Dune Energy (DUNRQ) 10-Q 2008 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2008

¨ 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 small business as specified in its charter)

Delaware	95-4737507
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification Number)

Two Shell Plaza, 777 Walker Street, Suite 2300, Houston, Texas 77002

(Address of principal executive offices)

(713) 229-6300

(Issuer’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 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  x                Non-Accelerated Filer  ¨

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 issuer’s classes of common stock, as of the latest practicable date: 94,777,560 shares of Common Stock, $.001 per share, as of October 31, 2008.

PART 1

FINANCIAL INFORMATION

Item 1. Financial Statements.

Dune Energy, Inc.

Consolidated Balance Sheets

(Unaudited)

	September 30, 2008			December 31, 2007
ASSETS
Current assets:
Cash	$	33,425,784		$	16,771,726
Accounts receivable, net of reserve for doubtful accounts of $396,629 and $396,629		17,575,225			31,474,433
Assets held for sale		1,210,810			76,492,464
Prepayments and other current assets		2,407,903			7,602,405
Total current assets		54,619,722			132,341,028
Oil and gas properties, using successful efforts accounting—proved		552,170,727			518,036,814
Less accumulated depreciation, depletion, amortization and impairment		(81,255,198	)		(41,529,191	)
Net oil and gas properties		470,915,529			476,507,623
Property and equipment, net of accumulated depreciation of $1,162,235 and $416,324		2,256,507			2,632,400
Deferred financing costs, net of accumulated amortization of $821,265 and $371,353		1,770,460			2,220,372
Other assets		2,250,275			2,229,723
Deposit—related party		—			500,000
		6,277,242			7,582,495
TOTAL ASSETS	$	531,812,493		$	616,431,146
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	4,377,886		$	56,648,904
Accrued liabilities		37,708,677			30,948,966
Derivative liabilities		10,320,499			4,131,078
Other current liabilities		2,310,720			3,953,021
Total current liabilities		54,717,782			95,681,969
Long-term debt, net of discount of $11,010,028 and $12,755,924		288,989,972			287,244,076
Deferred taxes		12,996,439			29,929,436
Other long-term liabilities		11,126,693			16,762,462
Total liabilities		367,830,886			429,617,943
Commitments and contingencies		—			—
Redeemable convertible preferred stock, net of discount of $9,639,584 and $10,943,172, liquidation preference of $1,000 per share, 750,000 shares designated, 231,071 and 227,918 shares issued and outstanding		221,431,416			216,974,828
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, 94,777,560 and 79,258,174 shares issued and outstanding		94,778			79,258
Additional paid-in capital		55,112,172			56,079,580
Accumulated other comprehensive loss		(2,656,971	)		(3,831,228	)
Accumulated deficit		(109,999,788	)		(82,489,235	)
Total stockholders’ deficit		(57,449,809	)		(30,161,625	)
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT	$	531,812,493		$	616,431,146

See notes to consolidated financial statements.

2

Dune Energy, Inc.

Consolidated Statements of Operations

(Unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2008			2007			2008			2007
Revenues	$	36,304,350		$	23,965,137		$	124,498,520		$	35,773,776
Operating expenses:
Lease operating expense and production taxes		10,542,897			10,898,946			33,857,045			17,134,243
Exploration expense		14,950			42,452			114,950			383,391
Accretion of asset retirement obligation		165,697			786,806			483,463			1,053,336
Depletion, depreciation and amortization		12,187,417			11,342,760			40,514,691			17,093,089
General and administrative expense		4,852,145			5,842,565			15,022,657			15,401,921
Bad debt expense		—			—			—			396,629
Loss on impairment of investment		—			—			—			3,192,250
Total operating expense		27,763,106			28,913,529			89,992,806			54,654,859
Operating income (loss)		8,541,244			(4,948,392	)		34,505,714			(18,881,083	)
Other income (expense):
Interest income		227,924			724,273			425,693			1,252,349
Interest expense		(8,856,723	)		(6,644,717	)		(26,381,409	)		(23,175,268	)
Gain (loss) on derivative liabilities		23,655,374			5,735,368			(13,065,754	)		3,811,986
Total other income (expense)		15,026,575			(185,076	)		(39,021,470	)		(18,110,933	)
Income (loss) from continuing operations before income taxes		23,567,819			(5,133,468	)		(4,515,756	)		(36,992,016	)
Income tax benefit (expense)		(8,979,340	)		—			1,720,503			—
Income (loss) from continuing operations		14,588,479			(5,133,468	)		(2,795,253	)		(36,992,016	)
Discontinued operations:
Income (loss) from operations of Barnett Shale Properties (including impairment in 2008 of $41,893,165)		(478,054	)		216,554			(39,927,805	)		1,332,747
Income tax benefit		182,139			—			15,212,494			—
Income (loss) on discontinued operations		(295,915	)		216,554			(24,715,311	)		1,332,747
Net income (loss)		14,292,564			(4,916,914	)		(27,510,564	)		(35,659,269	)
Preferred stock dividend		(6,791,034	)		(8,211,980	)		(87,218,441	)		(8,211,980	)
Net income (loss) available to common shareholders	$	7,501,530		$	(13,128,894	)	$	(114,729,005	)	$	(43,871,249	)
Net income (loss) per share:
Basic from continuing operations	$	0.08		$	(0.17	)	$	(1.04	)	$	(0.65	)
Basic from discontinued operations		—			—			(0.28	)		0.02
Total basic	$	0.08		$	(0.17	)	$	(1.32	)	$	(0.63	)
Net income (loss) per share:
Diluted from continuing operations	$	0.06		$	(0.17	)	$	(1.04	)	$	(0.65	)
Diluted from discontinued operations		—			—			(0.28	)		0.02
Total diluted	$	0.06		$	(0.17	)	$	(1.32	)	$	(0.63	)
Weighted average shares outstanding:
Basic		93,655,276			77,941,874			86,744,254			70,089,815
Diluted		226,949,884			77,941,874			86,744,254			70,089,815

See notes to consolidated financial statements.

3

Dune Energy, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

	Nine months ended September 30,
	2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(27,510,564	)	$	(35,659,269	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Loss (income) from discontinued operations		24,715,311			(1,332,747	)
Depletion, depreciation and amortization		40,514,691			17,093,089
Amortization of deferred financing costs and debt discount		2,195,808			7,052,196
Stock-based compensation		3,916,090			7,134,872
Loss on impairment of investment		—			3,192,250
Exploration expense		114,950			383,391
Bad debt expense		—			396,629
Deferred tax benefit		(1,720,503	)		—
Accretion of asset retirement obligation		483,463			1,053,336
Loss on derivative liabilities		3,338,345			(2,861,454	)
Changes in:
Accounts receivable		13,482,188			1,218,865
Prepayments and other assets		4,095,335			902,493
Payments made to settle asset retirement obligations		(1,038,825	)		—
Accounts payable and accrued liabilities		(45,455,821	)		28,652,227
NET CASH PROVIDED BY CONTINUING OPERATIONS		17,130,468			27,225,878
NET CASH PROVIDED BY DISCONTINUED OPERATIONS		7,189,892			5,145,587
NET CASH PROVIDED BY OPERATING ACTIVITIES		24,320,360			32,371,465
CASH FLOWS FROM INVESTING ACTIVITIES
Acquisition of Goldking, net of $1,155,720 cash received		—			(327,344,280	)
Investment in proved and unproved properties		(34,248,862	)		(58,653,675	)
Purchase of furniture and fixtures		(412,793	)		(692,735	)
Proceeds from sale of assets		38,122,619			—
Increase in other assets		(20,552	)		(41,598	)
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES—CONTINUED OPERATIONS		3,440,412			(386,732,288	)
NET CASH USED IN INVESTING ACTIVITIES—DISCONTINUED OPERATIONS		(9,053,023	)		(34,527,163	)
NET CASH USED IN INVESTING ACTIVITIES		(5,612,611	)		(421,259,451	)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from convertible preferred stock		—			203,677,812
Proceeds from long-term debt		28,100,000			356,909,062
Proceeds from sale of common stock		—			18,000,000
Payments on preferred stock issuance costs		—			(1,053,156	)
Payments on long-term debt issuance costs		—			(6,286,414	)
Payments on long-term debt		(28,100,000	)		(104,771,263	)
Payments on long-term debt—related parties		—			(27,423,932	)
Payments on short-term debt		(2,053,691	)		(868,864	)
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		(2,053,691	)		438,183,245
NET CHANGE IN CASH BALANCE		16,654,058			49,295,259
Cash balance at beginning of period		16,771,726			3,574,705
Cash balance at end of period	$	33,425,784		$	52,869,964
SUPPLEMENTAL DISCLOSURES
Interest paid	$	16,310,601		$	3,360,886
Income taxes paid		—			—
NON-CASH DISCLOSURES
Common stock issued for conversion of debt	$	—		$	2,692,250
Common stock issued for purchase of Goldking		—			18,000,000
Common stock issued for conversion of preferred stock		15,240,000			—
Common stock issued for cashless exercise of options		59			3
Redeemable convertible preferred stock dividends		87,218,441			8,211,980
Accretion of discount on preferred stock		1,303,589			—

See notes to consolidated financial statements.

4

DUNE ENERGY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 — ACCOUNTING 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.

On May 15, 2007, Dune completed the purchase of all of the issued and outstanding shares of common stock of Goldking Energy Corporation (“Goldking”) pursuant to a Stock Purchase and Sale Agreement dated effective April 13, 2007 with Goldking Energy Holdings, L.P. The accompanying consolidated financial statements include all activity for Goldking Energy Corporation from May 15, 2007 (date of acquisition). See Note 4 for discussion of the Goldking acquisition.

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 2008. Therefore, please read these financial statements and notes to the financial statements together with the audited financial statements and notes thereto in our 2007 Form 10-K. The income statement for the nine months ended September 30, 2008 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.

Successful efforts method of accounting

With the acquisition of Goldking, Dune elected to switch from full cost to successful efforts method of accounting for its investments in oil and gas properties, effective January 1, 2007. The successful efforts method is the preferable method of accounting for oil and gas properties. 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. The Company believes that, in light of the Goldking acquisition and its increased level of development and exploration activities, the successful efforts method of accounting provides a better matching of expenses to the period in which oil and gas production is realized. As a result, the Company believes that the change in accounting method was appropriate.

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 Dune to calculate depreciation, depletion and amortization expense on individual properties rather than one pool of costs. In addition, under the successful efforts method, Dune assesses its properties individually for impairment compared to one pool of costs under the full cost method.

The change in accounting method constituted a “Change in Accounting Principle,” requiring that all prior period financial statements be adjusted to reflect the results and balances that would have been reported had Dune been following the successful efforts method of accounting from its inception. The cumulative effect of the change in accounting method as of December 31, 2006 was to increase the balance of the Company’s net investment in oil and gas properties and retained earnings at those dates by $4,805,966. The change in accounting method resulted in an increase (decrease) in the net loss of ($917,602) and $65,531 for the three and nine months ended September 30, 2007, respectively. There was no material impact on earnings per share (basic and diluted) for these respective periods. The change in method of accounting had no impact on cash or working capital.

5

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 producing 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 $11,818,774 and $10,774,493 for the three months ended September 30, 2008 and 2007, and $39,433,293 and $16,371,080 for the nine months ended September 30, 2008 and 2007, respectively.

Discontinued operations

During the second quarter of 2008, the Company signed a Purchase and Sale Agreement to sell its Barnett Shale Properties located in Denton and Wise Counties, Texas. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-lived Assets,” the results of operations of this divestiture have been reflected as discontinued operations. See Note 9 for additional information regarding discontinued operations.

Derivatives

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.

Impact of recently issued accounting standards

In September 2006, the FASB issued SFAS No. 157 “Fair Value Measurement.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. See Note 10 for the impact on Dune’s consolidated financial statements for the nine months ended September 30, 2008.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 is effective as of the beginning of an entity’s first fiscal year beginning after November 15, 2007 with early adoption allowed. The adoption of SFAS No. 159 did not have a material impact on the Company’s financial position or results of operations.

In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities” (FSP EITF 03-6-1). FSP EITF 03-6-1 addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in computing earnings per share under the two-class method described in SFAS No. 128, “Earnings Per Share.” FSP EITF 03-6-1 is effective for the Company as of January 1, 2009 and in accordance with its requirements it will be applied retrospectively. The Company does not expect the adoption of FSP EITF 03-6-1 to have a material impact on its consolidated financial statements.

6

Earnings per Share

The Company follows SFAS No. 128, Earnings per Share, for computing and presenting earnings per share which requires, among other things, dual presentation of basic and diluted income (loss) per share on the face of the statement of operations. Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common shares were exercised or converted into common shares or resulted in the issuance of common shares that then shared in the earnings of the entity. For the three months ended September 30, 2008, the Company’s 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 Company’s 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.

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. 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 September 30, 2008, standby letters of credit were issued amounting to $8.79 million. There were no loans outstanding under the Revolver Commitment as of September 30, 2008.

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.

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.

7

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 $599,052 and $1,745,896 and is included in interest expense in the consolidated statements of operations for the three and nine months ended September 30, 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 $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 Company’s 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 Company’s 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 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 $1.75 and the dividend rate increased to 12% per annum.

Additionally, in accordance with Emerging Issues Task Force (“EITF”) No. 00-27, “Application of Issue No. 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, to Certain Convertible Instruments,” 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

8

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 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 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 SFAS 133 and EITF No. 00-19 and determined that it was not applicable to either provision.

The Preferred Stock discount is being amortized over five years using the effective interest method and is charged to paid-in capital as the Company has a deficit balance in retained earnings. Charges to paid-in capital for the three and nine months ended September 30, 2008 amounted to $446,857 and $1,303,588, respectively.

During the nine months ended September 30, 2008, holders of 15,240 shares of the Preferred Stock converted their shares into 11,700,567 shares of common stock. This amount includes 3,266,083 shares to satisfy the underlying make whole provision associated with the converted Preferred Stock.

During the nine months ended September 30, 2008, Dune paid dividends on the Preferred Stock in the amount of $18,393,000. In lieu of cash, the Company elected to issue 18,393 additional shares of Preferred Stock.

NOTE 4 — ACQUISITION

On May 15, 2007, Dune completed its purchase of all of the issued and outstanding shares of common stock of Goldking pursuant to that certain stock purchase and sale agreement dated effective April 13, 2007 with Goldking Energy Holdings, L.P.

The purchase price was $328,500,000, paid as follows: (a) $310,500,000 in cash and (b) 10,055,866 shares of Dune’s common stock, representing shares having a value of $18,000,000 based on the closing price of Dune’s common stock on April 13, 2007. The cash portion of the purchase price was financed from the net proceeds of the $516,000,000 offering of Senior Secured Notes and Preferred Stock. The Company incurred additional costs of $1,802,414 related to the acquisition.

The acquisition has been accounted for in accordance with the provisions of SFAS No. 141, “Business Combinations.” The total purchase price was allocated to the net tangible assets based on the estimated fair values. The preliminary allocation of the purchase price was based upon valuation data as of May 15, 2007 and

9

updated at December 31, 2007 to provide for a deferred tax liability related to differences in book and tax basis of oil and natural gas properties acquired. The final allocation of the purchase price is as follows:

Assets:
Cash and equivalents	$	1,155,720
Accounts receivable		17,681,299
Other current assets		3,954,840
Oil and natural gas properties		391,438,250
Other assets		4,739,050
Liabilities:
Accounts payable and accrued liabilities		(32,192,616	)
Current maturities of long-term debt		(981,390	)
Other liabilities		(10,270,669	)
Deferred tax liability		(45,222,070	)
	$	330,302,414

The following unaudited pro forma information assumes the acquisition of Goldking Energy Corporation occurred as of the beginning of each period. The pro forma results are not necessarily indicative of what actually would have occurred had the acquisition been in effect for the period presented.

	As Reported			Pro-Forma
Nine months ended September 30, 2007:
Revenues	$	35,773,776		$	64,050,630
Net loss available to common shareholders		(43,871,249	)		(60,833,255	)
Loss per share		(0.63	)		(0.81	)

NOTE 5 — HEDGING 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.

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As part of the Swap Agreement, Wells Fargo assumed the rights, liabilities, duties and obligations of substantially all Goldking’s 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, 2008

Crude Oil Trade Details

Instr.	Beg. Date	Ending Date	Floor		Ceiling		Fixed		Total Bbls 2008	Bbl/d	Total Bbls 2009	Bbl/d	Total Volumes
Collar	Jan-08	Dec-08	$	65.00	$	89.10			24,000	261		—	24,000
Collar	Jan-09	Dec-09	$	55.00	$	60.95				—	264,000	723	264,000
Puts	Jan-08	Dec-08	$	65.00					30,000	326		—	30,000
Swap	Jan-08	Dec-08					$	69.60	30,000	326		—	30,000
Swap/Cap	Jan-07	Dec-09			$	72.50	$	60.00	4,200	46	10,080	28	14,280
									88,200	959	274,080	751	362,280
								Days	92		365
		Hedged Daily Production							959		751

Natural Gas Trade Details

Instr.	Beg. Date	Ending Date	Floor		Ceiling		Fixed		Total Mmbtu 2008	Mmbtu/d	Total Mmbtu 2009	Mmbtu/d	Total Volumes
Collar	Jan-08	Dec-08	$	8.00	$	10.50			120,000	1,304		—	120,000
Collar	Jan-09	Dec-09	$	7.25	$	8.77				—	1,680,000	4,603	1,680,000
Puts	Jan-08	Dec-08	$	8.50					180,000	1,957		—	180,000
Swap	Jan-08	Dec-08					$	8.14	240,000	2,609		—	240,000
3-Way Collar	Jan-07	Dec-09	$	6.62					165,000	1,793	492,000	1,348	657,000
					$	13.35	$	6.62	123,750	1,345	369,000	1,011	492,750
									828,750	9,008	2,541,000	6,962	3,369,750
								Days	92		365
		Hedged Daily Production							9,008		6,962

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 Statement of Financial Accounting Standards No. 133,“Accounting for Derivative Instruments and Hedging Activities”, as amended by SFAS No. 138, “Accounting for Certain Derivative Instruments and Certain Hedging Activities” and SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (herein referred as “SFAS 133”). Under SFAS 133, all derivatives are recorded at fair value on the balance sheet.

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,

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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 months ended September 30, 2008, Dune recorded a gain on the derivatives of $23,655,374, composed of an unrealized gain on changes in mark-to-market valuations of $28,107,101 and a realized loss on cash settlements of ($4,451,727). For the nine months ended September 30, 2008, Dune recorded a loss on the derivatives of ($13,065,754), composed of an unrealized loss on changes in mark-to-market valuations of ($3,338,348) and a realized loss on cash settlements of ($9,727,406). At September 30, 2008, there was an unrealized net loss on the prior year open hedge contracts of ($2,656,971).

NOTE 6 — COMMITMENTS AND CONTINGENCIES

Dune and its subsidiaries are involved in litigation in the ordinary course of business. These proceedings are subject to the uncertainties inherent in any litigation. Dune is defending itself vigorously in all such matters and does not believe that the ultimate disposition of such proceedings will have a material adverse effect on its consolidated financial position, results of operations or liquidity.

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. The matter is being reviewed by the federal regulators to deem the cause of the responsibility. While the final outcome can not be currently determined and any costs to remediate the area may not be covered by insurance, the Company does not believe it will have a material impact on its results of operations or financial position.

The Company is not aware of any other environmental claims existing as of September 30, 2008 which have not been provided for, covered by insurance or otherwise have a material impact on its financial position or results of operations. There can be no assurance, however, that current regulatory requirements will not change, or past non-compliance with environmental laws will not be discovered on the Company’s properties.

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 $1,472,220 and $3,916,090 for the three and nine months ended September 30, 2008, respectively, and $978,441 and $7,134,872 for the three and nine months ended September 30, 2007, respectively.

The 2007 Stock Incentive Plan, which was approved by Dune’s 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 Dune’s 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.

During the nine months ended September 30, 2008, option holders exercised 85,000 options on a cashless basis for 59,465 shares of common stock. This transaction resulted in an increase in common stock of $59 and a reduction in paid-in capital of $59. Dune received no cash consideration in this transaction.

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On March 14, 2008, the Company issued 527,058 shares of common stock 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 which vests on the one year anniversary of the grant date.

On March 31, 2008, the Company issued 20,484 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 the 2008 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.

On June 30, 2008, the Company issued 39,448 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 the 2008 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.

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.

On September 30, 2008, the Company issued 58,864 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 election at the beginning of the 2008 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.

A summary of stock option transactions follow:

	Options		Weighted Average Price
Outstanding as of December 31, 2007	2,950,000		$	1.73
Granted during 2008	—			—
Cancelled or expired	(15,000	)		(1.77	)
Exercised	(85,000	)		(0.54	)
Outstanding as of September 30, 2008	2,850,000		$	1.78

Options outstanding and exercisable at September 30, 2008 are as follows:

Exercise Price	Number of Shares	Remaining life	Intrinsic Value (In-the-money) Options
0.54	20,000	0.1 years	$	4,000
0.85	25,000	1.3 years		—
0.90	50,000	0.3 years		—
1.25	250,000	1.4 years		—
1.50	50,000	2.9 years		—
1.87	500,000	3.6 years		—
1.94	500,000	3.3 years		—
2.35	300,000	2.1 years		—
2.44	1,125,000	1.7 years		—
2.54	30,000	1.9 years		—
	2,850,000		$	4,000

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Warrants outstanding at September 30, 2008 are as follows:

Exercise Price	Number of Shares	Remaining Life	Intrinsic Value (In-the-money) Warrants
1.35	558,172	7.0 years	$	—
1.85	324,324	2.0 years		—
2.65	900,000	2.3 years		—
	1 ,782,496		$	—

NOTE 8 — INCOME TAXES

Dune operates through its various subsidiaries in the United States (“U.S.); accordingly, 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 accounts for income taxes pursuant to Statement of Financial Accounting Standard No. 109,Accounting for 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 Dune’s financial statements or tax returns. Dune 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.

Dune adopted FASB interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of SFAS No. 109, (“FIN 48”), effective January 1, 2007. The adoption of FIN 48 did not have a material effect on Dune’s consolidated financial statements. FIN 48 prescribes a minimum recognition threshold and measurement methodology that a tax position taken or expected to be taken in a tax return is required to meet before being recognized in the financial statements. It also provides guidance for derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. Dune recognizes interest and penalties related to unrecognized tax benefits within the provision for income taxes on continuing tax benefits as of the date of adoption. There are no unrecognized tax benefits that if recognized would affect the tax rate. There was no interest or penalties recognized as of the date of adoption or for the nine months ended September 30, 2008.

The Company files tax returns in the U.S. and states in which it has operations and is subject to taxation. Tax years subsequent to 2004 remain open to examination by taxing authorities.

Dune’s effective tax rate for the nine months ended September 30, 2008 and 2007 was approximately 38.1%, due to state taxes, and 0%, due to the cumulative net operating loss with a full valuation allowance, respectively.

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 historical carryover cost for tax purposes (See Note 4). As a result, the Company has significant deferred tax liabilities in excess of its deferred tax assets. Management has determined that a valuation allowance is no longer necessary as the realization of its deferred tax assets is more likely than not.

NOTE 9 — 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 adjustment. The disposition of the Barnett Shale Properties allows the Company to focus on substantially higher rates of return generated by its Gulf Coast fields, the majority of which were acquired last year. The effective date of the sale was May 1, 2008 with two closings occurring on August 29, 2008 and September 4, 2008 in the amount of $38.1 million. One final set of properties

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are still awaiting a close which is anticipated to occur on or before December 15, 2008 in the amount of $1.2 million. The difference between the $41.5 million and the proceeds of $39.3 million reflects post-closing adjustments.

In conjunction with the pending sale of these assets, the Company recognized a loss of $41,893,165 in 2008 to write down the related carrying amounts to their fair value plus the cost to sell. The assets of the discontinued operations, consisting of net oil and gas properties, are presented separately under the caption “Assets held for sale” in the accompanying Balance Sheets at September 30, 2008 and December 31, 2007.

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, 2008 and 2007 are summarized as follows:

	Three months ended September 30,					Nine months ended September 30,
	2008			2007		2008			2007
Revenues	$	3,302,552		$	2,771,381	$	12,097,272		$	7,792,986
Costs and expenses:
Lease operating expense		1,230,955			826,807		4,148,477			1,398,543
Production costs		167,298			311,863		758,903			1,248,856
Depletion, depreciation and amortization		1,398,562			1,416,157		5,224,532			3,812,840
Impairment on asset		983,791			—		41,893,165			—
Total operating expense		3,780,606			2,554,827		52,025,077			6,460,239
Income (loss) from discontinued operations before income taxes		(478,054	)		216,554		(39,927,805	)		1,332,747
Provision for income taxes		182,139			—		15,212,494			—
Income (loss) on discontinued operations	$	(295,915	)	$	216,554	$	(24,715,311	)	$	1,332,747
Production:
Oil (bbl)		1,349			3,814		5,820			9,275
Gas (mcf)		362,839			473,772		1,345,551			1,302,536
Total (mcfe)		370,933			496,656		1,380,471			1,358,186

NOTE 10 — FAIR VALUE MEASUREMENTS

Dune adopted SFAS No. 157, “Fair Value Measurements,” effective January 1, 2008 for financial assets and liabilities measured on a recurring basis. SFAS No. 157 applies to all financial assets and financial liabilities that are being measured and reported on a fair value basis. In February 2008, the FASB issued FSP No. 157-2, which delayed the effective date of SFAS No. 157 by one year for nonfinancial assets and liabilities. As defined in SFAS No. 157, 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). SFAS No. 157 requires disclosure that establishes a framework for measuring fair value and expands disclosure about fair value measurements. The statement 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

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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 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 SFAS No. 157, 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 SFAS No. 157 pricing levels as of September 30, 2008:

	Fair Value Measurements at September 30, 2008 Using
	Level 1		Level 2			Level 3		Total
Oil and gas derivative assets	$	—	$	333,035		$	—	$	333,035
Oil and gas derivative liabilities		—		(13,393,355	)		—		(13,393,355	)
Total	$	—	$	(13,060,320	)	$	—	$	(13,060,320	)

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

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 2007 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 extensive 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 field extensions, delineating deeper formations within existing fields and high risk/high reward exploratory drilling for 2008 and beyond. In addition, we will constantly review, rationalize and “high-grade” our properties in order to optimize our existing asset base. Consistent with this goal, during the third quarter of 2008, we closed $38.1 million of our previously announced sale of our Barnett Shale assets, located in Denton and Wise Counties, Texas. The difference between the $38.1 million and the $41.5 million original sale price reflects post-closing adjustments as well as one final set of properties anticipated to close by December 15, 2008. Certain customary final settlement adjustments are expected to occur during the fourth quarter.

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 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.

Hurricanes

As previously announced,during the third quarter we experienced two production disruptions by hurricanes Gustav and Ike resulting in production shut-ins on certain fields of approximately 27 days. As a result of Gustav, approximately 25 Mmcfe/day net was shut in. Many of our onshore Louisiana fields were flooded and incurred minor structural damage. Total net shut in production for Hurricane Ike was approximately 30 Mmcfe/day. Post Ike damage was very similar to Gustav. Such damage is not anticipated to exceed Dune’s deductibles for insurance claims. Most fields impacted are back on production and ramping up to pre-Gustav/Ike levels. The Leeville field in Lafourche Parish, Louisiana and South Florence field in Vermillion Parish, Louisiana did not resume full production until October 1, 2008. Live Oak field in Vermillion Parish, Louisiana did not resume production until November 1, 2008. Deferred production is 3.5 Mmcfe/day net from Leeville and South Florence and 1 Mmcfe/day net from Live Oak. In total, Dune estimates that production deferrals associated with the two hurricanes will be approximately 0.5 Bcfe.

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Liquidity and Capital Resources

During the first nine months of 2008 compared to the first nine months of 2007, net cash flow provided by operating activities decreased by $8.1 million to $24.3 million. This decline was primarily attributable to our efforts to substantially reduce our accounts payable which had accumulated in 2007 as a result of our aggressive capital program.

Our current assets stood at $54.6 million on September 30, 2008. Primarily owing to the closing of the Barnett Shale sale during the quarter, cash on hand comprised approximately $33.4 million of this amount. This compared to $16.8 million at the end of the calendar year 2007 and $52.9 million at the end of the third calendar quarter of 2007. The Barnett Shale disposition, as mentioned earlier, also facilitated the reduction in our accounts payable from $56.6 million at year end 2007 to $4.4 million at September 30, 2008.

The financial statements continue to reflect our active and ongoing drilling and facilities upgrade program which involved almost $59.4 million of capital investment in the fourth quarter of 2007 and another $43.3 million during the first nine months of 2008. Expenditures in the discontinued Barnett Shale operations accounted for $9.1 million of the total. We now expect to spend approximately $19.1 million during the final three months of 2008 on continuing development and exploitation of our hydrocarbon assets. The hurricanes caused only minor damage to certain of our production operations and, as a result, no material cash outlays are expected to be necessary to restore this capacity.

During the first nine months of 2008, as a result of an increase in our borrowing base, the availability under our revolving line of credit was increased to $40 million. As of September 30, 2008, there were no borrowings under our credit facility compared with $28.1 million outstanding at the previous quarter.

Semi-annual interest of $15.75 million on our 10 ¹/2% Senior Secured Notes due 2012 is due to be paid on December 1, 2008 and 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, 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 very favorable position to meet our financial obligations and ongoing capital programs even as commodity prices soften from their mid-year highs.

For 2009, capital spending will be targeted at between $50 million and $80 million. The exact amount will depend upon individual well performance results, cash flow and, where applicable, partner negotiations on the timing of drilling operations. Capital spending at the lower end of the range would be expected to result in 2009 production volumes holding at or slightly above the forecasted 2008 fourth quarter level of 32 - 34 Mmcfe/day or 12 - 13 Bcfe annually. Expenditures at or near the upper side of the capital budget would be anticipated to result in an increase in the 2009 production level to 40 - 44 Mmcfe/day or 15 - 16 Bcfe annually.

Results of Operations

Year-over-year production volumes were up significantly as a result of the Goldking acquisition and increased operating and drilling activities, rising from 3,830 mcfe for the first nine months of 2007 to 8,629 mcfe for the same nine month period of 2008. Nevertheless, this increase was tempered partially by the adverse impact on production of hurricanes Gustav and Ike during the third quarter of 2008. Consequently, volumes were down for this period when compared to the same time frame of 2007.

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The following table reflects the increase in oil and gas sales revenue from continuing operations due to the changes in prices and volumes.

	Three Months Ended September 30,					Nine Months Ended September 30,
	2008			2007		2008		2007
	(In thousands, except prices)					(In thousands, except prices)
Gas production volume (Mcf)		1,399			1,413		4,615		2,090
Gas sales revenue	$	14,390		$	9,835	$	48,240	$	15,045
Price per Mcf	$	10.29		$	6.96	$	10.45	$	7.20
Increase in gas sales revenue due to:
Change in production volume	$	(97	)			$	18,180
Change in prices		4,652					15,015
Total increase in gas sales revenue	$	4,555				$	33,195
Oil production volume (Bbls)		177			188		669		290
Oil sales revenue	$	21,915		$	14,177	$	76,259	$	20,729
Price per barrel	$	123.81		$	75.41	$	113.99	$	71.48
Increase in oil sales revenue due to:
Change in production volume	$	(827	)			$	27,057
Change in prices		8,565					28,473
Total increase in oil sales revenue	$	7,738				$	55,530
Total production Mcfe		2,461			2,541		8,629		3,830
Price per Mcfe	$	14.75		$	9.45	$	14.43	$	9.34

We recorded net income for the three months ended September 30, 2008 of $14.3 million or $0.16 basic and $0.06 diluted income per share compared to a net loss available to common shareholders of $13.1 million or $0.17 basic and diluted loss per share for the three months ended September 30, 2007. For the first nine months of 2008, we recorded a net loss available to common shareholders of $114.7 million or $1.32 basic and diluted loss per share compared to a $43.9 million net loss available to common shareholders or $0.63 basic and diluted loss per share for the first nine months of 2007. Although we also showed a $2.8 million loss from continuing operations for the first nine months of the fiscal year, the third quarter results produced $14.6 million of net income from continuing operations. Net loss for the nine months ended September 30, 2008 was greater than in the prior year primarily because of the substantial impact of the impairment associated with the sale of the Barnett Shale properties and the effects of the loss on derivative liabilities. However, as result of declining commodities prices in the third quarter, the same gain or loss on derivative liabilities explains much of the improvement to positive net income from continuing operations and available to common shareholders for the three month period over the previous year. The net income (loss) available to common shareholders over the 2008 period was largely affected by the Preferred Stock dividend associated with the beneficial conversion feature which was triggered on May 1, 2008. In summary, the improvement in the net income from continuing operations for the three month and nine month periods ending September, 2008 over the comparable period of 2007 was the result of higher production and commodity prices, tempered somewhat by the hurricanes in the third quarter and gain or loss on derivative liabilities throughout the period.

Revenues

Revenue from continuing operations for the current quarter ended September 30, 2008 increased $12.3 million from the comparable 2007 quarter to $36.3 million. This was largely the result of higher commodity prices as production was down slightly to 2,461 for the quarter from 2,541 for the same period last year. This was due to shut-ins caused by hurricanes Gustav and Ike.

Revenue from continuing operations for the current nine months ended September 30, 2008 increased $88.7 million from the comparable 2007 period to $124.5 million. The Goldking acquisition and higher commodity

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prices were the primary reasons. The remaining increase for the period is primarily due to gains in production going from 3,830 mcfe for the first three quarters of 2007 to 8,629 mcfe for the same timeframe in 2008.

Operating expenses

General and administrative expense (G&A expense)

G&A expense for the current quarter ended 2008 decreased $1.0 million from the comparable 2007 quarter to $4.8 million. Stock-based compensation accounted for $1.5 million of the 2008 third quarter total versus $1.0 million for the same period of 2007. This increase was offset by reductions in personnel expense for the third quarter as one-time severance payments to former Goldking employees were made in 2007.

For the nine months ended September 30, 2007 and 2008, G&A expense was down slightly from $15.4 million to $15.0 million. Stock-based compensation accounted for $7.1 million of the total for the first three quarters of 2007 and $3.9 million in 2008. This reduction was offset by the impact of a full nine months of personnel expense in 2008 compared to four and a half months in 2007 resulting from the Goldking acquisition. On a unit of production basis, G&A fell from $2.30/Mcfe for the third quarter of 2007 to $1.97/Mcfe for the same period of 2008 and from $4.02/Mcfe for the nine months of 2007 to $1.74/Mcfe for the same period of 2008.

Lease operating expense and production taxes

Lease operating expense and production taxes from continuing operations for the current quarter ended September 30, 2008 declined slightly from $10.9 million for the comparable 2007 quarter to $10.5 million.

Lease operating expense and production taxes from continuing operations for the nine months ended September 30, 2008 increased $16.7 million from the comparable 2007 period to $33.9 million. The Goldking acquisition made up most of this increase. However, workover expenses and higher production taxes also contributed to the increase. Nevertheless, total operating expenses for the first nine months of the year fell to $3.92/Mcfe compared to $4.47/Mcfe for the same period of 2007.

Exploration costs

For the quarter ended September 30, 2007 and 2008, exploration costs decreased from $0.042 million to $0.015 million, respectively. Additionally, for the nine months ended September 30, 2007 and 2008, exploration costs decreased from $0.383 million to $0.115 million. This reflects the Company’s focus on evaluating development opportunities associated with the Goldking acquisition, which occurred May 15, 2007, and on drilling development wells in order to convert proved undeveloped reserves to proved developed reserves.

Accretion of asset retirement obligation

Accretion expense for asset retirement obligations of $0.2 million represented a $0.6 million reduction for the quarter ended September 30, 2008 compared to the comparable period in 2007. Similarly, accretion expense for the nine month period ended September 30, 2008 totaled $0.5 million which reflected a $0.6 million decrease from the comparable period of 2007. The declines reflect the impact of reevaluating abandonment costs at year end 2007 on the properties acquired from Goldking.

Depletion, depreciation and amortization (DD&A)

For the current quarter of 2008, the Company recorded DD&A expense from continuing operations of $12.2 million compared to $11.3 million for 2007 representing a modest increase of $0.9 million, even though production was down slightly from the same quarter of 2007. For the current nine months of 2008, the Company

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recorded DD&A expense from continuing operations of $40.5 million compared to $17.1 million for 2007 representing an increase of $23.4 million. This increase is primarily due to approximately $111.1 million of capital expenditures in the third and fourth quarters of 2007 as well as $34.2 million of capital expenditures for the first nine months of 2008 which increased the depletable base. The majority of expenditures thus far in 2008 have been focused on field facilities enhancements, PUD drilling and workovers, all of which do not add new reserves to the base. Additionally, production increased 4.8 million mcfe between the two periods.

Other income (expense)

Interest income

Interest income was $0.2 million in the current quarter ended September 30, 2008 compared to $0.7 million in comparable 2007 quarter. Additionally, interest income decreased $0.8 million for the current nine months ended 2008 compared to the 2007 comparable period. 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 quarter ended September 30, 2008 amounted to $8.9 million compared to $6.6 million in the comparable quarter ended 2007. The increase of $2.3 million is attributable in part to outstanding borrowings under the Revolver Commitment of $28.1 million as of June 30, 2008 which was paid off in August, 2008.

Interest expense for the nine months ended September 30, 2008 amounted to $26.4 million compared to $23.2 million in the comparable period of 2007. This increase reflects interest expense on the Company’s additional borrowings under our Revolver Commitment outstanding during 2008.

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, 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 loss on derivatives is being recognized currently in earnings. For the current quarter ended September 30, 2008, the Company incurred a gain on derivatives of $23.7 million, composed of an unrealized gain of $28.1 million due to the change in the mark-to-market valuation partially offset by a realized loss of $4.4 million for cash settlements, compared to a $5.7 million realized gain for the 2007 comparable quarter resulting in an increase of $18.0 million. The gain on the derivatives in the third quarter is primarily attributable to a decline in the fair market value of our derivative liability related to open contracts due to falling oil and gas prices as of September 30, 2008.

For the current nine months ended September 30, 2008, the Company incurred a loss on derivatives of $13.0 million, composed of an unrealized loss of $3.3 million due to the change in the mark-to-market valuation and a realized loss of $9.7 million for cash settlements, compared to a $3.8 million realized gain for the 2007 comparable period. This difference is reflective of the decrease in oil and gas prices for the period.

Income tax benefit

In the first nine months of 2007, the Company’s taxes were subject to a full valuation allowance yielding $0 tax benefit. As a result of the Goldking acquisition in the second quarter of 2007, the Company has significant deferred tax liabilities in excess of its deferred tax assets. Management has determined that a valuation allowance is no longer necessary as the realization of its deferred tax assets is more likely than not. Consequently, for the first nine months of 2008, the Company has recorded an income tax benefit of $1.7 million for continuing operations.

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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 three and nine months ended September 30, 2007, the Company reclassified $0.2 million and $1.3 million, respectively, as income from discontinued operations. No provision for income tax was computed for these amounts.

For the three and nine months ended September 30, 2008, the Company generated income from the operation of the Barnett Shale Properties of $0.5 million and $2.0 million, respectively. This income was offset by a $1.0 million and $41.9 million impairment to write down the related carrying amounts to their fair value less cost to sell for the three and nine months ended September 30, 2008. Additionally, an income tax benefit of $0.2 million and $15.2 was provided from this transaction yielding a $0.3 million and $24.7 million loss on discontinued operations for the three and nine months ended September 30, 2008.

Net Loss

For the current quarter ended September 30, 2008, the net income from continuing operations reached $14.6 million, up from the comparable 2007 quarter net loss from continuing operations of $5.1 million. Additionally, for the nine months ended for 2008, the net loss decreased $34.2 million from the comparable 2007 period to $2.8 million. The net loss from discontinued operations after tax benefit at September 30, 2008 was $24.7 million. Total net loss from continuing and discontinued operations for the nine month period ended September 30, 2008 was $27.5 million.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

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 5 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.

Item 4. Controls and Procedures.

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 SEC’s 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 Company’s disclosure controls and procedures. Based upon the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2008, our disclosure controls and procedures are effective.

During the quarter ended September 30, 2008, 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.

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PART II

OTHER INFORMATION

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

During the quarter ended September 30, 2008, our Compensation Committee awarded an aggregate of 3,113,500 shares of Restricted Stock under the Dune Energy Inc. 2007 Stock Incentive Plan (the “Plan”) to employees and non-employee directors. Such shares of Restricted Stock vest in equal installments over a three year period on each of August 1, 2009, 2010 and 2011, provided the recipient remains employed by us on such date. We also issued an aggregate of 58,864 shares of Restricted Stock under the Plan to three non-employee directors in lieu of cash for services rendered during our third quarter. In accordance with the Plan, these three individuals made a one-time election at the beginning of the 2008 fiscal year to receive shares of Restricted Stock in lieu of cash for services rendered. The shares granted to these three individuals vest on September 30, 2009, provided the recipient is still a director on that date.

Item 6. Exhibits

(a) Exhibits

Exhibit Number	Description
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

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SIGNATURES

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.

	DUNE ENERGY, INC.
Date: November 6, 2008	By:	/s/    JAMES A. WATT
	Name:	James A. Watt
	Title:	President and Chief Executive Officer
Date: November 6, 2008	By:	/s/    FRANK T. SMITH, JR.
	Name:	Frank T. Smith, Jr.
	Title:	Chief Financial Officer

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INDEX TO EXHIBITS

Exhibit Number	Description
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

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