Dune Energy 10-Q 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
For the quarterly period ended September 30, 2009
For the transition period from to
Commission file number 001-32497
DUNE ENERGY, INC.
(Exact name of small business as specified in its charter)
Two Shell Plaza, 777 Walker Street, Suite 2300, Houston, Texas 77002
(Address of principal executive offices)
(Issuers telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 to submit and post such files). Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer x
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes ¨ No x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date: 174,684,632 shares of Common Stock, $.001 per share, as of October 23, 2009.
DUNE ENERGY, INC.
CONSOLIDATED BALANCE SHEETS
See notes to consolidated financial statements.
DUNE ENERGY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See notes to consolidated financial statements.
DUNE ENERGY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See notes to consolidated financial statements.
DUNE ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1ACCOUNTING POLICIES AND BASIS OF PRESENTATION
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 production primarily to domestic pipelines and refineries. Its operations are presently focused in the states of Texas and Louisiana.
Dune prepared these financial statements according to the instructions for Form 10-Q. Therefore, the financial statements do not include all disclosures required by generally accepted accounting principles. However, Dune has recorded all transactions and adjustments necessary to fairly present the financial statements included in this Form 10-Q. The adjustments made are normal and recurring. The following notes describe only the material changes in accounting policies, account details or financial statement notes during the first nine months of 2009. Therefore, please read these financial statements and notes to the financial statements together with the audited financial statements and notes thereto in our 2008 Form 10-K. The income statement for the nine months ended September 30, 2009 cannot necessarily be used to project results for the full year. Dune has made certain reclassifications to prior year financial statements in order to conform to current year presentations.
During the second quarter of 2008, the Company sold its Barnett Shale Properties located in Denton and Wise Counties, Texas. In accordance with FASB ASC 360-10-5Impairment or Disposal of Long-lived Assets, the results of operations of this divestiture have been reflected as discontinued operations. See Note 7 for additional information regarding discontinued operations.
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, will continue to be reported in accumulated other comprehensive loss until such time that they are charged to income or loss as the volumes underlying the cash flow hedges are realized.
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 will expire or are canceled during a period are reflected in the computations for the time they were outstanding during the periods being reported. For the three months ended September 30, 2008, the Companys stock options and warrants were excluded from the computation of diluted earnings per share because the exercise price was greater than the average market price of the common shares yielding an antidilutive effect. However, the Companys redeemable convertible preferred stock of 231,071 shares yielded additional diluted weighted average common shares of 133,294,608 for a total of 226,949,884 diluted weighted average common shares outstanding for the third quarter of 2008. Since Dune incurred losses for all other periods, the impact of the common stock equivalents would be antidilutive and therefore are not included in the calculation.
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 is effective for interim and annual periods ending after September 15, 2009. The Codification is effective for the Company this quarter and the adoption did not have a material impact on its consolidated financial position, results of operations or cash flows.
NOTE 2DEBT FINANCING
Wells Fargo Foothill Credit Agreement (Short-term debt)
On May 15, 2007, Dune entered into a credit agreement among it, each of Dunes subsidiaries named therein as borrowers, each of Dunes 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 4, 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 Fargos Base Rate or the LIBOR rate, at Dunes 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 September 30, 2009, standby letters of credit were issued amounting to $8.8 million. During the second quarter of 2009, there were new borrowings of $17.0 million which are outstanding under the Revolver Commitment with an interest rate of LIBOR plus 2% as of September 30, 2009.
As security for Dunes 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 Dunes 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 Companys subsidiaries have each guaranteed the Companys 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 Dunes common stock. This amendment also added James A. Watt and Alan Gaines to the list of Permitted Holders, which already included Itera Holdings BV 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 an Event of Default that had previously been waived until July 17, 2009 by the lender. The 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 BV, Natural Gas Partners VII, LP, Alan Gaines and James Watt. In the second quarter, 21,116 preferred shares were converted into 31.2 million common shares resulting in 139.5 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 Companys CFO, or James Watt, the Companys CEO, cease employment with the Company and a successor acceptable to the lenders is not appointed within 30 days of termination of employment.
Senior Secured Notes (Long-term debt)
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 Dunes 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.
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 Dunes assets, including without limitation, those oil and gas leasehold interests located in Texas and Louisiana held by Dunes operating subsidiaries. The Senior Secured Notes are unconditionally guaranteed on a senior secured basis by each of Dunes 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 $673,327 and $1,962,368 and is included in interest expense in the Consolidated Statements of Operations for the three and nine months ended September 30, 2009, respectively.
NOTE 3REDEEMABLE 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 $3.00 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 Companys common stock for the 30 trading days up to and including April 30, 2008 was less than $2.50 per share. The Certificate of Designations also provided that, if the volume weighted average price of the Companys common stock plus 10% over this 30 day trading period was less than $1.75, then the dividend payable on the Preferred Stock would increase. Because the volume weighted average price of the Companys 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 $1.75 and the dividend rate increased to 12% per annum.
Additionally, in accordance with FASB ASC 470-20-30Debt 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 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 should be amortized from the date of issuance to the earliest conversion date. Additionally, all unamortized discount remaining at the date of conversion is 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 pursuant to customary anti-dilution provisions and may also be adjusted upon the occurrence of a fundamental change as defined in the Certificate of Designations. In the event a holder of Dunes 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 Companys common stock for the 10 trading days preceding any such conversion. The equity ownership of holders of Dunes 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 Companys 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 815Derivatives 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 three and nine months ended September 30, 2009 amounted to $500,298 and $1,459,487, respectively.
During the nine months ended September 30, 2009, holders of 52,753 shares of the Preferred Stock converted their shares into 72,090,320 shares of common stock. This amount includes 41,944,718 shares 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 $7,279,764.
During the nine months ended September 30, 2009 and 2008, Dune paid dividends on the Preferred Stock in the amount of $20,651,000 and $18,393,000, respectively. In lieu of cash, the Company elected to issue 20,651 and 18,393 additional shares of Preferred Stock, respectively.
NOTE 4HEDGING ACTIVITIES
In accordance with a requirement of the WF Agreement, Dune and its operating subsidiaries also entered into a Swap Agreement (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.
As part of the Swap Agreement, Wells Fargo assumed the rights, liabilities, duties and obligations of substantially all Goldkings counterparties under prior crude oil and natural gas hedging arrangements between Goldking and various other banking institutions. These hedging arrangements are summarized as follows:
DUNE ENERGY, INC.
Current Hedge Positions as of September 30, 2009
Crude Oil Trade Details
Natural Gas Trade Details
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 815Derivatives 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, will continue to be reported in accumulated other comprehensive loss until such time that they are charged to income or loss as the volumes underlying the cash flow hedges are realized. Beginning January 1, 2008, the gain or losses on derivatives are being recognized in earnings. For the three and nine months ended September 30, 2009, Dune recorded a loss on the derivatives of ($1,137,767) and ($1,261,322), composed of an unrealized loss on changes in mark-to-market valuations of ($2,637,416) and ($7,418,357) and a realized gain on cash settlements of $1,499,649 and $6,157,035. At September 30, 2009, there was an unrealized net loss on the prior year open hedge contracts of ($936,523).
NOTE 5RESTRICTED 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 $800,769 and $3,313,135 for the three and nine months ended September 30, 2009, respectively, and $1,472,220 and $3,916,090 for the three and nine months ended September 30, 2008, respectively.
The 2007 Stock Incentive Plan, which was approved by Dunes stockholders, reserves a total of 7,000,000 shares of common stock for issuance to employees and non-employee directors. The Plan is administered by Dunes Compensation Committee. On December 17, 2007, pursuant to its 2007 Stock Incentive Plan, the Company issued a total of 1,242,946 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. Through September 30, 2009, 298,585 shares were cancelled due to termination of certain employees.
On August 1, 2008, pursuant to its 2007 Stock Incentive Plan, the Company issued a total of 3,113,500 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. Through September 30, 2009, 272,334 shares were cancelled due to termination of certain employees.
On March 31, 2009, the Company issued 319,710 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 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.
On June 30, 2009, the Company issued 303,570 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 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.
On September 30, 2009, the Company issued 331,895 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 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.
NOTE 6INCOME TAXES
For the year ended December 31, 2008, the Company incurred a significant impairment loss of our oil and gas properties due to the steep decline in global energy prices over that same time period. As a result, Dune 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 carryforwards and net deferred tax assets in the U.S. Under these current circumstances, it is managements opinion that the realization of these tax attributes does not reach the more likely than not criteria under FASB ASC 740Income Taxes. As a result, the Companys taxes through September 30, 2009 are subject to a full valuation allowance.
NOTE 7DISCONTINUED 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.
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 three and nine months ended September 30, 2009 and 2008 are summarized as follows:
NOTE 8FAIR VALUE MEASUREMENTS
Dune adopted, without any impact on its consolidated financial statements, FASB ASC 820-10-05Fair Value Measurements and Disclosures, effective January 1, 2008 for financial assets and liabilities measured on a recurring basis. The following table summarizes the valuation of our investments and financial instruments by FASB ASC 820-10-05 pricing levels as of September 30, 2009:
NOTE 9COMMITMENTS 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 a third party. However, federal and state regulations 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. Cost to date of approximately $800,000 has been covered by the Companys insurance minus the standard deductibles. The
Company still feels another party has the primary responsibility for this occurrence but is committed to working with the 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 Companys insurance will continue to cover the clean up costs or if the Company can be successful in proving the other party should be primarily responsible for the cost of remediation.
NOTE 10SUBSEQUENT EVENT
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 2,250,000 shares of Dunes common stock were issued subject to certain vesting requirements. These agreements were entered into after careful consideration by the Companys Compensation Committee and approved by the Board of Directors.
Subsequent to September 30, 2009 through October 23, 2009, holders of 3,359 shares of Preferred Stock converted their shares into approximately 3,379,459 shares of common stock. The October 23, 2009 date was used due to the complexity in calculating the total number of stock conversions given the requirements of the make whole provision.
The following discussion will assist in the understanding of our financial position and results of operations. The information below should be read in conjunction with the consolidated financial statements, the related notes to consolidated financial statements and our 2008 Form 10-K. 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 revenue, 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.
Our primary focus will continue to be the development and exploration efforts in our Gulf Coast properties. We believe that our acreage position will allow us to grow organically through low risk drilling in the near term. This position continues to present attractive opportunities to expand our reserve base through field extensions and high risk/high reward exploratory drilling opportunities. In addition, we will constantly review, rationalize and high-grade our properties in order to optimize our existing asset base.
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.
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 reserve base coupled with significant exploitation and exploration potential.
Liquidity and Capital Resources
During the first nine months of 2009 compared to the first nine months of 2008, net cash flow provided by continuing operations decreased by $18.7 million to ($1.6) million. This decline was primarily attributable to lower average oil and gas prices for the nine months ended September 30, 2009 of $53.66/bbl and $4.25/mcf compared to $113.99/bbl and $10.45/mcf for the nine months ended September 30, 2008.
Our current assets were $31.1 million on September 30, 2009. Cash on hand comprised approximately $19.9 million of this amount. This compared to $15.5 million at the end of the calendar year 2008 and $33.4 million at the end of the third calendar quarter of 2008. Accounts payable has been reduced from $21.7 million at year end 2008 to $9.3 million at September 30, 2009 and $4.4 million at September 30, 2008.
The financial statements continue to reflect our ongoing drilling and facilities upgrade program which involved almost $61.8 million of capital investment in 2008 and another $9.0 million during the first nine months of 2009. Expenditures in the discontinued Barnett Shale operations accounted for $9.0 million in 2008. We now expect to spend approximately $9.3 million during the final three months of 2009 on continuing development and exploitation of our asset base. However, this anticipated capital may be reduced or increased depending on available cash flow. Because we operate the majority of our properties, we can control the timing of expenditures.
During the third quarter of 2009, our revolving credit facility availability was increased to $40 million from $34.95 million. This will provide ample liquidity to meet our expected working capital needs for the remainder of 2009. As of September 30, 2009, borrowings under this credit facility totaled $17.0 million for working capital purposes. 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 52% of this production hedged over the next six months, 53% over the next twelve months and 54% through December 31, 2010. Over 54% of oil production and approximately 55% of gas production is hedged over this same 15 month time frame. Effectively all of the hedging instruments are collars. For the remainder of 2009, the lowest floor for oil is $55 and the highest ceiling is $88.10. The lowest floor for natural gas is $4.50 and the highest is $8.77. For essentially all 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 June 1, 2009 and is due semi-annually thereafter. The principal on the Senior Secured Notes is not due until 2012.
Shares of our Preferred Stock are not redeemable until the later of December 1, 2012 or the repayment in full of all senior secured debt or upon a change in control. Dividends are payable quarterly 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, sales of non-core properties and access to capital markets. The strength of our current cash position and availability under our revolver put us in a position to meet our financial obligations and ongoing capital programs in the current commodity price environment.
As mentioned above, capital spending for the remainder of the fiscal year will be targeted at approximately $9.3 million. The exact amount will depend upon individual well performance results, cash flow and, where applicable, partner negotiations on the timing of drilling operations. In addition, we expect to offer participations in our drilling program to industry partners over this time frame, thus potentially reducing our capital requirements.
Results of Operations
Year-over-year production decreased from 8,629 Mmcfe for the first nine months of 2008 to 6,850 Mmcfe for the same nine month period of 2009. This decrease was caused by normal reservoir declines and a very limited capital reinvestment program.
The following table reflects the decrease in oil and gas sales revenue from continuing operations due to the changes in prices and volumes:
We recorded a net loss available to common shareholders for the three months ended September 30, 2009 of ($20.9 million) or ($0.14) basic and diluted loss per share compared to net income available to common shareholders of $7.5 million or $0.08 basic and $0.06 diluted income per share for the same quarter of 2008. For the nine months ended September 30, 2009, we recorded a net loss available to common shareholders of ($68.7 million) or ($0.55) basic and diluted loss per share compared to a net loss available to common shareholders of ($114.7 million) or ($1.32) basic and diluted loss per share for the same period of 2008. The increase of $28.4 million for the quarter is a result of loss on derivative liabilities compared to a gain for the quarter ended September 30, 2008. The reduction of $46.0 million for the nine month period was largely influenced by two factors. First, the impact on preferred stock dividends of the beneficial conversion feature attributable to the one-time adjustment to the conversion price of the Preferred Stock which resulted in additional preferred stock dividends of $68.4 million. Second, there was a loss on discontinued operations of ($24.7 million) in 2008.
Although the loss from continued operations before income taxes increased during the three month period ($25.9 million) and the nine month period ($36.9 million), significant reductions in spending were necessary to offset approximately 64% reduction in revenues. This is reflected in the significant reductions in lease operating expense, DD&A and G&A expense.
Revenue from continuing operations for the current quarter ended September 30, 2009 decreased $21.1 million from the comparable 2008 quarter to $15.2 million. This was largely the result of reduced commodity prices which reflected a drop of $7.62/mcfe or 52%.
Revenue from continuing operations for the current nine months ended September 30, 2009 decreased $80.1 million from the nine months ended September 30, 2008 to $44.4 million. This was largely the result of reduced commodity prices which reflected a drop of $7.95/mcfe or 55%.
Lease operating expense and production taxes
Lease operating expense and production taxes from continuing operations for the current quarter ended September 30, 2009 decreased $3.0 million from the comparable 2008 quarter to $7.6 million. This decrease from $4.28/mcfe during the third quarter of 2008 to $3.54/mcfe for the same three month period of 2009 reflects Dunes efforts to reduce operating costs and the lower production costs associated with reduced revenues.
Lease operating expense and production taxes from continuing operations for the nine months ended September 30, 2009 decreased $11.3 million from the comparable 2008 period to $22.6 million. This decrease was composed of a reduction in operating costs of $2.6 million, production costs of $5.5 million, and workover expense of $4.2 million, slightly offset by increased transportation costs of $1.0 million. This translated into a reduction from $3.92/mcfe for the first nine months of 2008 to $3.30/mcfe for the same period of 2009.
Accretion of asset retirement obligation
Accretion expense for asset retirement obligations increased by $0.2 million for the quarter ended September 30, 2009 compared to the comparable period in 2008. Similarly, accretion expense for the nine month period ended September 30, 2009 reflected a $0.8 million increase from the comparable period of 2008. This increase is the result of reevaluating abandonment costs at the year end.
Depletion, depreciation and amortization (DD&A)
For the quarter ended September 30, 2009, the Company recorded DD&A expense of $5.5 million ($2.58/mcfe) compared to $12.2 million ($4.95/mcfe) for the quarter ended September 30, 2008 representing a
reduction of $6.7 million ($2.37/mcfe). Additionally, for the nine months ended September 30, 2009, the Company recorded DD&A expense of $21.2 million ($3.09/mcfe) compared to $40.5 million ($4.70/mcfe) for the nine months ended September 30, 2008 representing a reduction of $19.3 million ($1.61/mcfe).
These reductions reflect the impact of the 2008 impairment on the Companys oil and gas properties of $125.7 million which directly impact the depletable base for DD&A purposes. This reduction in the depletable base along with a reduction in production during the periods resulted in a 48%-55% reduction in DD&A expense.
General and administrative expense (G&A expense)
G&A expense for the current quarter ended 2009 decreased $1.8 million from the comparable 2008 quarter to $3.1 million. This decrease resulted principally from a reduction in personnel expense of $1.0 million and share-based compensation of $0.7 million.
For the nine months ended September 30, 2008 and 2009, G&A expense decreased $3.3 million to $11.7 million. This decrease consists of a decrease in personnel expense of $2.3 million and share-based compensation of $0.6 million.
On a unit of production basis, G&A fell from $1.97/mcfe for the third quarter of 2008 to $1.43/mcfe for the same period of 2009 and from $1.74/mcfe for the nine months of 2008 to $1.71/mcfe for the same period of 2009.
For the three and nine months ended September 30, 2009, there were no exploration costs compared to $0.01 million for the three and $0.1 million for the nine months ended September 30, 2008.
Other income (expense)
Interest income for the quarter ended September 30, 2009 was $0.2 million less than the comparable 2008 quarter. Additionally, interest income decreased $0.4 million for the current nine months ended September 30, 2009 compared to the 2008 comparable period. This was the result of using our cash balances to support working capital and contribute to the capital program.
Interest expense for the quarter ended September 30, 2009 amounted to $8.8 million compared to $8.9 million in the comparable quarter ended 2008.
Interest expense for the nine months ended September 30, 2009 amounted to $26.2 million compared to $26.4 million in the comparable period of 2008.
Gain (loss) on derivative liabilities
For the current quarter ended September 30, 2009, the Company incurred a loss on derivatives of $1.1 million composed of an unrealized loss of $2.6 million due to the change in the mark-to-market valuation and a realized gain of $1.5 million for cash settlements. This loss compared to a $23.7 million gain for the 2008 comparable quarter.
For the nine months ended September 30, 2009, the Company incurred a loss on derivatives of $1.3 million composed of an unrealized loss of $7.4 million due to the change in the mark-to-market valuation and a realized gain of $6.1 million for cash settlements. This loss compared to a $13.1 million loss for the 2008 comparable period.
Income tax benefit (expense)
As a result of the acquisition of all the outstanding stock of Goldking in 2007, the Company had significant deferred tax liabilities in excess of its deferred tax assets. Management determined that a valuation allowance was not necessary and the realization of its deferred tax assets were more likely than not. Consequently, Dune recorded an income tax expense of $9.0 million in the quarter ended September 30, 2008 and an income tax benefit of $1.7 million in the nine months ended September 30, 2008.
At December 31, 2008, the Company had fully utilized its deferred tax liability associated with the Goldking acquisition and has 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 the first three quarters of 2009.
Associated with the sale of the Barnett Shale Properties, the Company has reflected all activity for these assets as discontinued operations. For the three and nine months ended September 30, 2008, the Company reported a loss from discontinued operations of ($0.3 million) and ($24.7 million), respectively.
Net income (loss) available to common shareholders
For the third quarter ended September 30, 2009, net income available to common shareholders decreased ($28.4 million) from the comparable quarter of 2008. This decrease reflects the impact of a ($21.1 million) reduction in revenues, a ($2.9 million) increase in Preferred Stock dividends, and a ($24.8 million) reduction in the gain on derivative liabilities. This was partially offset by a $11.3 million reduction in operating expenses and a $9.0 million reduction in income tax expense.
For the nine months ended September 30, 2009, net income available to common shareholders increased $46.1 million from the comparable period of 2008. This increase reflects the impact of a ($80.1 million) reduction in revenues and a ($1.7 million) reduction in income tax benefit. This was offset by a $33.4 million reduction in operating expenses, a $11.8 million decrease in the loss on derivative liabilities, a $24.7 million reduction in the loss on discontinued operations and a $58.2 million reduction in Preferred Stock dividends.
Our primary exposure to market risk is the commodity pricing available to our oil and natural gas production. Realized commodity prices received for such production are primarily driven by the prevailing worldwide price for oil and spot prices applicable to natural gas. To mitigate some of this risk, we engage periodically in certain hedging activities, including price swaps, costless collars and, occasionally, put options, in order to establish some price floor protection (see Note 4 to financial statements). We also have some exposure to market risk consisting of changes in interest rates on borrowings under our credit agreement with our senior lender. An increase in interest rates would adversely affect our operating results and the cash flow available after debt service to fund operations. We manage exposure to interest rate fluctuations by optimizing the use of fixed and variable debt.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based closely on the definition of disclosure controls and procedures in Rule 13a-15(e). In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
At the end of the period covered by this quarterly report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures. Based upon the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2009, our disclosure controls and procedures are effective.
During the quarter ended September 30, 2009, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
During the quarter ended September 30, 2009, we issued an aggregate of 331,895 shares of common stock to three non-employee directors in lieu of cash for services rendered during our third quarter. These three individuals made a one-time election at the beginning of the 2009 fiscal year to receive shares of restricted common stock in lieu of cash for services rendered. The shares granted to these three individuals vest on September 30, 2010, provided the recipient is still a director on that date.
Pursuant to the requirements 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.
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