. Possible reserves are those additional reserves that are less certain to be recovered than probable reserves and when probabilistic methods are used, there should be at least a 10% probability that the total quantities ultimately recovered will equal or exceed proved plus probable plus possible reserve estimates.

Independent reserve engineers prepare the estimates of our oil and gas reserves presented in this report based on guidelines promulgated under GAAP and in accordance with the rules and regulations of the Securities and Exchange Commission. The evaluation of our reserves by the independent reserve engineers involves their rigorous examination of our technical evaluation and extrapolations of well information such as flow rates and reservoir pressure declines as well as other technical information and measurements. Reservoir engineers interpret these data to determine the nature of the reservoir and ultimately the quantity of total oil and gas reserves attributable to a specific property. Our total reserves in this report include only quantities that we expect to recover commercially using current prices, costs, existing regulatory practices and technology. While we are reasonably certain that the total reserves will be produced, the timing and ultimate recovery can be affected by a number of factors including completion of development projects, reservoir performance, regulatory approvals

 

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and changes in projections of long-term oil and gas prices. Revisions can include upward or downward changes in the previously estimated volumes or reserves for existing fields due to evaluation of (1) already available geologic, reservoir or production data or (2) new geologic or reservoir data obtained from wells. Revisions can also include changes associated with significant changes in development strategy, oil and gas prices or production equipment/facility capacity.

Standardized measure of discounted future net cash flows

The standardized measure of discounted future net cash flows relies on these estimates of oil and gas reserves using commodity prices and costs at year-end. Oil and condensate prices were calculated for each property using differentials to an average for the year of the first of the month ConocoPhillips WTI price of $57.80 per barrel and were held constant for the lives of the property. The weighted average price over the lives of the properties was $58.05 per barrel. Gas prices were calculated for each property using the differentials to an average for the year of the first of the month Henry Hub Louisiana Onshore price of $3.87 per million British thermal units and were held constant for the lives of the properties. The weighted average price over the lives of the properties was $4.135 per thousand cubic feet. The standardized measure is based on the average of the beginning of the month pricing for 2009. While we believe that future operating costs can be reasonably estimated, future prices are difficult to estimate since the market prices are influenced by events beyond our control. Future global economic and political events will most likely result in significant fluctuations in future oil prices.

Successful efforts method of accounting

Oil and gas exploration and production companies choose one of two acceptable accounting methods, successful efforts or full cost. The most significant difference between the two methods relates to the accounting treatment of drilling costs for unsuccessful exploration wells (“dry holes”) and exploration costs. Under the successful efforts method, exploration costs and dry hole costs (the primary uncertainty affecting this method) are recognized as expenses when incurred and the costs of successful exploration wells are capitalized as oil and gas properties. Entities that follow the full cost method capitalize all drilling and exploration costs including dry hole costs into one pool of total oil and gas property costs.

While it is typical for companies that drill exploration wells to incur dry hole costs, our primary activities during 2009 focused on development wells and our exploratory drilling activities were immaterial. Nevertheless, we will selectively expand our exploration drilling in the future. It is impossible to accurately predict specific dry holes. Because we can not predict the timing and magnitude of dry holes, quarterly and annual net income can vary dramatically.

The calculation of depreciation, depletion and amortization of capitalized costs under the successful efforts method of accounting differs from the full cost method in that the successful efforts method requires us to calculate depreciation, depletion and amortization expense on individual properties rather than one pool of costs. In addition, under the successful efforts method we assess our properties individually for impairment compared to one pool of costs under the full cost method.

Depreciation, Depletion and Amortization of Oil and Gas Properties

The unit-of-production method of depreciation, depletion and amortization of oil and gas properties under the successful efforts method of accounting is applied pursuant to the simple multiplication of units produced by the costs per unit on a field by field basis. Leasehold cost per unit is calculated by dividing the total cost by the estimated total proved oil and gas reserves associated with that field. Well cost per unit is calculated by dividing the total cost by the estimated total proved developed oil and gas reserves associated with that field. The volumes or units produced and asset costs are known and while the proved reserves have a high probability of recoverability, they are based on estimates that are subject to some variability. The factors which create this variability are included in the discussion of estimated total oil and gas reserves above.

 

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Impairment of Oil and Gas Properties

We test for impairment of our properties based on estimates of proved reserves. Proved oil and gas properties are reviewed for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. We estimate the future undiscounted cash flows of the affected properties to judge the recoverability of the carrying amounts. Initially this analysis is based on proved reserves. However, when we believe that a property contains oil and gas reserves that do not meet the defined parameters of proved reserves, an appropriately risk adjusted amount of these reserves may be included in the impairment evaluation. These reserves are subject to much greater risk of ultimate recovery. An asset would be impaired if the undiscounted cash flows were less than it carrying value. Impairments are measured by the amount by which the carrying value exceeds its fair value.

Impairment analysis is performed on an ongoing basis. In addition to using estimates of oil and gas reserve volumes in conducting impairment analysis, it is also necessary to estimate future oil and gas prices. The impairment evaluation triggers include a significant long-term decrease in current and projected prices, or reserve volumes, an accumulation of project costs significantly in excess of the amount originally expected and historical and current negative operating losses. Although we evaluate future oil and gas prices as part of the impairment analysis, we do not view short-term decreases in prices, even if significant, as impairment triggering events.

Exploratory Drilling Costs

The costs of drilling an exploratory well are capitalized as uncompleted wells pending the determination of whether the well has found proved reserves. If proved reserves are not found, these capitalized costs are charged to expense. On the other hand, the determination that proved reserves have been found results in continued capitalization of the well and its reclassification as a well containing proved reserves.

Asset Retirement Obligation

The Company follows FASB ASC 410 – Asset Retirement and Environmental Obligations which requires entities to record the fair value of a liability for legal obligations associated with the retirement obligations of tangible long-lived assets in the period in which it is incurred. The fair value of asset retirement obligation liabilities has been calculated using an expected present value technique. Fair value, to the extent possible, should include a market risk premium for unforeseeable circumstances. A five percent market risk premium was included in the Company’s Asset Retirement Obligation fair value estimate. When the liability is initially recorded, the entity increases the carrying amount of the related long-lived asset. Over time, accretion of the liability is recognized each period and the capitalized cost is amortized over the useful life of the related asset. Upon retirement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. This standard requires the Company to record a liability for the fair value of the dismantlement and plugging and abandonment costs, excluding salvage values.

Derivatives

Derivative financial instruments, utilized to manage or reduce commodity price risk related to Dune’s production, are accounted for under the provisions of FASB ASC 815—Derivatives and Hedging. Under this statement, derivatives are carried on the balance sheet at fair value. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivatives are recorded in other comprehensive income or loss and are recognized in the statement of operations when the hedged item affects earnings. If the derivative is not designated as a hedge, changes in the fair value are recognized in other expense. Ineffective portions of changes in the fair value of cash flow hedges are also recognized in loss on derivative liabilities.

Effective January 1, 2008, the Company discontinued, prospectively, the designation of its derivatives as cash flow hedges. The net derivative loss related to the discontinued cash flow hedges, as of December 31, 2007,

 

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continued to be reported in accumulated other comprehensive loss through December 31, 2009 and were charged to loss as the volumes underlying the cash flow hedges were realized. Beginning January 1, 2008, the gain or loss on derivatives is recognized currently in earnings.

Stock-based compensation

The Company follows the provisions of FASB ASC 718—Stock Compensation. The statement requires all stock-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values on the date of the grant. Due to significant declines in the price of Dune’s stock since the issuance of many employee grants, stock-based compensation amounts are high compared to current values.

Business Strategy

Dune is an independent energy company engaged in the exploration, development, acquisition and exploitation of natural gas and crude oil properties, with interest along the Gulf Coast. On May 15, 2007, we closed the Stock Purchase and Sale Agreement to acquire all of the capital stock of Goldking from Goldking Energy Holdings, L.P. Goldking was an independent energy company focused on the exploration, exploitation and development of natural gas and crude properties located onshore and in state waters along the Gulf Coast. The acquisition of Goldking substantially increased our proved reserves, provided significant drilling upside and increased our geographic and geological well diversification. Additionally, the acquisition of Goldking provided us with exploration opportunities within our core geographic area.

Our properties now cover over 90,000 gross acres across 26 oil and natural gas fields onshore and in state waters along the Texas and Louisiana Gulf Coast.

Grow Through Exploitation, Development, and Exploration of Our Properties. Our primary focus will continue to be the development and exploration efforts in our Gulf Coast properties. We believe that our properties and acreage position will allow us to grow organically through low risk drilling in the near term, as this property set continues to present attractive opportunities to expand our reserve base through workovers and recompletions, field extensions, delineating deeper formations within existing fields and higher risk/higher reward exploratory drilling. In addition, we will constantly review, rationalize and “high-grade” our properties in order to optimize our existing asset base.

Maintain and Utilize State of the Art Technological Expertise. We expect to maintain and utilize our technical and operations teams’ knowledge of salt-dome structures and multiple stacked producing zones common in the Gulf Coast to enhance our growth prospects and reserve potential. We will employ technical advancements, including 3-D seismic data, pre-stack depth migration and directional drilling to identify and exploit new opportunities in our asset base. We also plan to employ the latest drilling, completion and fracturing technology in all of our wells to enhance recoverability and accelerate cash flows associated with these wells.

Pursue Opportunistic Acquisitions of Underdeveloped Properties. We continually review opportunities to acquire producing properties, leasehold acreage and drilling prospects that are in core operating areas. We are seeking to acquire operational control of properties that we believe have a solid proved reserves base coupled with significant exploitation and exploration potential. We intend to continue to evaluate acquisition opportunities and make acquisitions that we believe will further enhance our operations and reserves in a cost effective manner.

Actively Manage the Risks and Rewards of Our Drilling Program. In summary, our strategy is to increase our oil and gas reserves and production while keeping our finding and development costs and operating costs (on a per Mcf equivalent (Mcfe) basis) competitive with our industry peers. We will implement this strategy through drilling exploratory and development wells from our inventory of available prospects that we have evaluated for

 

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geologic and mechanical risk and future reserve or resource potential. Our drilling program will contain some higher risk/higher reserve potential opportunities as well as some lower risk/lower reserve potential opportunities in order to achieve a balanced program of reserve and production growth. Success of this strategy is contingent on various risk factors, as discussed elsewhere in the 10-K.

In 2009 we invested $14.0 million in oil and gas properties. The investment added 5.5 Bcfe through extensions and discoveries. We produced 9.5 Bcfe during the year. Revisions of previous estimates were 21.3 Bcfe negative largely due to a 8.3 Bcfe negative performance revision at the Wieting #30 in our Chocolate Bayou field and a 10.6 Bcfe negative revision of PUD reserves at our North Broussard field due to mapping from 3-D seismic.

 

Capital Costs ($000):

   Year
Ended

2009
    Year
Ended

2008
    Two
Years
Ended

12/31/09
 

Acquisitions—Proved

   $ —        $ —        $ —     

Acquisitions—Unproved

     477        1,571        2,048   

Exploration

     —          115        115   

Development

     13,543        51,064        64,607   
                        

Total CAPEX before ARO

     14,020        52,750        66,770   

ARO Costs

     594        1,209        1,803   
                        

Total CAPEX including ARO

   $ 14,614      $ 53,959      $ 68,573   
                        

Asset Retirement Obligation (non-cash)

   $ 1,256      $ 7,403      $ 8,659   
                        

Proved Reserves (Mmcfe):

      

Beginning

     132,998        175,347        175,347   

Production

     (9,522     (12,781     (22,303

Purchases

     —          —          —     

Sale of reserves

     (2,205     (32,065     (34,270

Discoveries & Extensions

     5,508        13,481        18,989   

Revisions

     (21,304     (10,984     (32,288
                        

Ending Reserves

     105,475        132,998        105,475   
                        

Reserve Additions before Revisions (Mmcfe)

     5,508        13,481        18,989   

Reserve Additions after Revisions (Mmcfe)

     (15,796     2,497        (13,299

The implementation of our strategy requires that we continually incur significant capital expenditures in order to replace current production and find and develop new oil and gas reserves. In order to finance our capital and exploration program, we depend on cash flow from operations or bank debt and equity offerings as discussed below in Liquidity and Capital Resources.

Liquidity and Capital Resources

During fiscal 2009 compared to fiscal 2008, net cash flow provided by all operating activities decreased by $34.6 million to ($11.1) million. This decline was primarily attributable to an $81.7 million decline (56%) in total revenue to $64.9 million, which was precipitated by a 41% drop in the average oil price from $99.87 per barrel to $58.53 per barrel and a 55% fall in the average natural gas price from $9.62 per Mcf to $4.34 per Mcf. Total revenues and resulting cash flow were also negatively influenced by a 16% slump in average hydrocarbon production from 31.05 Mmcfe per day to 26.09 Mmcfe per day.

Our current assets stood at $32.8 million on December 31, 2009. Cash on hand at year-end was $15.1 million, which is essentially unchanged from $15.5 million at the end of calendar year 2008. Accounts payable has been reduced again year-over-year. This time it has fallen by $9.9 million (46%) to $11.8 million at year end 2009.

 

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The financial statements reflect a dramatic reduction in drilling and facilities upgrade program in response to the precipitous hydrocarbon price decline during the year. Capital investment in oil and gas related functions for the year totaled $14 million and involved primarily workover and extension drilling designed to offset declining production volume. This was a dramatic reversal from the $52.8 million spent during the more favorable pricing environment of 2008. As we operate the majority of our properties, we control the timing and amount of expenditures and are able to adjust quickly to changes in commodity prices and other variables that may have a material impact on liquidity and cash flow.

Availability under our revolving line of credit was reset from $40 million to $34.95 million at the beginning of the year as a result of a decline in eligible reserves at Comite and South Florence fields. During the third quarter of 2009, availability was returned to $40 million with the mid-year 2009 reserve report due to an increase in eligible reserves as a result of a workover at Comite and improved pricing metrics. As of December 31, 2009, $24 million of borrowings were outstanding as compared to no borrowings under our credit facility at December 31, 2008. This was also up from $17 million outstanding at the end of the third quarter of 2009 due to working capital requirements.

Our credit agreement requires that Dune hedge between 50% and 80% of production from proved developed producing oil and gas reserves for a rolling six month period. We currently have 55% of this production hedged over the next six months and 55% over the next twelve months. Effectively all of the hedging instruments are collars. For January 2010, the lowest floor for oil is $55 and the highest ceiling is $81.60. The lowest floor for natural gas is $5.00 and the highest is $6.60. For the remainder of 2010, there are two collars. The crude oil collar is $60.00/$88.10 and the natural gas collar is $4.50/$7.68.

Semi-annual interest of $15.75 million on our 10  1/2% Senior Secured Notes due 2012 was paid on December 31, 2009 and is due semi-annually thereafter. The principal on the Senior Secured Notes is not due until 2012.

Shares of our Senior Redeemable Convertible Preferred Stock are not redeemable until December 1, 2012 or upon a change in control. Dividends are payable quarterly beginning September 1, 2007 with the Company having the option of paying any dividend on the Preferred Stock in shares of common stock, shares of Preferred Stock or cash.

Our primary sources of liquidity are cash provided by operating activities, debt financing, and possibly entering into farmout or joint development agreements with respect to future drilling opportunities on existing acreage. The strength of our current cash position and remaining availability under our revolver put us in a favorable position to meet our financial obligations and ongoing capital programs.

For 2010, capital spending will be targeted at between $20 million and $22 million. The exact amount will depend upon individual well performance results, cash flow and, where applicable, partner negotiations on the timing of drilling operations. As previously indicated, the fact that we operate a majority of our properties affords us with the opportunity to reduce or increase our capital expenditure program depending on available cash flow and outside liquidity.

The following table summarizes our contractual obligations and commercial commitments as of December 31, 2009:

 

     Payments Due By Period
     Total    Less than
1 year
   1 - 3
years
   4 - 5 years    After 5 years
     (in thousands)

Contractual obligations:

              

Debt and interest

   $ 400,125    $ 31,500    $ 368,625    $ —      $ —  

Office lease

     1,402      801      601      —        —  
                                  

Total

   $ 401,527    $ 32,301    $ 369,226    $           —      $           —  
                                  

 

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Changes in our working capital accounts from 2008 to 2009 reflect a $9.9 million reduction in accounts payable.

Results of Operations

Comparison of 2009 and 2008

Year-over-year production decreased 16% to 9,521 Mmcfe in 2009 compared to 11,364 Mmcfe in 2008. This decrease was caused by normal reservoir declines and a very limited capital reinvestment program. Additionally, significant reductions in both oil and gas prices were incurred during this time period. The following table reflects the increase (decrease) in oil and gas sales revenue due to changes in price and volume:

 

     2009     % Increase
(Decrease)
    2008    % Increase
(Decrease)
    2007

Oil production volume (Mbbls)

     724      (18 %)      884    56     568

Oil sales revenue ($000)

   $ 42,383      (52 %)    $ 88,306    97   $ 44,892

Price per Bbl

   $ 58.53      (41 %)    $ 99.87    26   $ 79.04

Increase (decrease) in oil sales revenue due to:

           

Change in prices

   $ (36,565     $ 11,831     

Change in production volume

     (9,358       31,583     
                     

Total increase (decrease) in oil sales revenue

   $ (45,923     $ 43,414     
                     

Gas production volume (Mmcf)

     5,177      (15 %)      6,060    62     3,731

Gas sales revenue

   $ 22,490      (61 %)    $ 58,294    122   $ 26,308

Price per Mcf

   $ 4.34      (55 %)    $ 9.62    36   $ 7.05

Increase (decrease) in gas sales revenue due to:

           

Change in prices

   $ (31,994     $ 9,589     

Change in production volume

     (3,810       22,397     
                     

Total Increase (decrease) in gas sales revenue

   $ (35,804     $ 31,986     
                     

Total production volume (Mmcfe)

     9,521      (16 %)      11,364    59     7,139

Total revenue

   $ 64,873      (56 %)    $ 146,600    106   $ 71,200

Price per Mcfe

   $ 6.81      (47 %)    $ 12.90    29   $ 9.97

Increase (decrease) in revenue due to:

           

Change in prices

   $ (69,169     $ 21,420     

Change in production volume

     (12,558       53,980     
                     

Total increase (decrease) in revenue

   $ (81,727     $ 75,400     
                     

Revenues

Revenues for the year ended December 31, 2009 totaled $64.9 million as compared to $146.6 million for the year ended December 31, 2008. Production volumes for 2009 were 724 Mbbls of oil and 5.2 Bcf of natural gas or 9.5 Bcfe. This compares to 884 Mbbls of oil and 6.1Bcf of natural gas or 11.4 Bcfe for 2008. In 2009, the average sales price per barrel of oil was $58.53 and $4.34 per mcf for natural gas as compared to $99.87 per barrel and $9.62 per mcf, respectively for 2008. The primary reasons behind the decrease in revenue were lower production and lower average sales prices in 2009 versus 2008. Average price received per Mcfe produced was $6.81 in 2009 versus $12.90 in 2008 or a decline of 47%.

 

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Operating expenses

Lease operating expense and production taxes

The following table presents the major components of Dune’s lease operating expense for the last two years on a per Mcfe basis:

 

     Years Ending December 31,
     2009      2008
     Total     
 
Per
Mcfe
     Total     
 
Per
Mcfe

Direct operating expense

   $ 21,083    $ 2.21    $ 24,830    $ 2.18

Workovers

     1,906      0.20      5,456      0.48

Ad Valorem taxes

     1,108      0.12      1,258      0.11

Production taxes

     5,260      0.55      10,710      0.94

Transportation

     2,526      0.27      1,247      0.11
                           
   $ 31,883    $ 3.35    $ 43,501    $ 3.82
                           

Lease operating expense for the year ended December 31, 2009 totaled $31.9 million versus $43.5 million for the year ended December 31, 2008 representing a reduction of $11.6 million or 27%. This translated to a decrease of $0.47/Mcfe to $3.35/Mcfe on a volume basis. This reduction reflects the Company’s efforts to reduce operating costs as well as limit capital reinvestment in the form of workovers.

Exploration Expenses

There was no exploration expense for the year ended December 31, 2009 compared to $0.1 million in 2008. This result reflects the Company’s continuing focus on drilling development wells in order to convert proved undeveloped to proved developed reserves.

Accretion of asset retirement obligation

Accretion expense for asset retirement obligations increased $0.7 million during the year ended December 31, 2009 compared to 2008. This increase reflects the impact of upward revisions in estimated abandonment costs at December 31, 2008 which is reflected in the 2009 accretion expense.

Depletion, depreciation and amortization (DD&A)

For the year ended December 31, 2009, DD&A decreased to $35.4 million versus $56.7 million in 2008 representing a decrease of $21.3 million. This decrease reflects the impact of the 2008 impairment on the Company’s oil and gas properties of $125.7 million which directly impacts the depletable base for DD&A purposes. This reduction in the depletable base along with a 16% reduction in production volumes resulted in a 38% reduction in DD&A expense in 2009.

General and administrative expense (G&A expense)

G&A expense totaled $14.3 million for the year ended December 31, 2009 compared to $18.5 million for the same period of 2008 yielding a $4.2 million reduction. This decrease consists of a $1.2 million decline in non-cash stock-based compensation. The $3.0 million decrease in cash G&A is attributable to a reduction in total personnel to 48 employees from 52 a year earlier, no accrual for bonus payments in 2009 and strict cost controls in all areas.

Impairment of oil and gas properties

Dune recorded an impairment of oil and gas properties of $2.9 million for the year ended December 31, 2009 compared to an impairment of $125.7 million for the year ended December 31, 2008. The 2008 impairment

 

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was related to dramatically lower commodity prices at year end 2008 versus the same level in 2007 resulting in significant impairment in two of the Company’s major fields. The 2009 impairment was primarily isolated to one non-core Wyoming field which did not perform as anticipated when the well was completed.

Other income (expense)

Interest income

Interest income for the year ended December 31, 2009 was $0.5 million less than 2008. This was the result of using our cash balances to support working capital and contribute to the capital program.

Interest expense

Interest expense for the year ended December 31, 2009 amounted to $35.2 million compared to $35.0 million in 2008.

Gain (loss) on derivative liabilities

The Company recognized a loss on derivatives of ($2.8) million for the year ended December 31, 2009, composed of an unrealized loss on changes in mark-to-market valuations of ($9.5) million and a realized gain on cash settlements of $6.7 million. This compares to a gain of $4.1 million, composed of an unrealized gain on changes in mark-to-market valuations of $13.4 million and a realized loss on cash settlements of ($9.3) million, for the year ended December 31, 2008.

Income tax benefit

As a result of the Goldking acquisition in the second quarter of 2007, the Company had significant deferred tax liabilities in excess of its deferred tax assets. Management determined that a valuation allowance was no longer necessary as the realization of its deferred tax assets was more likely than not. Consequently, in 2008 the Company recorded an income tax benefit of $20.5 million for continuing operations and $9.4 million for discontinued operations.

At December 31, 2008, the Company had fully utilized its deferred tax liability associated with the Goldking acquisition and established a valuation allowance against its net deferred tax assets. The Company is no longer in a position to record an income tax benefit against future losses. Consequently, no income tax benefit was recorded in 2009.

Discontinued operations

Associated with the sale of the Barnett Shale Properties, the Company has reflected all activity for these assets as discontinued operations. For the year ended December 31, 2008, the Company generated a net gain from the operation of the Barnett Shale Properties of $2.1 million. This gain was added to a $43.9 million impairment to write down the related carrying amounts to their fair value less cost to sell. An income tax benefit of $9.4 million was added to this transaction yielding a $32.4 million loss on discontinued operations for 2008.

Net Loss available to common shareholders

For the year ended December 31, 2009, net loss available to common shareholders decreased $145.9 million from the comparable 2008 period. This decrease reflects the impact of an ($81.7) million reduction in revenues, an increase in loss on derivatives of ($6.9) million and a ($20.5) million reduction in income tax benefit. This was offset by a $36.5 million reduction in operating expenses, a $122.8 million decrease in the impairment of oil and gas properties, a $32.4 million reduction in the loss on discontinued operations and a $63.9 million reduction in Preferred Stock dividends.

 

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New Accounting Pronouncements

In June 2009, the FASB approved the “FASB Accounting Standards Codification” (the “Codification”) as the single source of authoritative non governmental U.S. GAAP to be launched on July 1, 2009. The Codification does not change current U.S. GAAP but it is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered nonauthoritative. The Codification was effective for interim and annual periods ending after September 15, 2009. The Company adopted the provisions of the Codification during the period ended September 30, 2009 and the adoption did not have a material impact on its consolidated financial position, results of operations or cash flows.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (ASC 855) to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. ASC 855 is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted the provisions of ASC 855 for the period ended June 30, 2009. There was no impact on the Company’s operating results, financial position or cash flows.

In December 2008, the SEC issued Release No. 33-8995, Modernization of Oil and Gas Reporting (ASC 2010-3), which amends the oil and gas disclosures for oil and gas producers contained in Regulations S-K and S-X. The goal of Release No. 33-8995 is to provide investors with a more meaningful and comprehensive understanding of oil and gas reserves. Energy companies affected by Release No. 33-8995 are now required to price proved oil and gas reserves using the unweighted arithmetic average of the price on the first day of each month within the 12-month period prior to the end of the reporting period, unless prices are defined by contractual arrangements, excluding escalations based on future conditions. SEC Release No. 33-8995 is effective beginning for financial statements for fiscal years ending on or after December 31, 2009. The impact on the Company’s operating results, financial position and cash flows has been recorded in the financial statements.

 

Item 8. Financial Statements and Supplementary Data.

The response to this item is included in Item 15—Financial Statements.

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

None.

 

Item 9A. Controls and Procedures.

(a) Disclosure Controls and Procedures.

We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit to the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified by the SEC’s rules and forms, and that information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate to allow timely decisions regarding required disclosure.

In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, under the supervision and with the participation of management, including our CEO and CFO, of the effectiveness of our disclosure controls and procedures as of December 31, 2009. As described below under Management’s Annual Report on Internal Control over Financial Reporting, our CEO and CFO have concluded that, as of December 31, 2009, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

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(b) Management’s Annual Report on Internal Control over Financial Reporting.

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is designed to provide reasonable assurance to the Company’s Management and Directors regarding the reliability of financial reporting and the preparation of published financial statements. The Company’s internal control over financial reporting includes those policies and procedures that:

 

  1. pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 

  2. provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

 

  3. provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control—Integrated Framework. Based on such assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2009.

Malone & Bailey, P.C., our independent registered public accounting firm who also audited the Company’s consolidated financial statements, has issued its own attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009, which is filed herewith.

(c) Changes in Internal Control Over Financial Reporting. There have not been any changes in the Company’s internal control over financial reporting during the fourth quarter ended December 31, 2009 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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(d)Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of

Dune Energy, Inc.

Houston, Texas

We have audited Dune Energy, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Dune Energy, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Dune Energy, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Dune Energy, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity(deficit), and cash flows for the years then ended and our report dated March 25, 2010 expressed an unqualified opinion thereon.

/s/  MaloneBailey, LLP

www.malonebailey.com

Houston, Texas

March 25, 2010

 

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Item 9B. Other Information.

On November 30, 2009, we held a special meeting of our stockholders, seeking approval of (i) a 1-for-5 reverse stock split on our outstanding shares of common stock and (ii) an amendment to our 2007 Incentive Stock Plan which would authorize an additional 7 million shares (pre-split) to be reserved for issuance under the Plan. The results of the voting were as follows:

 

Proposal

   Votes For    Votes Against    Abstentions    Broker Non-Votes

Reverse Stock Split

   108,078,859    17,068,171    166,637    -0-

Amendment to Plan

   77,991,316    5,631,427    320,061    41,370,863

Based on the foregoing, the reverse stock split was effective on December 2, 2009. Unless otherwise indicated, all references herein to outstanding shares are on a post-split basis.

On March 23, 2010, we entered into a Third Amendment to our senior credit agreement. Among other things, the Third Amendment extended the Maturity Date thereunder from May 15, 2010 to the earlier of March 31, 2011, or the date that is 90 days prior to the earliest date on which any principal amount of our Senior Secured Notes is scheduled to become due and payable. In addition, the $10 million minimum liquidity requirement was removed in favor of new monthly covenants with respect to cumulative EBITDA and minimum monthly production. Going forward, we will also be required to maintain a minimum of $80 million of proved developed producing reserves. An annual ceiling was also placed on our capital expenditures. The borrowing rate options have been increased to LIBOR plus 5% or Base Rate plus 5% and letter of credit fees are now 3.5%. A minimum floor of 1% has also been placed under the LIBOR rate. The non-use fee under our credit agreement has been increased to 0.75%. The borrowing base calculation is based solely on 65% of proved developed producing reserves and the hydrocarbon pricing assumptions used are to be the lower of a formula based on the NYMEX strip or the price deck utilized by our senior lenders then in effect. Finally, there is a $500,000 closing fee and an early termination fee.

PART III

The information required by Part III will be incorporated by reference into this Form 10-K from the Registrant’s Definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the end of the Registrant’s fiscal year covered by this Form 10-K.

 

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PART IV

 

Item 15. Exhibits, Financial Statement Schedules.

(a)(1) Financial Statements

The response to this item is submitted in a separate section of this report.

(a)(3) Exhibits

 

Exhibit Nos.

  

Description

3.1    Amended and Restated Certificate of Incorporation (1)
3.1.1    Certificate of Amendment of Certificate of Incorporation (2)
3.2    Amended and Restated By-Laws (3)
4.1    Certificate of Designations, dated May 15, 2007, for 10% Senior Redeemable Convertible Preferred Stock of the Company (4)
4.1.1    Certificate of Correction to Certificate of Designations, dated February 26, 2008 (11)
4.2    Form of Placement Agent Warrant (5)
4.3    Form of Investor Registration Rights Agreement (5)
4.4    Form of Warrant, dated as of September 26, 2006, from Company to Bernard National Senior Funding, Ltd. and Drawbridge Special Opportunities Fund LP (6)
4.5    Indenture, dated May 15, 2007, among the Company, each of Dune Operating Company and Vaquero Partners LLC, as guarantors, and The Bank of New York, as trustee and collateral agent (4)
4.6    First Supplement to Indenture dated as of December 30, 2008 (12)
4.7    Form of Global 10  1/2% Senior Secured Exchange Note due 2012 (11)
10.1    Employment Agreement, dated April 17, 2007, between the Company and James A. Watt (7)
10.1.1    Amended and Restated Employment Agreement, dated as of December 30, 2008 between the Company and James A. Watt (12)
10.1.2    Employment Agreement, dated as of October 1, 2009, between the Company and James A. Watt (15)
10.2    Employment Agreement, dated April 17, 2007, between the Company and Alan Gaines (7)
10.2.1    Amendment to Employment Agreement of Alan Gaines dated May 9, 2007 (2)
10.2.2    Amended and Restated Employment Agreement, dated as of December 30, 2008 between the Company and Alan Gaines (12)
10.2.3    Employment Agreement, dated as of February 16, 2009, between the Company and Alan Gaires (16)
10.3    Employment Agreement dated as of April 17, 2007, between the Company and Amiel David (7)
10.3.1    Amendment to Employment Agreement of Amiel David dated May 9, 2007 (2)
10.3.2    Amended and Restated Employment Agreement, dated as of December 30, 2008 between the Company and Amiel David (12)
10.4    Restricted Stock Agreement, dated April 17, 2007, between the Company and James A. Watt (7)
10.4.1    Restricted Stock Agreement (Performance Based), dated October 1, 2009, between the Company and James A. Watt (15)
10.4.2    Restricted Stock Agreement (Time-Vesting), dated October 1, 2009, between the Company and James A. Watt (15)
10.5    Restricted Stock Agreement, dated April 17, 2007, between the Company and Alan Gaines (7)
10.6    Restricted Stock Agreement, dated April 17, 2007, between the Company and Frank T. Smith, Jr. (7)
10.6.1    Restricted Stock Agreement (Performance Based), dated October 1, 2009, between the Company and Frank T. Smith, Jr. (15)
10.6.2    Restricted Stock Agreement (Time-Vesting), dated October 1, 2009, between the Company and Frank T. Smith, Jr. (15)

 

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Table of Contents

Exhibit Nos.

  

Description

10.7    Exploration and Development Agreement between Company and American Natural Energy Corporation, dated effective as of August 26, 2005(8)
10.8    Stock Purchase and Sale Agreement dated effective April 13, 2007 between the Company and Goldking Energy Holdings, L.P. (7)
10.9    Form of Registration Rights Agreement (7)
10.10    Purchase Agreement dated as of May 1, 2007 between the Company and Jefferies & Company, Inc. (10)
10.11    Notes Registration Rights Agreement, dated May 15, 2007, between the Company and Jefferies & Company, Inc. (4)
10.12    Preferred Stock Registration Rights Agreement, dated May 15, 2007, between the Company and Jefferies & Company, Inc. (4)
10.13    Security Agreement, dated May 15, 2007, among The Bank of New York, as collateral agent, and each of the Company, Goldking Operating Company and Vaquero Partners LLC, as grantors, and Dune Operating Company and Goldking Energy Corporation, as guarantors (4)
10.14    Intercreditor Agreement, dated May 15, 2007, among Wells Fargo Foothills, Inc., The Bank of New York and the Company, among others named therein (4)
10.15    Credit Agreement dated May 15, 2007 among the Company, its subsidiaries named therein as borrowers, its subsidiaries named therein as guarantors, certain lenders named therein and Wells Fargo Foothill, Inc., as arranger and administrative agent (4)
10.16    First Amendment to Credit Agreement dated as of August 4, 2008 (13)
10.17*    Third Amendment to Credit Agreement dated as of March 23, 2010
10.18    Purchase and Sale Agreement, dated as of June 30, 2008 between the Company and Pioneer Natural Resources, Inc. (14)
10.19    First Amendment to Purchase and Sale Agreement dated as of July 31, 2008 (13)
10.20    1992 ISDA Master Agreement, together with Schedule, dated May 15, 2007 among Wells Fargo Foothill, Inc. and the Company (4)
14.1    Code of Conduct and Ethics(11)
21.1*    List of Subsidiaries
23.1*    Consent of DeGolyer and MacNaughton, independent petroleum engineers
31.1*    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1*    Certification pursuant to 18 U.S.C. 1350, adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002, by Chief Executive Officer
32.2*    Certification pursuant to 18 U.S.C. 1350, adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002, by Chief Financial Officer
99.1*    Reserve Report Of Independent Engineer

 

* Indicates filed herewith
(1) Previously filed as an exhibit to the Company’s Annual Report on Form 10-KSB for the year ended December 31, 2002, and incorporated by reference herein.
(2) Previously filed as an exhibit to the Company’s Report on Form 10-Q for the quarterly period ended March 31, 2007, and incorporated by reference herein.
(3) Previously filed as an exhibit to the Company’s Report on Form 8-K, filed on May 19, 2004, and incorporated by reference herein.
(4) Previously filed as an exhibit to the Company’s Report on Form 8-K, filed May 21, 2007, and incorporated by reference herein.
(5) Previously filed as an exhibit to the Company’s Annual Report on Form 10-KSB for year ended December 31, 2006, and incorporated by reference herein.
(6) Previously filed as an exhibit to the Company’s Report on Form 8-K, filed on September 28, 2006, and incorporated by reference herein.

 

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(7) Previously filed as an exhibit to the Company’s Report on Form 8-K, filed April 18, 2007, and incorporated by reference herein.
(8) Previously filed as an exhibit to the Company’s Report on Form 8-K, filed on October 24, 2005, and incorporated by reference herein.
(9) Previously filed as an exhibit to the Company’s Report on Form 8-K filed on July 24, 2006, and incorporated by reference herein.
(10) Previously filed as an exhibit to the Company’s Report on Form 8-K, filed May 4, 2007, and incorporated by reference herein.
(11) Previously filed as an exhibit to the Company’s Report on Form 10-K filed on March 10, 2008, and incorporated by reference herein.
(12) Previously filed as an exhibit to the Company’s Report on Form 8-K filed on December 30, 2008, and incorporated by reference herein.
(13) Previously filed as an exhibit to the Company’s Report on Form 10-Q for the quarterly period ended June 30, 2008, and incorporated by reference herein.
(14) Previously filed as an exhibit to the Company’s Report on Form 8-K filed on July 7, 2008, and incorporated by reference herein.
(15) Previously filed as an exhibit to the Company’s Report on Form 8-K filed on October 5, 2009, and incorporated by reference herein.
(16) Previously filed as an exhibit to the Company’s Report on Form 8-K filed on February 18, 2009, and incorporated by reference herein.

 

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DUNE ENERGY INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     PAGE

Dune Energy, Inc.—

  

Report of Independent Registered Public Accounting Firm

   F-2

Consolidated Balance Sheets at December 31, 2009 and 2008

   F-3

Consolidated Statements of Operations for the Years Ended December 31, 2009 and 2008

   F-4

Consolidated Statements of Cash Flows for the Years Ended December 31, 2009 and 2008

   F-5

Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the Years Ended December  31, 2009 and 2008

   F-6

Notes to Consolidated Financial Statements

   F-7

 

F-1


Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of

Dune Energy, Inc

Houston, Texas

We have audited the accompanying consolidated balance sheets of Dune Energy, Inc (a Delaware Corporation) as of December 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity (deficit), 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 audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform an 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 Dune Energy, Inc as of December 31, 2009 and 2008 and the results of its operations and cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Dune Energy, Inc’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria), and our report dated March 25, 2010 expressed an unqualified opinion thereon.

/s/    MaloneBailey, LLP

www.malonebailey.com

Houston, Texas

March 25, 2010

 

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Table of Contents

Dune Energy, Inc.

Consolidated Balance Sheets

 

     December 31,  
     2009     2008  

ASSETS

    

Current assets:

    

Cash

   $ 15,053,571      $ 15,491,532   

Accounts receivable, net of reserve for doubtful accounts of $0 and $396,629

     15,026,945        14,477,918   

Prepayments and other current assets

     2,724,666        6,910,422   

Derivative assets

     —          4,015,219   
                

Total current assets

     32,805,182        40,895,091   
                

Oil and gas properties, using successful efforts accounting—proved

     593,661,488        578,074,569   

Less accumulated depreciation, depletion, amortization and impairment

     (260,548,612     (222,876,172
                

Net oil and gas properties

     333,112,876        355,198,397   
                

Property and equipment, net of accumulated depreciation of $2,247,220 and $1,406,927

     1,215,123        2,086,313   

Deferred financing costs, net of accumulated amortization of $1,565,280 and $970,068

     1,026,445        1,621,657   

Other assets

     4,427,826        2,250,868   
                
     6,669,394        5,958,838   
                

TOTAL ASSETS

   $ 372,587,452      $ 402,052,326   
                

LIABILITIES AND STOCKHOLDERS’ DEFICIT

    

Current liabilities:

    

Accounts payable

   $ 11,760,370      $ 21,662,965   

Accrued liabilities

     21,656,922        20,038,900   

Derivative liability

     1,596,545        —     

Short-term debt

     1,579,308        2,013,699   

Preferred stock dividend payable

     1,985,000        2,446,985   
                

Total current liabilities

     38,578,145        46,162,549   

Long-term debt, net of discount of $7,737,553 and $10,393,213

     316,262,447        289,606,787   

Other long-term liabilities

     18,051,230        15,732,483   
                

Total liabilities

     372,891,822        351,501,819   
                

Commitments and contingencies

     —          —     

Redeemable convertible preferred stock, net of discount of $7,205,812 and $9,179,927, liquidation preference of $1,000 per share, 750,000 shares designated, 192,050 and 236,805 shares issued and outstanding

     184,844,188        227,625,073   

STOCKHOLDERS’ DEFICIT

    

Preferred stock, $.001 par value, 1,000,000 shares authorized, 250,000 shares undesignated, no shares issued and outstanding

     —          —     

Common stock, $.001 par value, 300,000,000 shares authorized, 39,801,796 and 19,225,816 shares issued and outstanding

     39,802        19,226   

Treasury stock, at cost (68,089 and 6,802 shares)

     (48,642     (8,332

Additional paid-in capital

     97,600,721        50,232,715   

Accumulated other comprehensive loss

     —          (3,709,177

Accumulated deficit

     (282,740,439     (223,608,998
                

Total stockholders’ deficit

     (185,148,558     (177,074,566
                

TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT

   $ 372,587,452      $ 402,052,326   
                

See summary of significant accounting policies and notes to consolidated financial statements.

 

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Table of Contents

Dune Energy, Inc.

Consolidated Statements of Operations

 

     For the Year Ended December 31,  
     2009     2008  

Revenues

   $ 64,873,255      $ 146,599,698   
                

Operating expenses:

    

Lease operating expense and production taxes

     31,882,904        43,501,273   

Exploration expense

     —          114,950   

Accretion of asset retirement obligation

     1,643,503        911,012   

Depletion, depreciation and amortization

     35,354,218        56,692,441   

General and administrative expense

     14,321,383        18,470,758   

Impairment of oil and gas properties

     2,874,000        125,694,000   
                

Total operating expense

     86,076,008        245,384,434   
                

Operating loss

     (21,202,753     (98,784,736
                

Other income(expense):

    

Interest income

     45,054        501,591   

Interest expense

     (35,192,809     (35,022,056

Gain (loss) on derivative liabilities

     (2,780,933     4,071,507   
                

Total other income(expense)

     (37,928,688     (30,448,958
                

Loss from continuing operations before income taxes

     (59,131,441     (129,233,694

Income tax benefit

     —          20,505,873   
                

Loss from continuing operations

     (59,131,441     (108,727,821
                

Discontinued operations:

    

Income (loss) from operations of Barnett Shale Properties
(including impairment of $43,895,525 in 2008)

  

 

—  

  

 

 

(41,815,505

    

Income tax benefit (expense)

     —          9,423,563   
                

Income (loss) on discontinued operations

     —          (32,391,942
                

Net loss

     (59,131,441     (141,119,763

Preferred stock dividend

     (36,727,085     (100,597,155
                

Net loss available to common shareholders

   $ (95,858,526   $ (241,716,918
                

Net loss per share:

    

Basic and diluted from continuing operations

   $ (3.44   $ (11.79

Basic and diluted from discontinued operations

     —          (1.82
                

Total basic and diluted

   $ (3.44   $ (13.61
                

Weighted average shares outstanding:

    

Basic and diluted

     27,846,561        17,763,632   

Comprehensive loss:

    

Net loss

   $ (59,131,441   $ (141,119,763

Other comprehensive income

     3,709,177        51,936   
                

Comprehensive loss

   $ (55,422,264   $ (141,067,827
                

See summary of significant accounting policies and notes to consolidated financial statements.

 

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Table of Contents

Dune Energy, Inc.

Consolidated Statements of Cash Flows

 

     For the Year Ended
December 31,
 
     2009     2008  

CASH FLOWS FROM OPERATING ACTIVITIES

    

Net loss

   $ (59,131,441   $ (141,119,763

Adjustments to reconcile net loss to net cash used in operating activities:

    

Loss (income) from discontinued operations

     —          32,391,942   

Depletion, depreciation and amortization

     35,354,218        56,692,441   

Amortization of deferred financing costs and debt discount

     3,250,872        2,961,426   

Stock-based compensation

     4,145,712        5,282,671   

Realized gain on sale of investment

     —          (146,210

Impairment of oil and gas properties

     2,874,000        125,694,000   

Exploration expense

     —          114,950   

Accretion of asset retirement obligation

     1,643,503        911,012   

Loss (gain) on derivative liabilities

     9,506,580        (13,358,724

Deferred tax benefit

     —          (20,505,873

Changes in:

    

Accounts receivable

     (774,980     16,082,845   

Prepayments and other assets

     931,379        (2,448,783

Payments made to settle asset retirement obligations

     (594,476     (1,208,920

Accounts payable and accrue liabilities

     (8,261,725     (45,146,857
                

NET CASH PROVIDED BY (USED IN) CONTINUING OPERATIONS

     (11,056,358     16,196,157   

NET CASH PROVIDED BY DISCONTINUED OPERATIONS

     —          7,304,552   
                

NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES

     (11,056,358     23,500,709   
                

CASH FLOWS FROM INVESTING ACTIVITIES

    

Investment in proved and unproved properties

     (14,020,179     (52,750,005

Deposits

     —          500,000   

Proceeds from sale of investment

     —          424,098   

Purchase of furniture and fixtures

     (4,452     (546,886

Decrease (increase) in other assets

     1,077,419        (21,145
                

NET CASH USED IN INVESTING ACTIVITIES—CONTINUING OPERATIONS

     (12,947,212     (52,393,938

NET CASH USED IN INVESTING ACTIVITIES—DISCONTINUED OPERATIONS

     —          27,653,027   
                

NET CASH USED IN INVESTING ACTIVITIES

     (12,947,212     (24,740,911
                

CASH FLOWS FROM FINANCING ACTIVITIES

    

Proceeds from long-term debt

     24,000,000        28,100,000   

Proceeds from short-term debt

     2,030,539        2,589,057   

Payments on long-term debt

     —          (28,100,000

Payments on short-term debt

     (2,464,930     (2,629,049
                

NET CASH PROVIDED BY FINANCING ACTIVITIES

     23,565,609        (39,992
                

NET CHANGE IN CASH BALANCE

     (437,961     (1,280,194

Cash balance at beginning of period

     15,491,532        16,771,726   
                

Cash balance at end of period

   $ 15,053,571      $ 15,491,532   
                

SUPPLEMENTAL DISCLOSURES

    

Interest paid

   $ 31,881,106      $ 32,060,629   

Income taxes paid

     —          —     

NON-CASH DISCLOSURES

    

Redeemable convertible preferred stock dividends

   $ 34,752,970      $ 98,833,909   

Asset retirement obligation revision

     1,256,447        7,402,701   

Accretion of discount on preferred stock

     1,974,115        1,763,246   

Common stock issued for conversion of preferred stock

     71,547,000        16,441,000   

See summary of significant accounting policies and notes to consolidated financial statements.

 

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Table of Contents

Dune Energy, Inc.

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)

Years ended December 31, 2009 and 2008

 

                             Additional
Paid-In
Capital
    Accumulated
Other
Comprehensive
Loss
    Accumulated
Deficit
    Total
Stockholders’
Equity (Deficit)
 
     Common Stock     Treasury Stock          
     Shares     Amount     Shares     Amount          

Balance at December 31, 2007

   15,851,639        15,852      —          —          56,142,986        (3,831,228     (82,489,235     (30,161,625

Conversion of preferred stock

   2,651,416        2,651            16,438,349            16,441,000   

Purchase of treasury stock

       (6,802     (8,332     8,332            —     

Amortization and reclass of OCI

               122,051          122,051   

Restricted stock issued

   801,178        801            (801         —     

Restricted stock cancelled

   (90,310     (90         90            —     

Stock issued for cashless exercise of stock options

   11,893        12            (12         —     

Stock-based compensation

             5,282,671            5,282,671   

Preferred stock dividends

             (25,875,654         (25,875,654

Accretion of discount on preferred stock

             (1,763,246         (1,763,246

Net loss

                 (141,119,763     (141,119,763
                                                            

Balance at December 31, 2008

   19,225,816      $ 19,226      (6,802   $ (8,332   $ 50,232,715      $ (3,709,177   $ (223,608,998   $ (177,074,566

Conversion of preferred stock

   19,167,799        19,169            71,527,831            71,547,000   

Purchase of treasury stock

       (61,287     (40,310           (40,310

Amortization and reclass of OCI

               3,709,177          3,709,177   

Restricted stock issued

   1,431,480        1,430            (1,430         —     

Restricted stock cancelled

   (23,299     (23         23            —     

Stock-based compensation

             4,145,712            4,145,712   

Preferred stock dividends

             (26,330,015         (26,330,015

Accretion of discount on preferred stock

             (1,974,115         (1,974,115

Net loss

                 (59,131,441     (59,131,441
                                                            

Balance at December 31, 2009

   39,801,796      $ 39,802      (68,089   $ (48,642   $ 97,600,721      $ —        $ (282,740,439   $ (185,148,558
                                                            

See summary of significant accounting policies and notes to consolidated financial statements.

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of operations and organization

Dune Energy, Inc., a Delaware corporation (“Dune” or the “Company”), is an independent energy company that was formed in 1998. Since May 2004, Dune has been engaged in the exploration, development, exploitation and production of oil and natural gas. Dune sells its oil and gas products primarily to domestic pipelines and refineries. Its operations are presently focused in the States of Texas and Louisiana.

Consolidation

The accompanying consolidated financial statements include all accounts of Dune and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.

Reclassifications and Adjustments

Certain prior year amounts in the consolidated financials statements have been reclassified to conform to the fiscal 2009 presentation. All historical share and per share data in the consolidated financial statements and notes thereto have been restated to give retroactive recognition of the 1-for-5 reverse stock split. In the consolidated statements of stockholders’ equity, for all periods presented, the par value of the reduced shares was reclassified to additional paid-in-capital from common stock. See Note 4 for additional information regarding the reverse stock split.

Oil and gas properties

Dune follows the successful efforts method of accounting for its investment in oil and gas properties. The unit-of-production method of depreciation, depletion and amortization of oil and gas properties under the successful efforts method of accounting is applied pursuant to the simple multiplication of units produced by the costs per unit on a field by field basis. Leasehold cost per unit is calculated by dividing the total cost by the estimated total proved oil and gas reserves associated with that field. Well cost per unit is calculated by dividing the total cost by the estimated total proved developed oil and gas reserves associated with that field. The volumes or units produced and asset costs are known and while the proved reserves have a high probability of recoverability, they are based on estimates that are subject to some variability. Amortization expense amounted to $34,488,147, and $55,652,979 for the years ended December 31, 2009 and 2008, respectively.

We test for impairment of our properties based on estimates of proved reserves. Proved oil and gas properties are reviewed for impairment whenever events or circumstances indicate that the carrying amount may not be recoverable. We estimate the future undiscounted cash flows of the affected properties to judge the recoverability of the carrying amounts. Initially this analysis is based on proved reserves. However, when we believe that a property contains oil and gas reserves that do not meet the defined parameters of proved reserves, an appropriately risk adjusted amount of these reserves may be included in the impairment evaluation. These reserves are subject to much greater risk of ultimate recovery. An asset would be impaired if the undiscounted cash flows were less than its carrying value. Impairments are measured by the amount by which the carrying value exceeds its fair value.

Impairment analysis is performed on an ongoing basis. In addition to using estimates of oil and gas reserve volumes in conducting impairment analysis, it is also necessary to estimate future oil and gas prices and costs, considering all available evidence at the date of review. The impairment evaluation triggers include a significant long-term decrease in current and projected prices or reserve volumes, an accumulation of project costs

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

significantly in excess of the amount originally expected and historical and current negative operating losses. Although we evaluate future oil and gas prices as part of the impairment analysis, we do not view short-term decreases in prices, even if significant, as impairment triggering events.

During the years ended December 31, 2009 and 2008, the Company impaired its oil and gas properties by $2,874,000 and $125,694,000, respectively, which are reflected in the accompanying Consolidated Statements of Operations. The 2008 impairment was related to dramatically lower commodity prices at year end 2008 while the 2009 impairment was primarily isolated to one non-core Wyoming field which did not perform as anticipated when the well was completed.

Properties not subject to amortization consist of exploration and development costs which are evaluated on a property-by-property basis. There were no material costs not subject to amortization as of December 31, 2009 and 2008.

Asset Retirement Obligation

The Company follows FASB ASC 410—Asset Retirement and Environmental Obligations which requires entities to record the fair value of a liability for legal obligations associated with the retirement obligations of tangible long-lived assets in the period in which it is incurred. This standard requires the Company to record a liability for the fair value of the dismantlement and plugging and abandonment costs excluding salvage values. When the liability is initially recorded, the entity increases the carrying amount of the related long-lived asset. Over time, accretion of the liability is recognized each period and the capitalized cost is amortized over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement.

Concentrations of credit risk and allowance

Substantially all of the Company’s receivables are due from oil and natural gas purchasers. The Company sold 79% of its oil and natural gas production to two customers in 2009 and 68% of its oil and natural gas production to two customers in 2008. Historically, credit losses incurred on receivables of the Company have not been significant.

The Company maintains an allowance for doubtful accounts on trade receivables equal to amounts estimated to be uncollectible. This estimate is based upon historical collection experience combined with a specific review of each customer’s outstanding trade receivable balance. Dune established a reserve for doubtful accounts related to the revenue receivable from ANEC of $396,629 in 2007. This balance was included in a transaction with ANEC during 2009 and is no longer reserved. Management believes that the allowance for doubtful accounts is adequate; however, actual write-offs may exceed the recorded allowance.

The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. Accounts are guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) up to $250,000 in 2009 and 2008. At December 31, 2009 and December 31, 2008, the Company had approximately $16,666,103 and $19,671,576, respectively, in excess of FDIC insured limits. The Company has not experienced any losses in such accounts.

Revenue recognition

Dune records oil and gas revenues following the entitlement method of accounting for production in which any excess amount received above Dune’s share is treated as a liability. If less than Dune’s share is received, the underproduction is recorded as an asset. Dune did not have an imbalance position in terms of volumes or values at December 31, 2009 or 2008.

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Cash and cash equivalents

Cash and cash equivalents include cash in banks and highly liquid investments which mature within three months of the date of purchase.

Use of estimates

The preparation of these financial statements in conformity with accounting principles generally accepted in the United States of America 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 amount of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The most critical estimate we make is the engineering estimate of proved oil and gas reserves. This estimate affects the application of the successful efforts method of accounting, the calculation of depreciation, depletion and amortization of oil and gas properties and the estimate of the impairment of our oil and gas properties. It also affects the estimated lives used to determine asset retirement obligations. In addition, the estimates of proved oil and gas reserves are the basis for the related standardized measure of discounted future net cash flows.

Property and equipment

Property and equipment is valued at cost. Depreciation is computed using the straight-line method over estimated useful lives of 3 to 5 years. Additions are capitalized and maintenance and repairs are charged to expense as incurred. Gains and losses on dispositions of equipment are reflected in other income.

Deferred financing costs

In connection with debt financing, Dune paid $6,286,413 in fees for the year ended December 31, 2007. These fees were recorded as deferred financing costs and are being amortized over the life of the loans using the straight-line method which approximates the effective interest method as the principal amounts on the debt financings are due at maturity.

Amortization of deferred financing costs and debt discount for the years ended December 31, 2009 and 2008 amounted to $3,250,872 and $2,961,426, respectively.

Long-lived assets

Long-lived assets including investments to be held and used or disposed of other than by sale are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. When required, impairment losses on assets to be held and used or disposed of other than by sale are recognized based on the fair value of the asset. Long-lived assets to be disposed of by sale are reported at the lower of the asset’s carrying amount or fair value less cost to sell.

Deposit—related party

In 2006, Dune entered into a definitive contract with its largest shareholder, Itera Holdings, B.V. The terms called for the construction of and subsequent long-term contract for a drilling rig for the exclusive use on the Barnett Shale properties. The contract called for a $500,000 deposit which was to be applied to payments due at the end of the contract period. In the second quarter 2008, Dune released the drilling rig and the deposit with Itera Holdings, B.V. was forfeited due to early termination of the contract. Payments totaling $0 and $1,915,469 were made during the years ended December 31, 2009 and 2008, respectively.

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Derivatives

The Company follows the provisions of FASB ASC 815—Derivatives and Hedging. The statement requires the accounting recognition of all derivative instruments as either assets or liabilities at fair value. Under the provisions of the statement, the Company may or may not elect to designate a derivative instrument as a hedge against changes in the fair value of an asset or a liability (a fair value hedge”) or against exposure to variability in expected future cash flows (a “cash flow hedge”).

Effective January 1, 2008, the Company discontinued, prospectively, the designation of its derivatives as cash flow hedges. The net derivative loss related to discontinued cash flow hedges, as of December 31, 2007, continued to be reported in accumulated other comprehensive loss through December 31, 2009 and were charged to loss as the volumes underlying the cash flow hedges were realized.

Stock-based compensation

The Company follows the provisions of FASB ASC 718—Stock Compensation. The statement requires all stock-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values on the date of grant

Income taxes

Dune accounts for income taxes pursuant to FASB ASC 740—Income Taxes, which requires recognition of deferred income tax liabilities and assets for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. The Company provides for deferred taxes on temporary differences between the financial statements and tax basis of assets using the enacted tax rates that are expected to apply to taxable income when the temporary differences are expected to reverse.

In July 2006, the FASB issued FASB ASC 740—Income Taxes effective for years beginning after December 15, 2006. The statement establishes a more-likely-than-not threshold for recognizing the benefits of tax return positions in the financial statements. Also, the statement implements a process for measuring those tax positions which meet the recognition threshold of being ultimately sustained upon examination by the taxing authorities. There are no uncertain tax positions taken by the Company on its tax returns and the adoption of the statement had no material impact to the Company’s consolidated financial statements. The Company files tax returns in the US and states in which it has operations and is subject to taxation. Tax years subsequent to 2006 remain open to examination by U.S. federal and state tax jurisdictions.

Loss per share

Basic earnings per share amounts are calculated based on the weighted average number of shares of common stock outstanding during each period. Diluted earnings per share is based on the weighted average numbers of shares of common stock outstanding for the periods, including dilutive effects of stock options, warrants granted and convertible preferred stock. Dilutive options and warrants that are issued during a period or that expire or are canceled during a period are reflected in the computations for the time they were outstanding during the periods being reported. Since Dune has incurred losses for all periods, the impact of the common stock equivalents would be antidilutive and therefore are not included in the calculation.

Fair value of financial instruments

The Company’s financial instruments consist of cash, receivables, payables and long-term debt. The carrying amount of cash, receivables and payables approximates fair value because of the short-term nature of these items. The carrying amount of long-term debt approximates fair value due to the relationship between the interest rate on long-term debt and the Company’s incremental risk adjusted borrowing rate.

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Impact of recently issued accounting standards

In June 2009, the FASB approved the “FASB Accounting Standards Codification” (the “Codification”) as the single source of authoritative non governmental U.S. GAAP to be launched on July 1, 2009. The Codification does not change current U.S. GAAP but it is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered nonauthoritative. The Codification was effective for interim and annual periods ending after September 15, 2009. The Company adopted the provisions of the Codification during the period ended September 30, 2009 and the adoption did not have a material impact on its consolidated financial position, results of operations or cash flows.

In May 2009, the FASB issued SFAS No. 165, Subsequent Events (ASC 855), to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. FASB ASC 855 is effective for interim and annual reporting periods ending after June 15, 2009. The Company adopted the provisions of FASB ASC 855 for the period ended June 30, 2009. There was no impact on the Company’s operating results, financial position or cash flows.

In December 2008, the SEC issued Release No. 33-8995, Modernization of Oil and Gas Reporting (ASC 2010-3), which amends the oil and gas disclosures for oil and gas producers contained in Regulations S-K and S-X. The goal of Release No. 33-8995 was to provide investors with a more meaningful and comprehensive understanding of oil and gas reserves. Energy companies affected by Release No. 33-8995 are now required to price proved oil and gas reserves using the unweighted arithmetic average of the price on the first day of each month within the 12-month period prior to the end of the reporting period, unless prices are defined by contractual arrangements, excluding escalations based on future conditions. SEC Release No. 33-8995 is effective beginning for financial statements for fiscal years ending on or after December 31, 2009. The impact on the Company’s operating results, financial position and cash flows has been recorded in the financial statements.

NOTE 2—DEBT FINANCING

Wells Fargo Foothill Credit Agreement

On May 15, 2007, Dune entered into a credit agreement among it, each of Dune’s subsidiaries named therein as borrowers, each of Dune’s subsidiaries named therein as guarantors, certain lenders and Wells Fargo Foothill, Inc. (“Wells Fargo”), as arranger and administrative agent (the “WF Agreement”). Subject to the satisfaction of a Borrowing Base formula (based on the proved producing and non-producing reserves of Dune and its operating subsidiaries), numerous conditions precedent and covenants, the WF Agreement provides for a revolving credit commitment of up to $20 million, which may be extended up to $40 million upon request by Dune so long as no Default or Event of Default exists or would exist at time of such request (the “Revolver Commitment”), with a sub-limit of $20 million for issuance of letters of credit. Effective February 29, 2008, Dune requested and received the extension up to $40 million under the Revolver Commitment. The borrowing base was reset to $34,949,080 as of February 2009 and reset back to $40 million in August 2009. Unless earlier payment is required under the WF Agreement, advances under the Revolver Commitment must be paid on or before May 15, 2010. Under the WF Agreement, interest on advances accrues at either Wells Fargo’s Base Rate or the LIBOR rate, at Dune’s option, plus an applicable margin ranging from 0.25% to 2.0% based upon the ratio of outstanding advances and letters of credit usage under the WF Agreement to the Borrowing Base or Revolver Commitment, whichever is less. With respect to letters of credit issued under the WF agreement, fees accrue at a rate equal to the applicable margin for any LIBOR rate advances multiplied by the daily balance of the undrawn amount of all outstanding letters of credit. As of December 31, 2009, standby letters of credit were issued

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

amounting to $8.5 million. During the year ended December 31, 2009, there were new borrowings of $24.0 million which are outstanding under the Revolver Commitment with an interest rate of LIBOR plus 2% as of December 31, 2009.

As security for Dune’s obligations under the WF Agreement, Dune and certain of its operating subsidiaries granted Wells Fargo a security interest in and a first lien on all of Dune’s existing and after-acquired assets including, without limitation, the oil and gas properties and rights that Dune acquired in the Goldking acquisition. In addition, two of the Company’s subsidiaries have each guaranteed the Company’s obligations.

On August 4, 2008, Dune amended the WF Agreement pursuant to which the definitions of “Change of Control” and “Permitted Holders” were modified to provide that a Change of Control occurs when any group or person, other than Permitted Holders, becomes the beneficial owner, directly or indirectly, of 25% or more of Dune’s common stock. This amendment also added James A. Watt and Alan Gaines to the list of Permitted Holders, which already included Itera Holdings B.V. and Natural Gas Partners VII, LP.

On July 8, 2009, Dune signed a second amendment to its credit agreement with Wells Fargo modifying the “Change of Control” definition and thus curing a technical event of default that had previously been waived until July 17, 2009 by the lender. The technical event of default was triggered on May 6, 2009 when the Permitted Holders no longer held 51% or more of our outstanding common stock. The Permitted Holders were defined as Itera Holdings B.V., Natural Gas Partners VII, LP, Alan Gaines and James Watt. In the second quarter of 2009, 21,116 preferred shares were converted into 6.2 million common shares resulting in 27.9 million common shares outstanding at the end of the quarter. The Permitted Holders held approximately 40.3% of the outstanding common stock of the Company at the end of the quarter. The modified definition states in part that a Change in Control occurs if any person or group other than the Permitted Holders becomes a beneficial owner of 15% or more of the outstanding common stock of the Company, that a majority of the members of the Board of Directors do not constitute Continuing Directors or that Frank Smith, the Company’s CFO, or James Watt, the Company’s CEO, cease employment with the Company and a successor acceptable to the lenders is not appointed within 30 days of termination of employment.

On March 23, 2010, the maturity date on the WF Agreement with Wells Fargo was extended until March 31, 2011 through a third amendment to the agreement. In addition, the $10 million minimum liquidity requirement was removed. New minimum monthly cumulative EBITDA and minimum monthly production covenants have been added. The Company is also required to maintain a minimum $80 million of proved developed producing reserves. An annual ceiling was also placed on capital expenditures. The borrowing rate options have been increased to LIBOR plus 5% or Base Rate plus 5% and letter of credit fees are now 3.5%. A minimum floor of 1% has also been placed under the LIBOR rate. The non-use fee under the agreement has been increased to 0.75%. The borrowing base calculation is based solely on 65% of proved developed producing reserves and the hydrocarbon pricing assumptions used are to be the lower of a formula based on the NYMEX strip or the WFF price deck then in effect. Finally, there is a $500,000 closing fee and an early termination fee.

Senior Secured Notes

On May 15, 2007, Dune sold to Jefferies & Company, Inc. $300 million aggregate principal amount of 10 1/2% Senior Secured Notes due 2012 (“Senior Secured Notes”) at a purchase price of $285 million. Net proceeds from the sale of the Senior Secured Notes together with the net proceeds from the sale of Dune’s Senior Redeemable Convertible Preferred Stock were used primarily to acquire all of the issued and outstanding capital stock of Goldking, to discharge outstanding indebtedness and for general working capital.

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

The Senior Secured Notes, bearing interest at the rate of 10 1/2% per annum, were issued under that certain indenture, dated May 15, 2007, among Dune, the guarantors named therein, and The Bank of New York Trust Company NA, as trustee (the “Indenture”). The Indenture contains customary representations and warranties by the Company as well as typical restrictive covenants whereby Dune has agreed, among other things, to limitations to incurrence of additional indebtedness, declaration of dividends, issuance of capital stock, sale of assets and corporate reorganizations.

The Senior Secured Notes are subject to redemption by Dune (i) prior to June 1, 2010, in connection with equity offerings at a repurchase price equal to 110.5% of the aggregate principal amount plus accrued interest for up to 35% of the outstanding principal amount of the Senior Secured Notes, (ii) during the twelve-month period beginning June 1, 2010, at a repurchase price equal to 105.25% of the aggregate principal amount plus accrued interest, and (iii) after June 1, 2011, at a repurchase price equal to 100% of the aggregate principal amount plus accrued interest. Holders of the Senior Secured Notes may put such notes to the Company for repurchase, at a repurchase price of 101% of the principal amount plus accrued interest, upon a change in control as defined in the Indenture.

The Senior Secured Notes are secured by a lien on substantially all of Dune's assets, including without limitation, those oil and gas leasehold interests located in Texas and Louisiana held by Dune’s operating subsidiaries. The Senior Secured Notes are unconditionally guaranteed on a senior secured basis by each of Dune’s existing and future domestic subsidiaries. The collateral securing the Senior Secured Notes is subject to, and made subordinate to, the lien granted to Wells Fargo under the WF Agreement.

The debt discount is being amortized over the life of the notes using the effective interest method. Amortization expense associated with the debt discount amounted to $2,655,660 and $2,362,711 and is included in interest expense in the Consolidated Statements of Operations for the years ended December 31, 2009 and 2008, respectively.

NOTE 3—REDEEMABLE CONVERTIBLE PREFERRED STOCK

During the quarter ended June 30, 2007, Dune sold to Jefferies & Company, Inc. pursuant to the Purchase Agreement dated May 1, 2007, 216,000 shares of its Senior Redeemable Convertible Preferred Stock ("Preferred Stock") for gross proceeds of $216 million less a discount of $12.3 million yielding net proceeds of $203.7 million. As provided in the Certificate of Designations, the Preferred Stock has a liquidation preference of $1,000 per share and originally paid a dividend at a rate of 10% per annum, payable quarterly, at the option of Dune, in additional shares of Preferred Stock, shares of common stock (subject to the satisfaction of certain conditions) or cash. The Preferred Stock was initially convertible into shares of our common stock, based on an initial conversion price of $15.00 per share of the common stock. However, the Certificate of Designations provided a one-time adjustment to the conversion price in the event that the volume weighted average price of the Company’s common stock for the 30 trading days up to and including April 30, 2008 was less than $12.50 per share. The Certificate of Designations also provided that, if the volume weighted average price of the Company’s common stock plus 10% over this 30 day trading period was less than $8.75, then the dividend payable on the Preferred Stock would increase. Because the volume weighted average price of the Company’s common stock was below these thresholds over this 30 day period, effective May 1, 2008, the conversion price of the Preferred Stock was lowered to $8.75 and the dividend rate increased to 12% per annum.

Additionally, in accordance with FASB ASC 470-20-30—Debt with Conversion and Other Options, a beneficial conversion feature was triggered as a result of the one time adjustment to the conversion price on May 1, 2008. The Company attributed a discount of $68,414,051 to the Preferred Stock based upon the

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

difference between the effective conversion price after the one-time adjustment of the shares and the closing price of the Preferred Stock on the date of issue. As the Preferred Stock does not have a stated redemption date, the discount resulting from the beneficial conversion feature was amortized from the date of issuance to the earliest conversion date. Additionally, all unamortized discount remaining at the date of conversion were recognized as a dividend. Therefore, on May 1, 2008, the Company recorded a dividend of $68,414,051 related to the beneficial conversion feature.

The conversion price of the Preferred Stock is subject to adjustment and may be adjusted upon the occurrence of a fundamental change as defined in the Certificate of Designations. In the event a holder of Dune’s Preferred Stock elects to convert such shares prior to June 1, 2010, then such holder shall be entitled to a make whole premium consisting of the present value of all dividends on the Preferred Stock as if paid in cash from the date of conversion through June 10, 2010, computed using a discount rate equal to the reinvestment yield (as defined in the Certificate of Designations). Dune may elect to pay this amount in cash or shares of its common stock. Should the Company elect to make such payment in shares of its common stock, then such share will be valued at a 10% discount to the volume weighted average price of the Company’s common stock for the 10 trading days preceding any such conversion. The equity ownership of holders of Dune’s common stock could be significantly diluted. The Preferred Stock is redeemable at the option of the holder on December 1, 2012 and subject to the terms of any of the Company’s indebtedness or upon a change of control. In the event Dune fails to redeem shares of Preferred Stock “put” to Dune by a holder, then the conversion price shall be lowered and the dividend rate increased. After December 1, 2012, Dune may redeem shares of Preferred Stock. The Company analyzed the adjustment of the conversion right and the make whole premium for derivative accounting under FASB ASC 815—Derivatives and Hedges and determined that it was not applicable to either provision.

The Preferred Stock discount is deemed a Preferred Stock dividend and is being amortized over five years using the effective interest method and is charged to additional paid-in capital as the Company has a deficit balance in retained earnings. Charges to additional paid-in capital for the years ended December 31, 2009 and 2008 amounted to $1,974,115 and $1,763,246, respectively.

During the years ended December 31, 2009 and 2008, holders of 71,547 and 16,441 shares of the Preferred Stock converted their shares into 19,167,799 and 2,651,416 shares of common stock, respectively. This amount includes 10,990,849 and 827,262 shares, respectively that the Company elected to issue to pay make whole premiums. Shares issued to satisfy the make whole premiums were deemed a Preferred Stock dividend for accounting purposes and increased the Preferred Stock dividend by $8,422,953 and $4,544,203, respectively.

During the years ended December 31, 2009 and 2008, Dune paid dividends on the Preferred Stock in the amount of $26,792,000 and $25,328,000, respectively. In lieu of cash, the Company elected to issue 26,792 and 25,328 additional shares of Preferred Stock, respectively.

NOTE 4—REVERSE STOCK SPLIT

On November 30, 2009, the Company’s stockholders approved a 1-for-5 reverse stock split. The reverse stock split was effective at the opening of trading on December 2, 2009. As a result of the reverse stock split, every five shares of the Company that a stockholder owned were converted into one share of the Company, thus reducing the number of outstanding shares of common stock from approximately 185.5 million shares to 37.1 million shares as of the close of business on December 1, 2009. Following the reverse stock split, the Company will continue to have 300 million authorized shares of common stock. Notwithstanding the reverse stock split, each shareholder continued to hold the same percentage of the Company’s outstanding common shares immediately following the reverse stock split as was held immediately prior to the split, except for fractional shares. Fractional shares created as a result of the reverse stock split were rounded up to the nearest whole share.

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

All share and per share amounts have been restated to reflect the 1-for-5 reverse stock split. This reverse stock split resulted in the reduction of 148.4 million issued and outstanding shares of common stock. It was accounted for by the transfer of $148,400 from common stock to additional paid-in capital, which is the amount equal to the par value of the reduced shares affected by the reverse stock split.

NOTE 5—HEDGING ACTIVITIES

In accordance with a requirement of the WF Agreement, Dune and its operating subsidiaries also entered into a Swap Agreement with Wells Fargo. The WF Agreement provides that Dune put in place, on a rolling six month basis, separate swap hedges, as adjusted from time to time as specified therein, with respect to notional volumes of not less than 50% and not more than 80% of the estimated aggregate production from (i) Proved Developed Producing Reserves (as defined in the WF Agreement) and (ii) estimated drilling by Dune and its subsidiaries with respect to each of crude oil and natural gas. These hedging arrangements are summarized as follows:

DUNE ENERGY, INC.

Current Hedge Positions as of December 31, 2009

Crude Oil

 

Instrument

   Beg.
Date
   Ending
Date
   Floor    Ceiling    Fixed    Total Bbls
2010
       Bbl/d        Total
Volumes

Collar

   Jan-10    Jan-10    $ 55.00    $ 81.60       16,000    44    16,000

Collar

   Dec-09    Dec-10    $ 60.00    $ 88.10       312,000    855    312,000
                             
                  328,000    899    328,000
                             

Days

                  365      

Hedged Daily Production (bbl)

   899      

Natural Gas

 

Instrument

   Beg.
Date
   Ending
Date
   Floor    Ceiling    Fixed    Total Mmbtu
2010
       Mmbtu/d        Total
Volumes

Collar

   Jan-10    Jan-10    $ 5.00    $ 6.60       231,000    633    231,000

Collar

   Feb-10    Dec-10    $ 4.50    $ 7.68       2,160,000    5,918    2,160,000
                             
                  2,391,000    6,551    2,391,000
                             

Days

                  365      

Hedged Daily Production (mmbtu)

   6,551      

Dune hedges a portion of forecasted crude oil and natural gas production volumes with derivative instruments. Dune uses various derivative instruments in connection with anticipated crude oil and natural gas sales to minimize the impact of commodity price fluctuations. The instruments include fixed price swaps, put options and costless collars. A collar is a combination of a purchased put option and sold call option. Dune accounts for its production hedge derivative instruments as defined in FASB ASC 815—Derivatives and Hedging.

Effective January 1, 2008, the Company discontinued, prospectively, the designation of its derivatives as cash flow hedges. The net derivative loss related to discontinued cash flow hedges, as of December 31, 2007, continued to be reported in accumulated other comprehensive loss through December 31, 2009 and were charged

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

to loss as the volumes underlying the cash flow hedges were realized. Beginning January 1, 2008, the gain or losses on derivatives are recognized in earnings. For the year ended December 31, 2009, Dune recorded a loss on the derivatives of ($2,780,933), composed of an unrealized loss on changes in mark-to-market valuations of ($9,506,580) and a realized gain on cash settlements of $6,725,647. For the year ended December 31, 2008, Dune recorded a gain on derivatives of $4,071,507, composed of an unrealized gain on changes in mark-to-market of $13,358,724 and a realized loss on cash settlements of ($9,287,217).

NOTE 6—COMMITMENTS AND CONTINGENCIES

The Company, as an owner or lessee and operator of oil and gas properties, is subject to various federal, state and local laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on the lessee under an oil and gas lease for the cost of pollution clean-up resulting from operations and subject the lessee to liability for pollution damages. In some instances, the Company may be directed to suspend or cease operations in the affected area. Dune maintains insurance coverage, which it believes is customary in the industry, although Dune is not fully insured against all environmental risks.

In connection with the acquisition of Goldking, the Company inherited an environmental contingency which after conducting its due diligence and subsequent testing believes is the responsibility of third parties. However, federal and state regulators have determined Dune is the responsible party for clean up of this area. Dune has maintained a passive maintenance of this site since it was first discovered after Hurricane Katrina. Costs to date of approximately $800,000 have been covered by the Company’s insurance minus the standard deductibles. The Company still feels other parties have the primary responsibility for this occurrence but is committed to working with various state and federal authorities on resolution of this issue. At this time no estimate of the final cost of remediation of this site can be determined or if the Company’s insurance will continue to cover clean up costs or if the Company can be successful in proving the other parties should be primarily responsible for the cost of remediation.

The Company has a long-term operating lease agreement for its corporate offices that expires September 30, 2011. Under the terms of the lease agreement, the Company received a build out allowance that is being amortized to expense over the term of the lease. In October 2007, the Company amended its lease agreement to expand the leased office space. The lease term for the additional space also expires on September 30, 2011. Rent expense for the years ended December 31, 2009 and 2008 was $0.8 million and $0.9 million, respectively.

Minimum rentals for each of the five years subsequent to December 31, 2009 are as follows (in thousands):

 

     Amount

2010

   $ 801

2011

     601

2012

     —  

2013

     —  

2014

     —  
      
   $ 1,402
      

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

NOTE 7—RESTRICTED STOCK, STOCK OPTIONS AND WARRANTS

The Company utilizes restricted stock, stock options and warrants to compensate employees, officers, directors and consultants. Total stock-based compensation expense including options, warrants and restricted stock was $4,145,712 and $5,282,671 for the years ended December 31, 2009 and 2008, respectively.

The 2007 Stock Incentive Plan, which was approved by Dune’s stockholders, reserves a total of 1,400,000 shares of common stock for issuance to employees and non-employee directors. The Plan is administered by Dune’s Compensation Committee. On December 17, 2007, pursuant to its 2007 Stock Incentive Plan, the Company issued a total of 248,591 shares of its common stock to its employees and non-employee directors. These shares vest ratably over a three year period with the initial vesting occurring December 17, 2008. During the years ended December 31, 2009 and 2008, 6,245 and 53,470 outstanding shares, respectively, failed to vest and were cancelled.

On March 14, 2008, the Company issued 105,412 shares of common stock related to 3 senior employees of the Company in connection with their 2007 annual bonus. Half of such bonus was paid in cash and the other half was paid in shares of restricted common stock equal to 125% of the cash portion and vested on the one year anniversary of the grant date.

At the end of each quarter of 2009 and 2008, the Company issued shares of common stock in lieu of cash for fees earned by 3 non-employee directors of the Company. These individuals made a one-time annual election at the beginning of each fiscal year to receive restricted common stock in lieu of cash for services rendered. The restricted common stock was equal to 125% of the fees to be paid and will vest on the one year anniversary of the grant date. Total issuances during the year ended December 31, 2009 and 2008 amounted to 407,702 and 73,068 shares, respectively.

On August 1, 2008, pursuant to its 2007 Stock Incentive Plan, the Company issued a total of 622,700 shares of its common stock to its employees and non-employee directors. These shares vest ratably over a three year period with the initial vesting occurring August 1, 2009. During the years ended December 31, 2009 and 2008, 17,985 and 36,840 shares, respectively, were cancelled due to termination of certain employees.

During the year ended December 31, 2008, option holders exercised 17,000 options on a cashless basis for 11,893 shares of common stock. This transaction resulted in an increase in common stock of $12 and a reduction in paid-in capital of $12. Dune received no cash consideration in this transaction. Additionally, options to purchase 5,000 and 17,000 shares of common stock expired during the years ended December 31, 2009 and 2008, respectively.

On October 1, 2009, the Company entered into new three year employment agreements with James A. Watt, President and CEO, and Frank T. Smith, Jr., Senior Vice President and CFO. The Company also entered into restrictive stock agreements with these individuals pursuant to which an aggregate of 450,000 shares of Dune’s common stock were issued subject to certain vesting requirements. These agreements were entered into after careful consideration by the Company’s Compensation Committee and approved by the Board of Directors.

On December 31, 2009, pursuant to its 2007 Stock Incentive Plan, the Company issued a total of 527,000 shares of its common stock to its employees, officers and non-employee directors. These shares vest ratably over a three year period with the initial vesting occurring December 31, 2010. Additionally, the Company issued a total of 46,780 shares of its common stock to employees as a condition of their employment. These shares vest at various dates over a three year period.

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

A summary of stock option transactions follows:

 

     Options     Weighted
Average
Price
 

Outstanding as of December 31, 2007

   590,000        8.65   

Granted during 2008

   —          —     

Cancelled or expired

   (17,000     (5.30

Exercised

   (17,000     (2.70
              

Outstanding as of December 31, 2008

   556,000        10.50   

Granted during 2009

   —          —     

Cancelled or expired

   (5,000     (4.25

Exercised

   —          —     
              

Outstanding as of December 31, 2009

   551,000      $ 10.56   
              

Options outstanding and exercisable at December 31, 2009 are as follows:

 

Exercise Price

   Number of
Shares
   Remaining
Life
   Intrinsic Value
(In-the-money)
Options

6.25

   50,000    0.2 years      —  

7.50

   10,000    1.7 years      —  

9.35

   100,000    2.3 years      —  

9.70

   100,000    2.1 years      —  

11.75

   60,000    0.8 years      —  

12.20

   225,000    0.4 years      —  

12.70

   6,000    0.7 years      —  
              
   551,000       $ —  
              

A summary of stock warrant transactions follows:

 

     Warrants    Weighted
Average
Price

Outstanding as of December 31, 2007

   356,500      11.20

Granted during 2008

   —        —  

Cancelled or expired

   —        —  

Exercised

   —        —  
           

Outstanding as of December 31, 2008

   356,500      11.20

Granted during 2009

   —        —  

Cancelled or expired

   —        —  

Exercised

   —        —  
           

Outstanding as of December 31, 2009

   356,500    $ 11.20
           

Warrants outstanding and their relative exercise price at December 31, 2009 are as follows:

 

Exercise Price

   Number of
Shares
   Remaining
Life
   Intrinsic Value
(In-the-money)
Warrants

6.75

   111,635    5.8 years    $ —  

9.25

   64,865    0.8 years      —  

13.25

   180,000    1.1 years      —  
              
   356,500       $ —  
              

 

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DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

NOTE 8—INCOME TAXES

Dune operates through its various subsidiaries in the United States (“U.S.”); accordingly, federal and state income taxes have been provided based upon the tax laws and rates of the U.S. as they apply to Dune’s current ownership structure.

Dune’s effective tax rate for continuing operations for the twelve months ended December 31, 2009 and 2008 was approximately 0% and 15.9%, respectively. The decrease in the tax rate is due primarily to the impairment of assets and the establishment of a valuation allowance, as further described below.

Prior to 2007, the Company’s taxes were subject to a full valuation allowance. During 2007, the Company acquired the stock of Goldking and was required to step-up the book basis of its oil and gas properties while using carryover cost basis for tax purposes. As a result, the Company has significant deferred tax liabilities in excess of its deferred tax assets. At that time, management determined that a valuation allowance was not necessary as the realization of its acquired deferred tax assets was more likely than not.

During the twelve months ended December 31, 2009 and 2008, the Company incurred a significant impairment loss of its oil and gas properties due to the steep decline in global energy prices over that same time period. As a result, the Company is in a position of cumulative reporting losses for the current and preceding reporting periods. The volatility of energy prices and uncertainty of when energy prices may rebound is not readily determinable by our management. At this date, this general fact pattern does not allow us to project sufficient sources of future taxable income to offset our tax loss carry forwards and net deferred tax assets in the U.S. for both federal and state taxes. Under the current circumstances, it is management’s opinion that the realization of these tax attributes does not reach the “more likely than not criteria” under FASB ASC 740—Income Taxes. Accordingly, the Company has established a valuation allowance of $46,894,646 and $20,808,320 at December 31, 2009 and 2008, respectfully against its U.S. net deferred tax assets relating to continuing operations. At December 31, 2009 and 2008, the Company had $0 and 5,211,864, respectfully of valuation allowance relating to U.S. net deferred tax assets from discontinued operations. Additionally, at December 31, 2008, the Company had $1,298,212 of deferred tax asset relating to other comprehensive income.

The income tax provision differs from the amount of income tax determined by applying the Federal Income Tax Rate to pre-tax income from continuing operations for the years ended December 31, 2009 and 2008 due to the following:

 

     Year ended December 31,  
           2009                 2008        
     (in thousands)  

Computed “expected” tax expense (benefit)

   $ (20,696   $ (45,232

Non-deductible expenses

     3        6   

State taxes, net of benefit

     —          (37

Accrual adjustment

     (182     4,162   

Other

     1,299        (213

Valuation allowance

     19,576        20,808   
                

Income tax expense (benefit)

   $ —        $ (20,506
                

Deferred tax assets at December 31, 2009 and 2008 are comprised primarily of net operating loss carry forwards and book impairment from write downs of assets. Deferred tax liabilities consist primarily of the difference between book and tax basis depreciation, depletion and amortization (DD&A). Book basis in excess of tax basis for oil and gas properties and equipment primarily results from differing methodologies for recording

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

property costs and depreciation, depletion and amortization under United States generally accepted accounting principles and income tax reporting. Additionally, upon the acquisition of the stock of Goldking, deferred tax liabilities have resulted for the difference in fair market value of the oil and gas properties relative to their historical tax basis.

Following is a summary of deferred tax assets and liabilities:

 

     Year ended
December 31,
 
     2009     2008  
     (in thousands)  

Current deferred tax assets:

    

State taxes

   $ —        $ 95   

Unrealized gains/losses

     —          257   

Accrued compensation

     —          601   

Loss on sale of discontinued operations

     —          14,095   

Derivative instruments

     —          1,298   
                

Total current deferred tax assets

     —          16,346   
                

Noncurrent deferred tax assets:

    

Oil and gas property and equipment (Book DD&A)

     52,501        40,127   

Asset retirement obligation

     1,585        1,793   

Book impairment of assets

     61,136        60,130   

Share-based compensation

     5,956        4,505   

Loss carry forwards

     113,105        89,567   

Other oil and gas property related

     2,532        1,961   

Deferred state tax benefit

     28        —     

Unrealized gain/losses

     50        —     

Other

     32        171   
                

Total noncurrent deferred tax assets

     236,925        198,254   
                

Total deferred tax assets

     236,925        214,600   
                

Current deferred tax liabilities

     —          —     
                

Noncurrent deferred tax liabilities:

    

Property and equipment (Tax DD&A)

     45,620        36,740   

Deferred tax on acquisition

     72,309        72,309   

Deferred state tax obligation

     —          67   

Unrealized gains/losses

     —          3,534   

Oil and gas exploration and development operations

     70,070        66,258   

Loss on discontinued operations

     —          6,149   

Asset retirement obligation

     2,032        2,032   

Other

     —          193   
                

Total noncurrent deferred tax liabilities

     190,031        187,282   
                

Total deferred tax liabilities

     190,031        187,282   
                

Net deferred tax assets

     46,894        27,318   

Valuation allowance

     (46,894     (27,318
                

Net deferred income tax asset (liabilities)

   $ —        $ —     
                

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

At December 31, 2009, the Company has U.S. tax loss carry forwards of approximately $305.8 million which will expire in various amounts beginning in 2020 through 2029.

The Company has determined that as a result of the acquisition of all the outstanding stock of Goldking, a change of control pursuant to Section 382 of the Internal Revenue Code of 1986 occurred at the Goldking level. As a result, the Company will be limited to utilizing approximately $13.5 million of Goldking’s U.S. net operating losses (“NOL’s”) to offset taxable income generated by the Company during the tax year ended December 31, 2009 and expects similar dollar limits in future years until the acquired U.S. NOL’s are either completely exhausted or expire unutilized.

NOTE 9—ASSET RETIREMENT OBLIGATION

Changes in the Company’s asset retirement obligations were as follows:

 

     Year Ended December 31,  
     2009     2008  

Asset retirement obligations, beginning of period

   15,658,519      $ 8,765,802   

Liabilities related to property sales

   —          (212,076

Revisions in estimated liabilities

   1,256,446        7,402,701   

Abandonment costs

   (594,476     (1,208,920

Accretion expense

   1,643,503        911,012   
              

Asset retirement obligations, end of period

   17,963,992      $ 15,658,519   
              

The Company maintains an escrow agreement that has been established for the purpose of assuring maintenance and administration of a performance bond which secures certain plugging and abandonment obligations assumed by the Company in the acquisition of oil and gas properties from EnerVest. At December 31, 2009 and 2008, the amount of the escrow account totaled $2,252,352 and $2,250,868, respectively and shown as other assets.

NOTE 10—DISCONTINUED OPERATIONS

In June, 2008 Dune signed a Purchase and Sale Agreement to sell its Barnett Shale Properties located in Denton and Wise Counties, Texas for $41.5 million, subject to adjustments. The disposition of the Barnett Shale Properties allowed the Company to focus on substantially higher rates of return generated by its Gulf Coast fields, the majority of which were acquired in 2007. The effective date of the sale was May 1, 2008 with two closings occurring on August 29, 2008 and September 4, 2008. One final set of properties closed on December 19, 2008.

In conjunction with the sale of these assets, the Company recognized a loss of $43,895,525 in 2008 to write down the related carrying amounts to their fair value plus the cost to sell.

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Pursuant to accounting rules for discontinuing operations, Dune has classified 2008 and prior reporting periods to present the activity related to the Barnett Shale Properties as a discontinued operation. Discontinued operations for the year ended December 31, 2008 are summarized as follows:

 

     For the Year Ended
December 31, 2008
 
  

Revenues

   $ 12,232,592   
        

Costs and expenses:

  

Lease operating expense and production taxes

     4,928,040   

Depletion, depreciation and amortization

     5,224,532   

Impairment on asset

     43,895,525   
        

Total operating expense

     54,048,097   
        

Income (loss) from discontinued operations before income taxes

     (41,815,505

Provision for income taxes

     9,423,563   
        

Loss on discontinued operations

   $ (32,391,942
        

Production:

  

Oil (bbl)

     5,820   

Gas (mcf)

     1,380,527   

Total (mcfe)

     1,415,447   

NOTE 11—FAIR VALUE MEASUREMENTS

Dune adopted FASB ASC 820-10-05—Fair Value Measurements and Disclosures effective January 1, 2008 for financial assets and liabilities measured on a recurring basis. The statement applies to all financial assets and financial liabilities that are being measured and reported on a fair value basis. As defined in the statement, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The statement requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements. It requires fair value measurements be classified and disclosed in one of the following categories:

 

Level 1 Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. We consider active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

Level 2 Quoted prices in markets that are not active or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that we value using observable market data. Substantially all of these inputs are observable in the marketplace throughout the full term of the derivative instrument, can be derived from observable data or supported by observable levels at which transactions are executed in the marketplace. Instruments in this category include non-exchange traded derivatives such as over-the-counter commodity price swaps, investments and interest rate swaps.

 

Level 3

Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e. supported by little or no market activity). Our valuation models are primarily industry-standard models that consider various inputs including: (a) quoted forward prices for commodities, (b) time value, (c) volatility factors and (d) current market and contractual prices for the underlying instruments, as well as other relevant

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

 

economic measures. Level 3 instruments primarily include derivative instruments, such as basic swaps, commodity price collars and floors, as well as investments. Although we utilize third party broker quotes to assess the reasonableness of our prices and valuation techniques, we do not have sufficient corroborating market evidence to support classifying these assets and liabilities as Level 2.

As required by FASB ASC 820-10-05, financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels. The following table summarizes the valuation of our investments and financial instruments by FASB ASC 820-10-05 pricing levels as of December 31, 2009:

 

     Fair Value Measurements
at December 31, 2009 Using
 
     Level 1    Level 2     Level 3    Total  

Oil and gas derivative assets

   $ —      $ —        $ —      $ —     

Oil and gas derivative liabilities

     —        (1,596,545     —        (1,596,545
                              

Total

   $ —      $ (1,596,545   $ —      $ (1,596,545
                              

NOTE 12—SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED)

There are numerous uncertainties inherent in estimating quantities of proved crude oil and natural gas reserves. Crude oil and natural gas reserve engineering is a subjective process of estimating underground accumulations of crude oil and natural gas that cannot be precisely measured. The accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment.

The Company retained Degolyer and MacNaughton, independent third-party reserve engineers, to perform an independent evaluation of proved, possible and probable reserves as of December 31, 2009. Results of drilling, testing and production subsequent to the date of the estimates may justify revision of such estimates. Accordingly, reserve estimates are often different from the quantities of crude oil and natural gas that are ultimately recovered. All of the Company’s reserves are located in the United States.

Reserves

Total reserves are classified by degree of proof as proved, probable, or possible. These classifications are in accordance with the reserves definitions of Rules 4-10(a) (1)-(32) of Regulation S-X of the SEC. Reserves are judged to be economically producible in future years from known reservoirs under existing economic and operating conditions and assuming continuation of current regulatory practices using conventional production methods and equipment. A description of reserve classifications are as follows:

Proved oil and gas reserves—Proved oil and gas reserves are those quantities of oil and gas which by analysis of geoscience and engineering data can be estimated with reasonable certainty to be economically producible—from a given date forward, from known reservoirs and under existing economic conditions, operating methods and government regulation—prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation. The project to extract the hydrocarbons must have commenced or the operator must be reasonably certain that it will commence the project within a reasonable time.

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Probable reserves—Probable reserves are those additional reserves that are less certain to be recovered than proved reserves but which, together with proved reserves, are as likely as not to be recovered. When deterministic methods are used, it is as likely as not that actual remaining quantities recovered will exceed the sum of estimated proved plus probable reserves. When probabilistic methods are used, there should be at least a 50% probability that the actual quantities recovered will equal or exceed the proved plus probable reserves estimates.

Possible reserves—Possible reserves are those additional reserves that are less certain to be recovered than probable reserves. When deterministic methods are used, the total quantities ultimately recovered from a project have a low probability of exceeding proved plus probable plus possible reserves. When probabilistic methods are used, there should be at least a 10% probability that the total quantities ultimately recovered will equal or exceed the proved plus probable plus possible reserves estimates.

The following reserve schedule was developed by the Company’s reserve engineers and sets forth the changes in estimated quantities for total reserves of the Company during the year ended December 31, 2009 and proved reserves for the year ending December 31, 2008:

 

     Year Ended December 31,  
     2009     2008  

TOTAL RESERVES AS OF:

   Oil
(Mbbls)
    Gas
(Mmcf)
    Total
Mmcfe
    Oil
(Mbbls)
    Gas
(Mmcf)
    Total
Mmcfe
 

Proved reserves, beginning of period

   8,199      83,807      133,001      9,631      117,564      175,350   

Revisions of previous estimates

   (394   (18,941   (21,305   (873   (5,741   (10,979

Extensions and discoveries

   455      2,779      5,509      409      11,027      13,481   

Production

   (724   (5,177   (9,521   (890   (7,441   (12,781

Sale of minerals in place

   (349   (113   (2,207   (78   (31,602   (32,070
                                    

Total proved reserves

   7,187      62,355      105,477      8,199      83,807      133,001   
                        

Total probable reserves

   425      4,041      6,591      N/A      N/A      N/A   

Total possible reserves

   44      6,779      7,043      N/A      N/A      N/A   
                        

Total reserves

   7,656      73,175      119,111      N/A      N/A      N/A   
                        

Revisions of previous estimates consist of:

 

     2009     2008  
      Oil
(Mbbls)
    Gas
(Mmcf)
    Total
(Mmcfe)
    Oil
(Mbbls)
    Gas
(Mmcf)
    Total
(Mmcfe)
 

Price changes

   (30   (297   (477   (279   (1,871   (3,545

Performance changes

   (364   (18,644   (20,828   (594   (3,870   (7,434
                                    
   (394   (18,941   (21,305   (873   (5,741   (10,979
                                    

Significant reserve changes were noted in certain categories and are explained below:

 

   

Revisions of previous estimates:

2009—There were two major components of the downward revisions of 21.3 Bcfe in reserves. First, the Chocolate Bayou field experienced an 8.3 Bcfe negative revision due to unexpected water breakthrough on the Wieting #30. Second, the North Broussard field declined 10.6 Bcfe due to revisions in PUD’s from 3D seismic interpretation. The remaining 2.4 Bcfe of negative revisions occurred across several fields consisting of positive and negative revisions on individual wells.

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

   

Sale of minerals in place:

2008—The 32.1 Bcfe reduction of reserves was due to the sale of the Newark East field.

Costs incurred in Oil and Gas Activities

Costs incurred in connection with the Company’s crude oil and natural gas acquisition, exploration and development activities for each of the years are shown below:

 

     Year Ended December 31,
         2009            2008    
     (in thousands)

Unproved property costs

   $ 477    $ 1,571

Exploration costs

     —        115

Development costs (excluding Barnett Shale for 2008)

     13,543      51,064

ARO Costs

     594      1,209
             

Total consolidated operations

   $ 14,614    $ 53,959
             

Asset retirement obligation (non-cash)

   $ 1,256    $ 7,403
             

Aggregate Capitalized Costs

Aggregate capitalized costs relating to the Company’s crude oil and natural gas producing activities, including asset retirement costs and related accumulated depreciation, depletion and amortization are as follows:

 

     Year Ended December 31,  
     2009     2008  
     (in thousands)  

Proved oil and gas properties

   $ 593,662      $ 578,075   

Accumulated DD&A

     (260,549     (222,877
                

Net capitalized costs

   $ 333,113      $ 355,198   
                

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Standardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves

The following information is based on the Company’s best estimate of the required data for the Standardized Measure of Discounted Future Net Cash Flows as of December 31, 2009 and 2008 in accordance with FASB ASC 932—Disclosures about Oil and Gas Producing Activities which requires the use of a 10% discount rate. This information is not the fair market value, nor does it represent the expected present value of future cash flows of the Company’s proved oil and gas reserves.

 

     Year Ended December 31,  
     2009     2008  
     (in thousands)  

Future cash inflows

   $ 675,053      $ 839,990   

Future production costs (1)

     238,961        238,300   

Future development costs

     100,112        134,933   

Future income tax expense

     —          15,195   
                

Future net cash flows

     335,980        451,562   

10% annual discount for estimated timing of cash flows

     (123,679     (167,926
                

Standardized measure of discounted future net cash flows at the end of the year

   $ 212,301      $ 283,636   
                

 

(1) Production costs include oil and gas operations expense, production ad valorem taxes, transportation costs and general and administrative expense supporting the Company’s oil and gas operations.

Future cash inflows are computed by applying year-end prices, adjusted for location and quality differentials on a property-by-property basis, to year-end quantities of proved reserves, except in those instances where fixed and determinable price changes are provided by contractual arrangements at year-end. The discounted future cash flow estimates do not include the effects of the Company’s derivative instruments. See the following table for average prices:

 

     December 31,
     2009    2008

Average crude oil price (per Bbl)

   $ 58.05    $ 40.41

Average natural gas price (per Mcf)

   $ 4.14    $ 6.07

Future production and development costs, which include dismantlement and restoration expense, are computed by estimating the expenditures to be incurred in developing and producing the Company’s proved crude oil and natural gas reserves at the end of the year, based on the year-end costs, and assuming continuation of existing economic conditions.

Future development costs include $34.3 million, $13.1 million and $2.6 million – that the Company expects to spend in 2010, 2011 and 2012, respectively, to develop proved non-producing and proved undeveloped reserves.

Future income tax expenses are computed by applying the appropriate year-end statutory tax rates to the estimated future pretax net cash flows relating to the Company’s proved crude oil and natural gas reserves, less the tax basis of the properties involved. The future income tax expenses give effect to tax credits and allowances, but do not reflect the impact of general and administrative costs and exploration expenses of ongoing operations relating to the Company’s proved crude oil and natural gas reserves.

 

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Table of Contents

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

 

Sources of Changes in Discounted Future Net Cash Flows

Principal changes in the aggregate standardized measure of discounted future net cash flows attributable to the Company’s proved crude oil and natural gas reserves, as required by FASB ASC 932-235, at year end are set forth in the table below:

 

     Year Ended December 31,  
     2009     2008  

Standardized measure of discounted future net cash flows at the beginning of the year

   $ 283,636      $ 637,151   

Extensions, discoveries and improved recovery

     14,391        38,304   

Revisions of previous quantity estimates

     (55,660     (31,212

Net change in timing

     —          —     

Changes in estimated future development costs

     12,350        (2,223

Purchases of minerals in place

     —          —     

Sale of minerals in place

     (3,719     (65,594

Net changes in prices and production costs

     (38,807     (336,765

Accretion of discount

     13,902        28,447   

Sales of oil and gas produced, net of production costs

     (32,991     (109,797

Development costs incurred during the period

     9,653        43,370   

Net change in income taxes

     9,546        81,955   
                

Standardized measure of discounted future net cash flows at the end of the year

   $ 212,301      $ 283,636   
                

NOTE 13—SUBSEQUENT EVENT

Pursuant to FASB ASC 855, we have evaluated all events or transactions that occurred from January 1, 2010 through March 25, 2010, the date of issuance of the audited consolidated financial statements. During this period we did not have any material recognizable subsequent events, except as disclosed below:

Subsequent to December 31, 2009, holders of 2,448 shares of Preferred Stock converted their shares into approximately 704,979 shares of common stock.

 

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Table of Contents

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.

 

    DUNE ENERGY, INC.
Date: March 25, 2010     By:   /s/    JAMES A. WATT        
      James A. Watt
      Chief Executive Officer

In accordance with the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in the capacities indicated below on March 25, 2010.

 

Signature and Title
/S/    JAMES A. WATT        
James A. Watt
Chief Executive Officer and Director
/S/    FRANK T. SMITH, JR.        
Frank T. Smith, Jr.
Chief Financial Officer
/S/    ALAN GAINES        
Alan Gaines
Chairman of the Board
/S/    RICHARD M. COHEN        
Richard M. Cohen
Director and Secretary
/S/    STEVEN BARRENECHEA        
Steven Barrenechea
Director
/S/    ALAN D. BELL        
Alan D. Bell
Director
/S/    WILLIAM E. GREENWOOD        
William E. Greenwood
Director
/S/    STEVEN M. SISSELMAN        
Steven M. Sisselman