Dune Energy (DUNRQ) 10-Q 2011 Q1 Quarterly report

UNITED STATES

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 March 31, 2011

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

For the transition period from            to            

Commission file number 001-32497

DUNE ENERGY, INC.

(Exact name of registrant as specified in its charter)

Delaware	95-4737507
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

Two Shell Plaza, 777 Walker Street, Suite 2300, Houston, Texas	77002
(Address of principal executive offices)	(Zip Code)

(713) 229-6300

(Registrant’s telephone number, including area code)

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 (§ 232.405 of this chapter) 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, a non-accelerated filer or a smaller reporting company. 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	¨  (Do not check if a smaller reporting company)	Smaller Reporting Company	x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the 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: 48,841,751 shares of Common Stock, $.001 par value per share, as of May 5, 2011.

PART 1

FINANCIAL INFORMATION

Item 1. Financial Statements.

Dune Energy, Inc.

Consolidated Balance Sheets

(Unaudited)

	March  31, 2011			December 31, 2010
ASSETS
Current assets:
Cash	$	25,311,987		$	23,670,192
Restricted cash		15,766,914			15,753,441
Accounts receivable		11,362,194			9,862,849
Prepayments and other current assets		2,964,961			2,542,624
Total current assets		55,406,056			51,829,106
Oil and gas properties, using successful efforts accounting—proved		530,868,959			526,760,643
Less accumulated depreciation, depletion, amortization and impairment		(294,481,670	)		(294,566,739	)
Net oil and gas properties		236,387,289			232,193,904
Property and equipment, net of accumulated depreciation of $2,918,189 and $2,817,158		423,666			527,357
Deferred financing costs, net of accumulated amortization of $1,603,193 and $1,456,592		639,486			786,087
Other assets		11,459,925			12,049,829
		12,523,077			13,363,273
TOTAL ASSETS	$	304,316,422		$	297,386,283
LIABILITIES AND STOCKHOLDERS’ DEFICIT
Current liabilities:
Accounts payable	$	11,627,015		$	6,953,863
Accrued liabilities		23,328,123			13,367,402
Short-term debt		40,797,278			1,395,237
Preferred stock dividend payable		1,616,000			2,206,000
Total current liabilities		77,368,416			23,922,502
Long-term debt, net of discount of $4,070,052 and $4,781,310		295,929,948			335,218,690
Other long-term liabilities		12,891,593			12,548,062
Total liabilities		386,189,957			371,689,254
Commitments and contingencies		—			—
Redeemable convertible preferred stock, net of discount of $4,386,691 and $4,964,014, liquidation preference of $1,000 per share, 750,000 shares designated, 156,031 and 207,912 shares issued and outstanding		151,644,309			202,947,986
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, 48,327,922 and 41,912,723 shares issued and outstanding		48,328			41,912
Treasury stock, at cost (128,388 shares)		(62,920	)		(62,920	)
Additional paid-in capital		133,108,135			81,040,691
Accumulated deficit		(366,611,387	)		(358,270,640	)
Total stockholders’ deficit		(233,517,844	)		(277,250,957	)
TOTAL LIABILITIES AND STOCKHOLDERS’ DEFICIT	$	304,316,422		$	297,386,283

See notes to consolidated financial statements.

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Dune Energy, Inc.

Consolidated Statements of Operations

(Unaudited)

	Three months ended March 31,
	2011			2010
Revenues	$	17,419,664		$	16,965,221
Operating expenses:
Lease operating expense		7,068,193			7,584,213
Accretion of asset retirement obligation		329,379			460,728
Depletion, depreciation and amortization		6,299,971			6,993,670
General and administrative expense		2,138,891			3,445,956
Total operating expense		15,836,434			18,484,567
Operating income (loss)		1,583,230			(1,519,346	)
Other income (expense):
Interest income		20,150			491
Interest expense		(9,944,127	)		(8,871,633	)
Gain on derivative liabilities		—			1,258,874
Total other income (expense)		(9,923,977	)		(7,612,268	)
Loss on continuing operations		(8,340,747	)		(9,131,614	)
Income on discontinued operations		—			1,213,434
Net loss		(8,340,747	)		(7,918,180	)
Preferred stock dividend		(4,898,323	)		(6,403,108	)
Net loss available to common shareholders	$	(13,239,070	)	$	(14,321,288	)
Net loss per share:
Basic and diluted from continuing operations	$	(0.28	)	$	(0.39	)
Basic and diluted from discontinued operations		—			0.03
Total basic and diluted	$	(0.28	)	$	(0.36	)
Weighted average shares outstanding:
Basic and diluted		46,789,054			40,197,415

See notes to consolidated financial statements.

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Dune Energy, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

	Three months ended March 31,
	2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss	$	(8,340,747	)	$	(7,918,180	)
Adjustments to reconcile net loss to net cash provided by operating activity:
Income on discontinued operations		—			(1,213,434	)
Depletion, depreciation and amortization		6,299,971			6,993,670
Amortization of deferred financing costs and debt discount		857,859			862,654
Stock-based compensation		180,183			820,889
Accretion of asset retirement obligation		329,379			460,728
Gain on derivative liabilities		—			(1,559,241	)
Changes in:
Accounts receivable		(1,499,345	)		1,521,574
Prepayments and other assets		(422,337	)		680,063
Payments made to settle asset retirement obligations		(10,773	)		(70,933	)
Accounts payable and accrued liabilities		14,658,798			4,772,620
NET CASH PROVIDED BY CONTINUING OPERATIONS		12,052,988			5,350,410
NET CASH PROVIDED BY DISCONTINUED OPERATIONS		—			2,336,307
NET CASH PROVIDED BY OPERATING ACTIVITIES		12,052,988			7,686,717
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in proved and unproved properties		(10,346,113	)		(1,498,491	)
Increase in restricted cash		(18,646	)		—
Purchase of furniture and fixtures		(43,552	)		—
Decrease in other assets		595,077			83,093
NET CASH USED IN INVESTING ACTIVITIES		(9,813,234	)		(1,415,398	)
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in loan costs		—			(500,000	)
Payments on short-term debt		(597,959	)		(676,846	)
NET CASH USED IN FINANCING ACTIVITIES		(597,959	)		(1,176,846	)
NET CHANGE IN CASH BALANCE		1,641,795			5,094,473
Cash balance at beginning of period		23,670,192			15,053,571
Cash balance at end of period	$	25,311,987		$	20,148,044
SUPPLEMENTAL DISCLOSURES
Interest paid	$	1,111,268		$	136,110
Income taxes paid		—			—
NON-CASH DISCLOSURES
Common stock issued for conversion of preferred stock	$	56,792,000		$	2,448,000
Redeemable convertible preferred stock dividends		4,321,000			5,873,739
Accretion of discount on preferred stock		577,323			529,369

See notes to consolidated financial statements.

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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.

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 three months of 2011. Therefore, please read these financial statements and notes to the financial statements together with the audited financial statements and notes thereto in our Annual Report on Form 10-K for the year ended December 31, 2010. The income statement for the three months ended March 31, 2011 cannot necessarily be used to project results for the full year.

Discontinued operations

On June 30, 2010, the Company closed the sale of its South Florence Properties located in Vermilion Parish, Louisiana. In accordance with FASB ASC 360-10 – 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 7 for additional information regarding discontinued operations.

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. 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

There were no new accounting pronouncements that had a significant impact on the Company’s operating results or financial position.

NOTE 2—DEBT FINANCING

Wells Fargo Foothill Credit Agreement (Short-term debt)

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 Capital Finance, Inc. formerly Wells Fargo Foothill (“Wells Fargo”), as arranger and administrative agent (the “WF Agreement”). On December 7, 2010, Wells Fargo assigned to Wayzata Opportunities Fund II, L.P. (“Wayzata”) its rights, obligations and commitment under this Credit Agreement with Dune. In connection with this assignment, the Company as a borrower entered into the Amended and Restated Credit Agreement (the “Credit Agreement”) with Wayzata as the sole lender and Wells Fargo as the administrative agent. The Credit

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Agreement is a $40 million term loan facility which will mature on March 15, 2012. Pursuant to the Credit Agreement, (i) interest is 15% per annum which is due and payable, in arrears, on the first day of each month at any time that obligations are outstanding and (ii) if any or all of the $40 million term loan is prepaid (whether mandatory or voluntary prepayment) on or prior to November 15, 2011, the Company shall owe a prepayment premium equal to 10% of the principal amount prepaid.

As security for its obligations under the Credit Agreement, Dune and certain of its operating subsidiaries continue to grant Agent a security interest in and a first priority lien on all of its oil and gas properties and certain deposit accounts. In addition, its subsidiary, Dune Operating Company has guaranteed the obligations.

The Credit Agreement also continues to contain various covenants that limit the Company’s ability to: incur indebtedness; dispose of assets; grant certain liens; enter into certain swaps; make certain investments; prepay any subordinated debt; merge, consolidate, recapitalize, consolidate or allow any material change in the character of our business; enter into farm-out agreements; enter into forward sales; enter into agreements which (i) warrant production of hydrocarbons (other than permitted hedges) and (ii) shall not allow gas imbalances, take-or-pay or other prepayment with respect to its oil and gas properties; and; enter into certain marketing activities.

The Credit Agreement modifies the definition of Change in Control to mean (i) that any “person” or “group”, other than Permitted Holders or Wayzata and its Affiliates, becomes the beneficial owner, directly or indirectly, of 35%, or more, of the Stock of the Company having the right to vote for the election of members of the Board of Directors, (ii) that a majority of the members of the Board of Directors do not constitute Continuing Directors, (iii) that the Company ceases to own and control, directly or indirectly, 100% of the outstanding Stock of each other Loan Party, (iv) either James Watt or Frank Smith shall cease to be involved in the day to day operations and management of the business of the Company, and a successor reasonably acceptable to Agent and Lenders is not appointed on terms reasonably acceptable to Agent and Lenders within 60 days of such cessation of involvement, or (v) any “Change of Control” or similar term, as defined in the Second Secured Debt Documents.

The Credit Agreement no longer contains covenants relating to minimum EBITDA and net hydrocarbon production, as well as no requirement to hedge. Instead, the Credit Agreement has a new financial covenant that requires Dune to maintain the following ratio: the total present value of future net revenues discounted at 10% of the proved developed reserves must be greater than two (2) times the value of the face amount of the term loan.

If an event of default exists under the Credit Agreement, the Lenders will be able to accelerate the maturity of the Credit Agreement and exercise other rights and remedies. Each of the following would continue to be an event of default: failure to pay any principal when due or any reimbursement amount, interest, fees or other amount within certain grace periods; a representation or warranty is proven to be incorrect when made; failure to perform or otherwise comply with the covenants, including, but not limited to maintenance of (i) required cash management activities and (ii) the interest reserve account, or conditions contained in the Credit Agreement or other loan documents, subject, in certain instances, to certain grace periods; default by the Company on the payment of any other indebtedness or results in the third party’s right to accelerate the maturity of such indebtedness; bankruptcy or insolvency events involving the Company or any of its subsidiaries; the loan documents cease to be in full force and effect; our failing to create a valid lien, except in limited circumstances; the occurrence of a Change in Control; the entry of, and failure to pay or have stayed pending appeal, one or more adverse judgments in excess of an aggregate amount of $5.0 million or more.

In connection with entering into the Credit Agreement on December 7, 2010, standby letters of credit totaling $8.5 million were taken down as the Company cash collateralized these obligations through a bonding agent and has reduced the obligation to $8 million at March 31, 2011.

On March 1, 2011, the Credit Agreement was amended, effective as of December 7, 2010, to permit “the repurchase or other acquisition by Parent of shares of common stock of Parent from employees, former

6

employees, directors or former directors of Parent or its Subsidiaries or permitted transferees of such employees, former employees, directors or former directors, in each case pursuant to the terms of the agreements (including employment agreements) or plans (or amendments thereto) or other arrangements approved by the Board of Directors of the Parent under which such shares were granted, issued or sold; provided, that (A) no Default or Event of Default has occurred and is continuing or would exist after giving effect to such repurchase or other acquisition, and (B) the aggregate amount of all such repurchases and other acquisitions following the Restatement Date shall not exceed $500,000.” This amendment also waived any misrepresentation that may have inadvertently arisen as a result of any such repurchase prior to the date of the amendment.

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. 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) 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 (ii) 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 Wayzata under the Credit 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 $711,258 and $713,851 and is included in interest expense in the consolidated statements of operations for the three months ended March 31, 2011 and 2010, 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 a dividend at a rate of 12% 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 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. The Preferred Stock is redeemable at the option of the holder on December 1, 2012 and subject to the terms of any of the Company’s indebtedness or upon a change of control. In the event Dune fails to redeem

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shares of Preferred Stock “put” to Dune by a holder, then the conversion price shall be lowered and the dividend rate increased. After December 1, 2012, Dune may redeem shares of Preferred Stock. The Company analyzed the adjustment of the conversion right and the make whole premium for derivative accounting under FASB ASC 815 – Derivatives and Hedges and determined that it was not applicable to either provision.

The Preferred Stock discount is deemed a Preferred Stock dividend and is being amortized over five years using the effective interest method and is charged to additional paid-in capital as the Company has a deficit balance in retained earnings. Charges to additional paid-in capital for the three months ended March 31, 2011 and 2010 amounted to $577,323 and $529,369, respectively.

During the three months ended March 31, 2011, holders of 56,792 shares of the Preferred Stock converted their shares into 6,490,526 shares of common stock. Subsequent to March 31, 2011, holders of 4,496 shares of Preferred Stock converted their shares into approximately 513,829 shares of common stock.

During the three months ended March 31, 2011 and 2010, Dune paid dividends on the Preferred Stock in the amount of $4,911,000 and $5,762,000, respectively. In lieu of cash, the Company elected to issue 4,911 and 5,762 additional shares of Preferred Stock, respectively.

NOTE 4—HEDGING ACTIVITIES

As a result of entering into the Credit Agreement, the Company is no longer required to hedge and all hedge balances were settled. Prior to this event, Dune accounted for its production hedge derivative instruments as defined in FASB ASC 815-Derivatives and Hedging. Accordingly, the Company designated derivative instruments as fair value hedges and recognized gain or losses in current earnings.

For the three months ended March 31, 2010, Dune recorded a gain on the derivatives of $1,258,874, composed of an unrealized gain on changes in mark-to-market valuations of $1,559,241 and a realized loss on cash settlements of ($300,367).

NOTE 5—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 $180,183 and $820,889 for the three months ended March 31, 2011 and 2010, respectively.

The 2007 Stock Incentive Plan, which was approved by Dune’s shareholders, authorizes the issuance of up to 3,200,000 shares of common stock for issuance to employees, officers and non-employee directors. The Plan is administered by Dune’s Compensation Committee. The following table reflects the vesting activity associated with the restricted stock awards as of March 31, 2011:

Grant Date	Shares Awarded		Shares Canceled			Shares Vested			Shares Unvested
December 17, 2007		248,591		(71,471	)		(177,120	)		—
March 13, 2008		105,412		—			(105,412	)		—
August 1, 2008		622,700		(110,789	)		(374,006	)		137,905
October 1, 2009		450,000		—			(100,499	)		349,501
December 31, 2009		573,780		(136,666	)		(163,921	)		273,193
November 11, 2010		938,900		(44,300	)		—			894,600
December 30, 2010		4,445		—			(4,445	)		—
		2,943,828		(363,226	)		(925,403	)		1,655,199

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Common shares available to be awarded at March 31, 2011 are as follows:

Total shares authorized	3,200,000
Total shares issued	(2,943,828	)
Total shares canceled	363,226
Total shares available	619,398

NOTE 6—INCOME TAXES

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 management. At this date, this general fact pattern does not allow the Company to project sufficient sources of future taxable income to offset tax loss carryforwards and net deferred tax assets in the U.S. Under these current circumstances, it is management’s opinion that the realization of these tax attributes does not reach the “more likely than not criteria” under FASB ASC 740 – Income Taxes. As a result, the Company’s taxes through March 31, 2011 are subject to a full valuation allowance.

NOTE 7—DISCONTINUED OPERATIONS

On June 30, 2010, Dune consummated the sale of the South Florence field located in Vermilion Parish, Louisiana. The disposition of the South Florence Properties allowed the Company to repay all outstanding borrowings under the WF Agreement and to invest in new assets or fund maintenance, repair or improvement of existing properties and assets. The effective date of the sale was May 1, 2010.

Consideration received by the Company for the South Florence Properties aggregated $29,189,243, consisting of the purchase price of $30 million, as adjusted to account for the sale of hydrocarbons and various related costs, expenses and charges incurred between the execution and the Purchase and Sale Agreement and completion of the sale.

Pursuant to accounting rules for discontinuing operations, Dune has classified 2010 and prior reporting periods to present the activity related to the South Florence Properties as a discontinued operation. Discontinued operations for the three months ended March 31, 2010 are summarized as follows:

	Three months ended March 31, 2010
Revenues	$	3,285,976
Costs and expenses:
Lease operating expense		949,669
Depletion, depreciation and amortization		1,122,873
Total operating expense		2,072,542
Income from discontinued operations	$	1,213,434
Production:
Oil (bbl)		28,821
Gas (mcf)		186,824
Total (mcfe)		359,750

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NOTE 8—COMMITMENTS AND CONTINGENCIES

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

In connection with the acquisition of Goldking, the Company inherited an environmental contingency which after conducting its due diligence and subsequent testing believes is the responsibility of a third party. However, federal and state regulators have determined Dune is the responsible party for clean up of this area. Dune has maintained a passive maintenance of this site since it was first discovered after Hurricane Katrina. Cost to date of approximately $1,100,000 has been covered by the Company’s 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 Company’s 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.

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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 Annual Report on Form 10-K for the year ended December 31, 2010. 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 expect to 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 three months of 2011 compared to the first three months of 2010, net cash flow provided by continuing operations increased by $6.7 million to $12.1 million. This increase was primarily attributable to an increase in accounts payable and accrued liabilities.

Our current assets were $55.4 million on March 31, 2011. Cash on hand comprised approximately $25.3 million of this amount. This compared to $23.7 million at the end of the calendar year 2010 and $20.1 million at the end of the first quarter of 2010. Accounts payable have been increased from $7.0 million at year end 2010 to $11.6 million at March 31, 2011. Accounts payable were $7.4 million at March 31, 2010.

The financial statements continue to reflect a modest but ongoing drilling and facilities upgrade program which amounted to $10.3 million during the first three months of 2011. The increased spending reflected drilling activity at the S and Deep Salt prospects at Garden Island Bay. We expect to spend approximately $14.3 million during the final nine months of 2011 on continuing development and exploitation of our asset base. This would represent a $15.9 million increase over our almost $8.7 million of capital investment in 2010. However, this anticipated capital may be reduced or increased depending on available cash flow and our continuing capital restructuring efforts. Because we operate the majority of our properties, we can control the timing of expenditures.

During the fourth quarter of 2010, Dune replaced its $40 million revolving credit facility from Wells Fargo Foothill with a new $40 million term loan facility from Wayzata. The new facility matures on March 15, 2012

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and provides for Wells Fargo Foothill to remain as agent for the facility. The Company has received all of the funds associated with the facility and has placed $23.7 million in escrow to cash collateralize $8.0 million of standby letters of credit and provide $15.7 million for the June 2011 bond interest payment on our Senior Secured Notes. The Company is deploying the remaining funds from the new term loan and available cash flow from operations to cover anticipated drilling and recompletion projects in 2011. Additionally, all hedging contracts were settled in 2010 and the Company no longer hedges its oil and gas production.

Semi-annual interest of $15.75 million on our 10^1/2% Senior Secured Notes due 2012 was paid on December 31, 2010 and is due on June 1 and December 1 thereafter. The principal on the Senior Secured Notes is not due until June 1, 2012.

Shares of our Senior Redeemable Convertible Preferred Stock are redeemable at the option of the holder on December 1, 2012 and subject to the terms of any of the Company’s indebtedness or upon a change 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 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 $14.3 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.

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Results of Operations

Year-over-year production decreased from 1,893 Mmcfe for the first three months of 2010 to 1,660 Mmcfe for the same three month period of 2011. This decrease was caused by normal reservoir declines which were not offset by increased production due to the limited amount of capital reinvestment made during 2010.

The following table reflects the increase (decrease) in oil and gas sales revenue due to the changes in prices and volumes:

	Quarter ended March 31,
	2011			%     Change			2010
Oil production volume (Mbbls)		140			-7	%		151
Oil sales revenue ($000)	$	13,566			18	%	$	11,497
Price per Bbl	$	96.90			27	%	$	76.14
Increase (decrease) in oil sales revenue due to:
Change in prices	$	2,906
Change in production volume		(837	)
Total increase (decrease) in oil sales revenue	$	2,069
Gas production volume (Mmcf)		821			-17	%		987
Gas sales revenue ($000)	$	3,854			-30	%	$	5,468
Price per Mcf	$	4.69			-15	%	$	5.54
Increase (decrease) in gas sales revenue due to:
Change in prices	$	(698	)
Change in production volume		(916	)
Total increase (decrease) in gas sales revenue	$	(1,614	)
Total production volume (Mmcfe)		1,660			-12	%		1,893
Total revenue ($000)	$	17,420			3	%	$	16,965
Price per Mcfe	$	10.49			17	%	$	8.96
Increase (decrease) in total revenue due to:
Change in prices	$	2,543
Change in production volume		(2,088	)
Total increase (decrease) in total revenue	$	455

We recorded a net loss available to common shareholders for the three months ended March 31, 2011 of ($13.2 million) or ($0.28) loss per share compared to net loss available to common shareholders of ($14.3 million) or ($0.36) loss per share for the same quarter of 2010. The decrease in loss of $1.1 million for the quarter is a result of improved commodity prices and reduction in G&A expense.

Revenues

Revenues for the quarter ended March 31, 2011 totaled $17.4 million compared to $17.0 million for the quarter ended March 31, 2010 representing a $0.4 million increase. Production volumes for 2011 were 140 Mbbls of oil and 0.8 Bcf of natural gas or 1.7 Bcfe. This compares to 151 Mbbls of oil and 1.0 Bcf of natural gas or 1.9 Bcfe representing a 12% decline in production volumes. In 2011, the average sales price per barrel of oil was $96.90 and $4.69 per mcf of natural gas as compared to $76.14 per barrel and $5.54 per mcf, respectively for 2010. These results indicate that the modest increase in revenue is primarily attributable to the increase in commodity prices as the average price received per Mcfe produced was $10.49 in 2011 versus $8.96 in 2010 representing an increase of 17%.

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Operating expenses

Lease operating expense

The following table presents the major components of Dune’s lease operating expense (in thousands) for the first quarter of 2011 and 2010 on a Mcfe basis:

	Quarter ended March 31,
	2011				2010
	Total		Per Mcfe		Total		Per Mcfe
Direct operating expense	$	4,512	$	2.72	$	5,428	$	2.87
Workovers		649		0.39		237		0.12
Ad valorem taxes		237		0.14		323		0.17
Production taxes		1,390		0.84		1,118		0.59
Transportation		280		0.17		478		0.25
	$	7,068	$	4.26	$	7,584	$	4.00

Lease operating expense for the quarter ended March 31, 2011 totaled $7.1 million versus $7.6 million for the same period of 2010 representing a 7% reduction. However, as a result of reduced volumes, lease operating expense per Mcfe increased $0.26. The overall reduction in lease operating expense between periods reflects Dune’s continued efforts to reduce field operating expenses.

Accretion of asset retirement obligation

Accretion expense for asset retirement obligations decreased by $0.1 million for the quarter ended March 31, 2011 compared to the comparable period in 2010. This small decrease is the result of reevaluating abandonment costs at year end.

Depletion, depreciation and amortization (DD&A)

For the quarter ended March 31, 2011, the Company recorded DD&A expense of $6.3 million ($3.80/mcfe) compared to $7.0 million ($3.69/mcfe) for the quarter ended March 31, 2010. This decrease reflects the impact of a 12% reduction in production volumes that directly impacts the DD&A calculation.

General and administrative expense (G&A expense)

G&A expense for the current quarter ended 2011 decreased $1.3 million from the comparable 2010 quarter to $2.1 million. Cash G&A expense for 2011 fell $0.7 million (27%) from 2010 to $1.9 million. These decreases resulted principally from a reduction in personnel expense of $0.3 million, share-based compensation of $0.7 million and legal fees of $0.3 million.

On a unit of production basis, G&A fell from $1.82/mcfe for the first quarter of 2010 to $1.29/mcfe for the same period of 2011.

Other income (expense)

Interest income

Interest income for the quarter ended March 31, 2011 was $0.02 million more than the comparable 2010 quarter. This was the result of higher cash balances held in escrow associated with the Credit Agreement.

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Interest expense

As a result of the higher interest rate applicable to the Credit Agreement, interest expense for the quarter ended March 31, 2011 was $9.9 million compared to $8.9 million in the comparable quarter ended 2010.

Gain (loss) on derivative liabilities

For the quarter ended March 31, 2010, the Company incurred a gain on derivatives of $1.3 million composed of an unrealized gain of $1.6 million due to the change in the mark-to-market valuation and a realized loss of $0.3 million for cash settlements. In December 2010 all hedging requirements were eliminated in connection with our entry into the Credit Agreement and all hedge balances were settled.

Net income (loss) available to common shareholders

For the first quarter ended March 31, 2011, net loss available to common shareholders decreased $1.1 million from the comparable quarter of 2010. This decrease reflects the impact of a $0.4 million increase in revenues, a $2.7 million decrease in operating expenses and a $1.5 million decrease in Preferred Stock dividends partially offset by a ($1.0 million) increase in interest expense, a ($1.3 million) reduction in the gain on derivative liabilities and ($1.2 million) decrease in income from discontinued operations.

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 Securities and Exchange Commission’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 March 31, 2011, our disclosure controls and procedures are effective.

During the quarter ended March 31, 2011, 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 6. Exhibits

(a) Exhibits

Exhibit Nos.	Description
3.1	Amended and restated Certificate of Incorporation of IP Factory, Inc. (1)
3.1.1	Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated May 7, 2003 (2)
3.1.2	Certificate of Amendment of Certificate of Incorporation, dated May 5, 2004 (3)
3.1.3	Certificate of Amendment of Certificate of Incorporation, dated June 12, 2007 (4)
3.1.4	Certificate of Amendment of Certificate of Incorporation, dated December 14, 2007 (5)
3.1.5	Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated December 1, 2009 (6)
3.2	Amended and Restated By-Laws of Dune Energy, Inc. (7)
10.1	First Amendment to Amended and Restated Credit Agreement and Waiver dated as of December 7, 2010 (8)
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.

* Filed herewith

(1) Incorporated by reference to Exhibit No. 3.1 to Form 10-KSB filed by Dune Energy, Inc. (Commission File No. 000-27897) on November 14, 2003.

(2) Incorporated by reference to Exhibit No. 3.1.1 to Form 10-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on March 3, 2011.

(3) Incorporation by reference to Exhibit No. 3.1 to Form 10-Q filed by Dune Energy, Inc. (Commission File No. 001-32497) for the quarterly period ended March 31, 2007.

(4) Incorporated by reference to Exhibit No. 3.1.3 to Form 10-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on March 3, 2011.

(5) Incorporated by reference to Exhibit No. 3.1.4 to Form 10-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on March 3, 2011.

(6) Incorporated by reference to Exhibit No. 3.1.2 to Form 8-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on December 1, 2009.

(7) Incorporated by reference to Exhibit No. 3.1 to Form 8-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on July 12, 2010.

(8) Incorporated by reference to Exhibit 10.22.1 to Form 10-K filed by Dune Energy Inc. (Commission File No. 001-32497) on March 3, 2011.

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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: May 5, 2011	By:	/S/    JAMES A. WATT
	Name:	James A. Watt
	Title:	President and Chief Executive Officer
Date: May 5, 2011	By:	/S/    FRANK T. SMITH, JR.
	Name:	Frank T. Smith, Jr.
	Title:	Chief Financial Officer

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INDEX TO EXHIBITS

Exhibit Nos.	Description
3.1	Amended and restated Certificate of Incorporation of IP Factory, Inc. (1)
3.1.1	Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated May 7, 2003 (2)
3.1.2	Certificate of Amendment of Certificate of Incorporation, dated May 5, 2004 (3)
3.1.3	Certificate of Amendment of Certificate of Incorporation, dated June 12, 2007 (4)
3.1.4	Certificate of Amendment of Certificate of Incorporation, dated December 14, 2007 (5)
3.1.5	Certificate of Amendment of Amended and Restated Certificate of Incorporation, dated December 1, 2009 (6)
3.2	Amended and Restated By-Laws of Dune Energy, Inc. (7)
10.1	First Amendment to Amended and Restated Credit Agreement and Waiver dated as of December 7, 2010 (8)
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.

* Filed herewith

(1) Incorporated by reference to Exhibit No. 3.1 to Form 10-KSB filed by Dune Energy, Inc. (Commission File No. 000-27897) on November 14, 2003.

(2) Incorporated by reference to Exhibit No. 3.1.1 to Form 10-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on March 3, 2011.

(3) Incorporation by reference to Exhibit No. 3.1 to Form 10-Q filed by Dune Energy, Inc. (Commission File No. 001-32497) for the quarterly period ended March 31, 2007.

(4) Incorporated by reference to Exhibit No. 3.1.3 to Form 10-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on March 3, 2011.

(5) Incorporated by reference to Exhibit No. 3.1.4 to Form 10-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on March 3, 2011.

(6) Incorporated by reference to Exhibit No. 3.1.2 to Form 8-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on December 1, 2009.

(7) Incorporated by reference to Exhibit No. 3.1 to Form 8-K filed by Dune Energy, Inc. (Commission File No. 001-32497) on July 12, 2010.

(8) Incorporated by reference to Exhibit 10.22.1 to Form 10-K filed by Dune Energy Inc. (Commission File No. 001-32497) on March 3, 2011.

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