Filed pursuant to Rule 424(b)(3)
Registration number 333-132978
DUNE ENERGY, INC.
Up to a maximum of 15,845,900 shares of Common Stock
This prospectus relates to the resale of up to 15,845,900 shares of our
common stock, $.001 par value per share ("Common Stock"), by the selling
security holders listed in the prospectus commencing on page 12, consisting of
up to 12,243,243 shares of Common Stock held by selling security holders and up
to 3,602,657 shares of our Common Stock issuable upon exercise of stock options
and common stock purchase warrants. The transactions in which the selling
security holders acquired the shares of Common Stock covered by this prospectus
are described in the section of this prospectus entitled "Selling Security
Holders."
The selling security holders, by themselves or through brokers and
dealers, may offer and sell the shares at prevailing market prices or in
transactions at negotiated prices. We will not receive any proceeds from the
selling security holders' resale of the shares of Common Stock. The selling
security holders will receive all proceeds from such sales. We will, in the
ordinary course of business, receive proceeds from the issuance of our Common
Stock upon exercise of the common stock purchase warrants.
Our Common Stock is traded on the American Stock Exchange under the symbol
"DNE". On May 16, 2006 the closing price of our Common Stock on the American
Stock Exchange was $3.35.
INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. SEE "RISK FACTORS"
BEGINNING ON PAGE 3.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
You should rely only on the information contained in this prospectus. We
have not authorized anyone to provide you with different information from that
contained in this prospectus. The selling security holders are offering to sell
and seeking offers to buy shares of our Common Stock only in jurisdictions where
offers and sales are permitted. The information contained in this prospectus is
accurate only as of the date of this prospectus, regardless of the time of
delivery of this prospectus or of any sale of our Common Stock.
The date of this prospectus is July 6, 2006
TABLE OF CONTENTS
Page
----
Prospectus Summary........................................................ 1
Risk Factors.............................................................. 3
Where You Can Find More Information....................................... 10
Use of Proceeds........................................................... 12
Determination of Offering Price........................................... 12
Selling Security Holders.................................................. 12
Plan of Distribution...................................................... 24
Legal Proceedings......................................................... 26
Directors, Executive Officers, Promoters and Control Persons.............. 26
Security Ownership of Certain Beneficial Owners, Directors and
Executive Officers and Related Shareholder Matters....................... 28
Description of Securities................................................. 30
Legal Matters............................................................. 30
Experts................................................................... 30
Business.................................................................. 30
Management's Discussion and Analysis and Plan of Operation................ 37
Properties................................................................ 44
Certain Relationships and Related Transactions............................ 44
Market for Common Equity and Related Stockholder Matters.................. 45
Executive Compensation.................................................... 47
Financial Statements...................................................... F-1
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PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this
prospectus. This summary does not contain all of the information you should
consider before investing in our Common Stock. You should read the entire
prospectus, including "Risk Factors" and the consolidated financial statements
and the related notes before making an investment decision.
In this prospectus, the "Company" and terms such as "we," "us" and "our,"
refer to Dune Energy, Inc., a Delaware corporation.
Our Company
The Company was incorporated in the State of Delaware on November 20,
1998, under the name of IP Factory, Inc. In May 2001, Hitthebeach.com, Inc., a
private company, was merged into the Company. On May 7, 2003, Merchant Builders,
Inc., a private company, merged into the Company and the Company changed its
name to Dune Energy, Inc.
In May of 2004, Itera Holdings BV ("Itera"), a company organized under the
laws of the Netherlands and one of the largest producers of natural gas in
Russia and the Baltics, acquired 78% of the Company's shares of Common Stock for
an aggregate purchase price of $12 million. Itera and our management have a
common vision to build the Company into a substantial U.S. independent
exploration and development company by combining Itera's capital resources with
the experience of our management team. Our headquarters are located at 3050 Post
Oak Blvd., Suite 695, Houston, Texas 77056 and our telephone number is (713)
888-0895.
We are an independent energy company engaged in the exploration,
development, and acquisition of natural gas and crude oil properties. Presently,
we have an interest in the following areas in Texas and Louisiana:
>> Barnett Shale - working interests (ranging between 92% and 100%) in
certain oil and gas leases covering approximately 1,725 gross acres in
Denton and Wise Counties, Texas, as well as an undivided interest in nine
producing wells thereon, plus a working interest in one additional well
undergoing completion, all located on the fairway of the prolific Barnett
Shale play in the North Texas Fort Worth Basin (the "Barnett Shale
Properties");
>> Bayou Couba - A working interest in certain exclusive exploration and
development rights covering approximately 11,000 gross contiguous acres in
St. Charles Parish, Louisiana, together with an undivided working interest
in three producing wells (the "Bayou Couba Property");
>> Welder Ranch - leases covering approximately 7,950 contiguous acres on the
Welder Ranch located in Victoria County, Texas, together with an undivided
working interest in four producing wells (the "Welder Ranch Property");
>> Pearsall Field - a working interest in two leases covering 2,400 acres and
the option to participate in additional leases covering approximately
9,000 acres in the Pearsall Field, located in Frio County, Texas, together
with an undivided working interest in two producing wells (the "Pearsall
Property"); and
>> Los Mogotes Field - a small but profitable working interest in one 18,000
acre lease containing multiple wells in the Los Mogotes Field, located in
Zapata County, Texas (the "Los Mogotes Property," and together with the
Welder Ranch Property and the Pearsall Property, the "South Texas
Properties").
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The Offering
This prospectus relates to the resale by selling security holders of up to
15,845,900 shares of our Common Stock, consisting of up to 12,243,243 shares of
Common Stock held by selling security holders and up to 3,602,657 shares of our
Common Stock issuable upon exercise of stock options and common stock purchase
warrants.
The issuances of such securities to the selling security holders was made
in reliance upon exemptions from the registration requirements of the Securities
Act provided by Section 4(2) of the Securities Act and Regulation D promulgated
thereunder. Additional information concerning the transactions in which the
rights to acquire the shares covered by this prospectus were obtained by the
selling security holders are set forth in the section of this prospectus
entitled "Selling Security Holders."
Sales by Selling Security Holders
The selling security holders may offer the Common Stock pursuant to this
prospectus in varying amounts and transactions so long as this prospectus is
then current under the rules of the SEC and we have not withdrawn the
registration statement. The offering of Common Stock may be through the
facilities of the American Stock Exchange or such other exchange or reporting
system where the Common Stock may be traded. Brokerage commissions may be paid
or discounts allowed in connection with such sales; however, it is anticipated
that the discounts allowed or commissions paid will be no more than the ordinary
brokerage commissions paid on sales effected through brokers or dealers. To our
knowledge, as of the date hereof, no one has made any arrangements with a broker
or dealer concerning the offer or sale of the Common Stock. See "Plan of
Distribution."
Outstanding Securities
As of May 16, 2006, there were 59,244,859 shares of our Common Stock
outstanding. On a fully-diluted basis, giving effect to and assuming the
exercise of all of our options and warrants, we had outstanding an aggregate of
62,847,516 shares of Common Stock as of May 16, 2006.
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RISK FACTORS
The reader should carefully consider each of the risks described below. If
any of the following risks develop into actual events, our business, financial
condition or results of operations could be materially adversely affected and
the trading price of the Common Stock could decline significantly.
RISKS RELATED TO THE BUSINESS
WE HAVE HAD OPERATING LOSSES AND LIMITED REVENUES TO DATE.
We have been operating at a loss each year since our inception. Net losses
applicable to common stockholders for the years ended December 31, 2004 and
December 31, 2005 were $1,114,961 and $1,584,643, respectively. Revenues for the
years ended December 31, 2004 and 2005 were $1,022,297 and $3,724,278,
respectively. We may not be able to generate significant revenues in the future.
In addition, we expect to incur substantial operating expenses in connection
with our gas and oil exploration and development activities. As a result, we may
continue to experience negative cash flow for at least the foreseeable future
and cannot predict when, or even if, we might become profitable. We needed and
have obtained waivers through July 31, 2006 from our senior and subordinated
lenders, of compliance with certain covenants in our lending arrangements
requiring certain levels of income from operations. We have agreed with our
senior and subordinated lenders to certain changes in our respective contractual
arrangements, including suspension of revolving credit availability under the
senior facility and the payment of certain interest amounts in subordinated
notes rather than cash under our subordinated facility. We have also agreed to
increase the rate of interest payable to our senior lenders on outstanding
indebtedness by two percent per annum effective from June 1, 2006. See
"Management's Discussion and Analysis or Plan of Operation - Financial Liquidity
and Capital Resources".
WE HAVE SUBSTANTIAL CAPITAL REQUIREMENTS THAT, IF NOT MET, MAY HINDER
OPERATIONS.
We have experienced and expect to continue to experience substantial
capital needs as a result of its active exploration, development, and
acquisition programs. We expect that additional external financing will be
required in the future to fund our growth. We may not be able to obtain
additional financing, and financing under existing or new credit facilities may
not be available in the future. Without additional capital resources, we may be
forced to limit or defer our planned natural gas and oil exploration and
development program and this will adversely affect the recoverability and
ultimate value of our natural gas and oil properties, in turn negatively
affecting our business, financial condition, and results of operations.
NATURAL GAS AND OIL PRICES ARE HIGHLY VOLATILE, AND LOWER PRICES WILL NEGATIVELY
AFFECT OUR FINANCIAL RESULTS.
Our revenue, profitability, cash flow, oil and gas reserves value, future
growth, and ability to borrow funds or obtain additional capital, as well as the
carrying value of our properties, are substantially dependent on prevailing
prices of natural gas and oil. Historically, the markets for natural gas and oil
have been volatile, and those markets are likely to continue to be volatile in
the future. It is impossible to predict future natural gas and oil price
movements with certainty. Prices for natural gas and oil are subject to wide
fluctuations in response to relatively minor changes in the supply of and demand
for natural gas and oil, market uncertainty, and a variety of additional factors
beyond our control. These factors include:
o the level of consumer product demand;
o overall economic conditions;
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o weather conditions;
o domestic and foreign governmental relations;
o the price and availability of alternative fuels;
o political conditions;
o the level and price of foreign imports of oil and liquefied natural gas;
and
o the ability of the members of the Organization of Petroleum Exporting
Countries to agree upon and maintain oil price controls.
Declines in natural gas and oil prices may materially adversely affect our
financial condition, liquidity, and ability to finance planned capital
expenditures and results of operations. We do not currently engage in any
hedging program to mitigate our exposure to fluctuation in oil and gas prices.
DRILLING FOR NATURAL GAS AND OIL IS A SPECULATIVE ACTIVITY AND INVOLVES NUMEROUS
RISKS AND SUBSTANTIAL AND UNCERTAIN COSTS THAT COULD ADVERSELY AFFECT US.
Our success will be largely dependent upon the success of our drilling
program. Drilling for natural gas and oil involves numerous risks, including the
risk that no commercially productive natural gas or oil reservoirs will be
discovered. The cost of drilling, completing, and operating wells is substantial
and uncertain, and drilling operations may be curtailed, delayed, or canceled as
a result of a variety of factors beyond our control, including:
o unexpected or adverse drilling conditions;
o elevated pressure or irregularities in geologic formations;
o equipment failures or accidents;
o adverse weather conditions;
o compliance with governmental requirements; and
o shortages or delays in the availability of drilling rigs, crews, and
equipment.
Even if drilled, our completed wells may not produce reserves of natural
gas or oil that are economically viable or that meet our earlier estimates of
economically recoverable reserves. Our overall drilling success rate or our
drilling success rate for activity within a particular project area may decline.
Unsuccessful drilling activities could result in a significant decline in our
production and revenues and materially harm our operations and financial
condition by reducing our available cash and resources. Because of the risks and
uncertainties of our business, our future performance in exploration and
drilling may not be comparable to our historical performance.
WE DEPEND ON SUCCESSFUL EXPLORATION, DEVELOPMENT, AND ACQUISITIONS TO MAINTAIN
RESERVES AND REVENUE IN THE FUTURE.
In general, the volume of production from natural gas and oil properties
declines as reserves are depleted, with the rate of decline depending on
reservoir characteristics. Except to the extent that we conduct successful
exploration and development activities or acquire properties containing proved
reserves, or both, our proved reserves will decline as reserves are produced.
Our future natural gas and oil production is, therefore, highly dependent on our
level of success in finding or acquiring additional reserves. We do not have an
established history of locating and developing properties that have gas and oil
reserves. As of the date hereof, none of our leased properties has generated
significant operating revenues. Additionally, the business of exploring for,
developing, or acquiring reserves is capital intensive. Recovery of our
reserves, particularly undeveloped reserves, will require significant additional
capital expenditures and successful drilling operations. To the extent cash flow
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from operations is reduced and external sources of capital become limited or
unavailable, our ability to make the necessary capital investment to maintain or
expand our asset base of natural gas and oil reserves would be impaired. In
addition, we are dependent on finding partners for our exploratory activity. To
the extent that others in the industry do not have the financial resources or
choose not to participate in our exploration activities, we will be adversely
affected.
RESERVE ESTIMATES DEPEND ON MANY ASSUMPTIONS THAT MAY TURN OUT TO BE INACCURATE
Any material inaccuracies in these reserve estimates or underlying
assumptions could materially affect the quantities and present values of our
reserves. The process of estimating natural gas and oil reserves is complex. It
requires interpretations of available technical data and various assumptions,
including assumptions relating to economic factors. Any significant inaccuracies
in these interpretations or assumptions could materially affect the estimated
quantities and present value of reserves shown in this report. In order to
prepare these estimates, we must project production rates and timing of
development expenditures. We must also analyze available geological,
geophysical, production and engineering data, and the extent, quality and
reliability of this data can vary. The process also requires economic
assumptions relating to matters such as oil and natural gas prices, drilling and
operating expenses, capital expenditures, taxes and availability of funds.
Therefore, estimates of oil and natural gas reserves are inherently imprecise.
Actual future production, oil and natural gas prices, revenues, taxes,
development expenditures, operating expenses and quantities of recoverable oil
and natural gas reserves most likely will vary from our estimates. A significant
variance could materially affect the estimated quantities and pre-tax present
value of reserves shown in this report. In addition, we may adjust estimates of
proved reserves to reflect production history, results of exploration and
development, prevailing oil and natural gas prices and other factors, many of
which are beyond our control.
OUR FUTURE ACQUISITIONS MAY YIELD REVENUES OR PRODUCTION THAT VARIES
SIGNIFICANTLY FROM OUR PROJECTIONS.
In acquiring producing properties, we assess the recoverable reserves,
future natural gas and oil prices, operating costs, potential liabilities and
other factors relating to the properties. Our assessments are necessarily
inexact and their accuracy is inherently uncertain. Our review of a subject
property in connection with its acquisition assessment will not reveal all
existing or potential problems or permit us to become sufficiently familiar with
the property to assess fully its deficiencies and capabilities. We may not
inspect every well, and we may not be able to observe structural and
environmental problems even when we do inspect a well. If problems are
identified, the seller may be unwilling or unable to provide effective
contractual protection against all or part of those problems. Any acquisition of
property interests may not be economically successful, and unsuccessful
acquisitions may have a material adverse effect on our financial condition and
future results of operations. We cannot assure you that:
o we will be able to identify desirable gas and oil prospects and acquire
leasehold or other ownership interests in such prospects at a desirable
price;
o any completed, currently planned, or future acquisitions of ownership
interests in gas and oil prospects will include prospects that contain
proven gas or oil reserves;
o we will have the ability to develop prospects which contain proven gas or
oil reserves to the point of production;
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o we will have the financial ability to consummate additional acquisitions
of ownership interests in gas and oil prospects or to develop the
prospects which we acquire to the point of production; or
o that we will be able to consummate such additional acquisitions on terms
favorable to us.
WE MAY EXPERIENCE DIFFICULTY IN ACHIEVING AND MANAGING FUTURE GROWTH.
Future growth may place strains on our resources and cause us to rely more
on project partners and independent contractors, possibly negatively affecting
our financial condition and results of operations. Our ability to grow will
depend on a number of factors, including:
o our ability to obtain leases or options on properties for which we
o have 3-D seismic data;
o our ability to acquire additional 3-D seismic data;
o our ability to identify and acquire new exploratory prospects;
o our ability to develop existing prospects;
o our ability to continue to retain and attract skilled personnel;
o our ability to maintain or enter into new relationships with project
partners and independent contractors;
o the results of our drilling program;
o hydrocarbon prices; and
o our access to capital.
We may not be successful in upgrading our technical, operations, and
administrative resources or in increasing our ability to internally provide
certain of the services currently provided by outside sources, and we may not be
able to maintain or enter into new relationships with project partners and
independent contractors. Our inability to achieve or manage growth may adversely
affect our financial condition and results of operations.
OUR BUSINESS MAY SUFFER IF WE LOSE KEY PERSONNEL.
We depend to a large extent on the services of certain key management
personnel, including our executive officers and other key employees, the loss of
any of whom could have a material adverse effect on our operations. We have
entered into employment agreements with each of Alan Gaines, our Chairman and
CEO, Amiel David, our President and COO, and Hugh Idstein, our CFO. See
"Executive Compensation - Employment Agreements." We do not maintain key-man
life insurance with respect to any of our employees. Our success will be
dependent on our ability to continue to employ and retain skilled technical
personnel.
WE FACE STRONG COMPETITION FROM OTHER NATURAL GAS AND OIL COMPANIES.
We encounter competition from other natural gas and oil companies in all
areas of our operations, including the acquisition of exploratory prospects and
proven properties. Our competitors include major integrated natural gas and oil
companies and numerous independent natural gas and oil companies, individuals,
and drilling and income programs. Many of our competitors are large,
well-established companies that have been engaged in the natural gas and oil
business much longer than we have and possess substantially larger operating
staffs and greater capital resources than we do. These companies may be able to
pay more for exploratory projects and productive natural gas and oil properties
and may be able to define, evaluate, bid for, and purchase a greater number of
properties and prospects than our financial or human resources permit. In
addition, these companies may be able to expend greater resources on the
existing and changing technologies that we believe are and will be increasingly
important to attaining success in the industry. We may not be able to conduct
its operations, evaluate, and select suitable properties and consummate
transactions successfully in this highly competitive environment.
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THE UNAVAILABILITY OR HIGH COST OF DRILLING RIGS, EQUIPMENT, SUPPLIES OR
PERSONNEL COULD AFFECT ADVERSELY OUR ABILITY TO EXECUTE ON A TIMELY BASIS OUR
EXPLORATION AND DEVELOPMENT PLANS WITHIN BUDGET, WHICH COULD HAVE A MATERIAL
ADVERSE EFFECT ON OUR FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Shortages or the high cost of drilling rigs, equipment, supplies or
personnel could delay or affect adversely our exploration and development
operations, which could have a material adverse effect on our financial
condition and results of operations. Demand for drilling rigs, equipment,
supplies and personnel currently is very high in the areas in which we operate,
particularly in the Barnett Shale. An increase in drilling activity in the areas
in which we operate could further increase the cost and decrease the
availability of necessary drilling rigs, equipment, supplies and personnel.
WE MAY NOT BE ABLE TO KEEP PACE WITH TECHNOLOGICAL DEVELOPMENTS IN OUR INDUSTRY.
The natural gas and oil industry is characterized by rapid and significant
technological advancements and introductions of new products and services using
new technologies. As others use or develop new technologies, we may be placed at
a competitive disadvantage, and competitive pressures may force us to implement
those new technologies at substantial costs. In addition, other natural gas and
oil companies may have greater financial, technical, and personnel resources
that allow them to enjoy technological advantages and may in the future allow
them to implement new technologies before we can. We may not be able to respond
to these competitive pressures and implement new technologies on a timely basis
or at an acceptable cost. If one or more of the technologies we use now or in
the future were to become obsolete or if we are unable to use the most advanced
commercially available technology, our business, financial condition, and
results of operations could be materially adversely affected.
WE ARE SUBJECT TO VARIOUS GOVERNMENTAL REGULATIONS AND ENVIRONMENTAL RISKS.
Natural gas and oil operations are subject to various federal, state, and
local government regulations that may change from time to time. Matters subject
to regulation include discharge permits for drilling operations, plug and
abandonment bonds, reports concerning operations, the spacing of wells,
unitization and pooling of properties, and taxation. From time to time,
regulatory agencies have imposed price controls and limitations on production by
restricting the rate of flow of natural gas and oil wells below actual
production capacity in order to conserve supplies of natural gas and oil. Other
federal, state, and local laws and regulations relating primarily to the
protection of human health and the environment apply to the development,
production, handling, storage, transportation, and disposal of natural gas and
oil, by-products thereof, and other substances and materials produced or used in
connection with natural gas and oil operations. In addition, we may be liable
for environmental damages caused by previous owners of property we purchase or
lease. Some environmental laws provide for joint and several strict liability
for remediation of releases of hazardous substances, rendering a person liable
for environmental damage without regard to negligence or fault on the part of
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such person. In addition, we may be subject to claims alleging personal injury
or property damage as a result of alleged exposure to hazardous substances such
as oil and gas related products. As a result, we may incur substantial
liabilities to third parities or governmental entities and may be required to
incur substantial remediation costs. We also are subject to changing and
extensive tax laws, the effects of which cannot be predicted. Compliance with
existing, new, or modified laws and regulations could have a material adverse
effect on our business, financial condition, and results of operations.
OUR ABILITY TO PRODUCE SUFFICIENT QUANTITIES OF OIL AND GAS FROM OUR PROPERTIES
MAY BE ADVERSELY AFFECTED BY A NUMBER OF FACTORS OUTSIDE OF OUR CONTROL.
Our business of exploring for and producing oil and gas involves a
substantial risk of investment loss. Drilling oil and gas wells involves the
risk that the wells may be unproductive or that, although productive, do not
produce oil and/or gas in economic quantities. Other hazards, such as unusual or
unexpected geological formations, pressures, mechanical failures, explosions,
fires, blowouts, release of toxic gases, loss of circulation of drilling fluids,
pipeline ruptures or spills, or other conditions may substantially delay or
prevent completion of any well. This could result in a total loss of our
investment in a particular property. Adverse weather conditions can also hinder
drilling operations. A productive well may become uneconomic if water or other
deleterious substances are encountered, which impair or prevent the production
of oil and/or gas from the well. In addition, production from any well may be
unmarketable if it is impregnated with water or other deleterious substances. As
with any petroleum property, there can be no assurance that oil and gas will be
produced from the properties in which we have interests. In addition, the
marketability of oil and gas which may be acquired or discovered is affected by
numerous factors beyond our control. These factors include the proximity and
capacity of oil and gas pipelines and processing equipment, market fluctuations
of prices, taxes, royalties, land tenure, allowable production and environmental
protection. We cannot predict how, when, or if any or all of these factors will
adversely affect our business. If we are unable to produce oil and/or natural
gas from our properties in commercial quantities, our operations will be
severely affected.
WE MAY NOT HAVE ENOUGH INSURANCE TO COVER ALL OF THE RISKS WE FACE.
In accordance with customary industry practices, we maintain insurance
coverage against some, but not all, potential losses in order to protect against
the risks we face. We do not carry business interruption insurance. We may elect
not to carry insurance if our management believes that the cost of available
insurance is excessive relative to the risks presented. In addition, we cannot
insure fully against pollution and environmental risks. The occurrence of an
event not fully covered by insurance could have a material adverse effect on our
financial condition and results of operations.
OPERATORS OF PROSPECTS IN WHICH WE PARTICIPATE MAY NOT MAINTAIN OR MAY FAIL TO
OBTAIN ADEQUATE INSURANCE.
Oil and gas operations are subject to particular hazards incident to the
drilling and production of oil and gas, such as blowouts, cratering, explosions,
uncontrollable flows of oil, gas or well fluids, fires and pollution and other
environmental risks. These hazards can cause personal injury and loss of life,
severe damage to and destruction of property and equipment, pollution or
environmental damage and suspension of operation. We do not operate all of the
properties in which we have an interest. In the projects in which we own a
non-operating interest directly or own an equity interest in a limited
partnership which in turn owns a non-operating interest, the operator for the
prospect maintains insurance of various types to cover our operations with
policy limits and retention liability customary in the industry. We believe the
coverage and types of insurance are adequate. The occurrence of a significant
adverse event that is not fully covered by insurance could result in the loss of
our total investment in a particular prospect which could have a material
adverse effect on our financial condition and results of operations.
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THE MARKETABILITY OF OUR NATURAL GAS PRODUCTION DEPENDS ON FACILITIES THAT WE
TYPICALLY DO NOT OWN OR CONTROL, WHICH COULD RESULT IN A CURTAILMENT OF
PRODUCTION AND REVENUES.
The marketability of our production depends in part upon the availability,
proximity, and capacity of natural gas gathering systems, pipelines, and
processing facilities. We generally deliver natural gas through gas gathering
systems and gas pipelines that we do not own under interruptible or short-term
transportation agreements. Under the interruptible transportation agreements,
the transportation of our gas may be interrupted due to capacity constraints on
the applicable system, for maintenance or repair of the system, or for other
reasons as dictated by the particular agreements. Our ability to produce and
market natural gas on a commercial basis could be harmed by any significant
change in the cost or availability of such markets, systems, or pipelines.
WE CANNOT CONTROL THE ACTIVITIES ON PROPERTIES WE DO NOT OPERATE AND ARE UNABLE
TO ENSURE THEIR PROPER OPERATION AND PROFITABILITY.
We do not operate all of the properties in which we have an interest. As a
result, we have limited ability to exercise influence over, and control the
risks associated with, operations of these properties. The failure of an
operator of our wells to adequately perform operations, an operator's breach of
the applicable agreements, or an operator's failure to act in ways that are in
our best interests could reduce our production and revenues. The success and
timing of our drilling and development activities on properties operated by
others depends upon a number of factors outside of our control, including the
operator's:
o timing and amount of capital expenditures;
o expertise and financial resources;
o inclusion of other participants in drilling wells; and
o use of technology.
WE MAY HEDGE THE PRICE RISKS ASSOCIATED WITH OUR PRODUCTION. OUR HEDGE
TRANSACTIONS MAY RESULT IN OUR MAKING CASH PAYMENTS OR PREVENT US FROM
BENEFITING TO THE FULLEST EXTENT POSSIBLE FROM INCREASES IN PRICES FOR NATURAL
GAS AND OIL.
Because natural gas and oil prices are unstable, as we grow, we may enter
into price-risk-management transactions such as swaps, collars, futures, and
options to reduce our exposure to price declines associated with a portion of
our natural gas and oil production and thereby to achieve a more predictable
cash flow. The use of these arrangements will limit our ability to benefit from
increases in the prices of natural gas and oil. Our hedging arrangements may
apply to only a portion of our production, thereby providing only partial
protection against declines in natural gas and oil prices. These arrangements
could expose us to the risk of financial loss in certain circumstances,
including instances in which production is less than expected, our customers
fail to purchase contracted quantities of natural gas and oil, or a sudden,
unexpected event materially impacts natural gas or oil prices.
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RISKS RELATED TO THE COMMON STOCK
YOU MAY EXPERIENCE DILUTION OF YOUR OWNERSHIP INTERESTS DUE TO THE FUTURE
ISSUANCE OF ADDITIONAL SHARES OF OUR COMMON STOCK.
We may in the future issue our previously authorized and unissued
securities which will result in the dilution of the ownership interests of our
present stockholders. We are currently authorized to issue 100,000,000 shares of
Common Stock and 1,000,000 shares of preferred stock with such designations,
preferences and rights as determined by our board of directors. As of May 16,
2006, we have outstanding 59,244,859 shares of Common Stock and have outstanding
options and warrants to purchase an additional 3,602,657 shares of Common Stock.
Some of these securities contain anti-dilution provisions that will result in
the issuance of additional shares in the event we sell additional shares of
Common Stock at prices less than the applicable conversion price. Issuance of
these shares of Common Stock may substantially dilute the ownership interests of
our existing stockholders. The potential issuance of such additional shares of
Common Stock may create downward pressure on the trading price of our Common
Stock that in turn will require us to issue additional shares to raise funds
through sales of our securities. We may also issue additional shares of our
capital stock in connection with the hiring of personnel, future acquisitions,
future private placements of our securities for capital raising purposes, or for
other business purposes. This will further dilute the interests of our existing
holders.
WE DO NOT INTEND TO PAY DIVIDENDS IN THE FORESEEABLE FUTURE.
We have never declared or paid a dividend on our Common Stock. We intend
to retain earnings, if any, for use in our operations and the expansion of our
business and therefore do not anticipate paying any dividends in the foreseeable
future.
A SIGNIFICANT MARKET FOR OUR COMMON STOCK MAY NOT DEVELOP.
Our Common Stock began trading on the American Stock Exchange on May 9,
2005. The average daily volume for the Common Stock over the past three months
is approximately 70,000 shares. We are not certain that an active trading market
in our Common Stock will develop, or if such a market develops, that it will be
sustained.
THE TRADING PRICE OF OUR COMMON STOCK MAY BE VOLATILE.
The trading price of our shares has from time to time fluctuated widely
and in the future may be subject to similar fluctuations. The trading price may
be affected by a number of factors, including the risk factors set forth herein,
as well as our operating results, financial condition, announcements or drilling
activities, general conditions in the oil and gas exploration and development
industry, and other events or factors. In addition, the potential influx of a
substantial number of shares into the public market as a result of the
effectiveness of this registration statement could have significant negative
effect on the trading price of our Common Stock. In recent years, broad stock
market indices, in general, and smaller capitalization companies, in particular,
have experienced substantial price fluctuations. In a volatile market, we may
experience wide fluctuations in the market price of our Common Stock. These
fluctuations may have an extremely negative effect on the market price of our
Common Stock.
WHERE YOU CAN FIND MORE INFORMATION
We have filed with the U.S. Securities and Exchange Commission, 450 Fifth
Street, N.W., Washington, D.C. 20549, a registration statement on Form SB-2,
under the Securities Act for the common stock offered by this prospectus. We
have not included in this prospectus all the information contained in the
registration statement and you should refer to the registration statement and
its exhibits for further information.
10
Any statement in this prospectus about any of our contracts or other
documents is not necessarily complete. If the contract or document is filed as
an exhibit to the registration statement, the contract or document is deemed to
modify the description contained in this prospectus. You must review the
exhibits themselves for a complete description of the contract or document.
The registration statement and other information may be read and copied at
the Commission's Public Reference Room at 450 Fifth Street N.W., Washington,
D.C. 20549. The public may obtain information on the operation of the Public
Reference Room by calling the Commission at 1-800-SEC-0330. The SEC maintains a
web site (HTTP://WWW.SEC.GOV.) that contains the registration statements,
reports, proxy and information statements and other information regarding
registrants that file electronically with the SEC such as us.
You may also read and copy any reports, statements or other information
that we have filed with the SEC at the addresses indicated above and you may
also access them electronically at the web site set forth above. These SEC
filings are also available to the public from commercial document retrieval
services.
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
Our disclosure and analysis in this prospectus contain some
forward-looking statements. Certain of the matters discussed concerning our
operations, cash flows, financial position, economic performance and financial
condition, including, in particular, future sales, product demand, competition
and the effect of economic conditions include forward-looking statements within
the meaning of section 27A of the Securities Act of 1933, referred to herein as
the Securities Act, and Section 21E of the Securities Exchange Act of 1934,
referred to herein as the Exchange Act.
Statements that are predictive in nature, that depend upon or refer to
future events or conditions or that include words such as "expects,"
"anticipates," "intends," "plans," "believes," "estimates" and similar
expressions are forward-looking statements. Although we believe that these
statements are based upon reasonable assumptions, including projections of
orders, sales, operating margins, earnings, cash flow, research and development
costs, working capital, capital expenditures, distribution channels,
profitability, new products, adequacy of funds from operations, these statements
and other projections and statements contained herein expressing general
optimism about future operating results and non-historical information, are
subject to several risks and uncertainties, and therefore, we can give no
assurance that these statements will be achieved.
Investors are cautioned that our forward-looking statements are not
guarantees of future performance and actual results or developments may differ
materially from the expectations expressed in the forward-looking statements.
As for the forward-looking statements that relate to future financial
results and other projections, actual results will be different due to the
inherent uncertainty of estimates, forecasts and projections and may be better
or worse than projected. Given these uncertainties, you should not place any
reliance on these forward-looking statements. These forward-looking statements
also represent our estimates and assumptions only as of the date that they were
made. We expressly disclaim a duty to provide updates to these forward-looking
statements, and the estimates and assumptions associated with them, after the
date of this filing to reflect events or changes in circumstances or changes in
expectations or the occurrence of anticipated events.
11
We undertake no obligation to publicly update any forward-looking
statement, whether as a result of new information, future events or otherwise.
You are advised, however, to consult any additional disclosures we make in our
Form 10-KSB, Form 10-QSB and Form 8-K reports to the SEC. Also note that we
provide a cautionary discussion of risk and uncertainties under the caption
"Risk Factors" in this prospectus. These are factors that we think could cause
our actual results to differ materially from expected results. Other factors
besides those listed here could also adversely affect us. This discussion is
provided as permitted by the Private Securities Litigation Reform Act of 1995.
USE OF PROCEEDS
We will not receive any of the proceeds from the selling stockholders'
sale of the shares offered under this prospectus.
DETERMINATION OF OFFERING PRICE
We are not selling any of the Common Stock that we are registering. The
Common Stock will be sold by the selling security holders listed in this
prospectus. The selling security holders may sell the Common Stock at the market
price as of the date of sale or a price negotiated in a private sale. Our Common
Stock is traded on the American Stock Exchange under the symbol "DNE". On May
16, 2006 the reported closing price for our Common Stock on the American Stock
Exchange was $3.35.
We have agreed to pay certain expenses in connection with the registration
of the securities offered by the selling security holders for resale pursuant to
this prospectus.
SELLING SECURITY HOLDERS
Based on information provided by the selling security holders, the table
below sets forth certain information, as of March 31, 2006 unless otherwise
noted, regarding the selling security holders. Certain of the selling security
holders are listed more than once in the following table because they fall into
multiple categories of selling security holders.
Percentage ownership of common stock is based on 59,244,859 shares of our
Common Stock outstanding as of March 31, 2006. In addition, the table below
assumes, for calculating each selling security holder's beneficial ownership,
that options, warrants and convertible securities held by such security holder
(but not, unless otherwise noted, those held by any other person) that are
exercisable within 60 days of March 31, 2006, have been exercised and converted
and the shares underlying them added to the number of shares of our Common Stock
deemed to be outstanding. For purposes of calculating the post-offering
ownership of each selling security holder, the table also assumes the sale of
all of the securities being offered by such selling security holder.
Next to the name of each selling stockholder listed below that is not a
natural person (or the name of which is not identified with a natural person),
we have set forth in parentheses the name of the natural person who has the
power to exercise voting and/or investment power over the shares owned by such
selling stockholder. Except for Sanders Morris Harris Inc., who served as the
placement agent in our September 2005 and February 2006 private offerings, no
selling stockholder is a registered broker-dealer.
12
The second column in the table below lists the number of shares of Common
Stock beneficially owned by each selling stockholder, based on his/her ownership
of the shares of our Common Stock.
The third column lists the shares of Common Stock being offered by this
prospectus by the selling stockholders.
The fourth column assumes the sale of all of the shares offered by the
selling stockholders pursuant to this prospectus.
The selling stockholders may sell all, some or none of their shares in
this offering. See "Plan of Distribution."
Common stock beneficially owned
after the offering
Number of shares
of common stock
beneficially Number of Percentage of
owned prior to shares being Number of outstanding
Name of selling security holders the offering offered shares shares
Investors in September 2005
Financing (1):
Apollo MicroCap Partners, L.P. (Kyle Krueger) 120,000 120,000 0 0
Apollo Capital Management Group, L.P. (Kyle Krueger) 150,000 150,000 0 0
Superius Securities Group Profit Sharing Plan (James
Hudgins) 433,000 433,000 0 0
Ridgeston Limited (Alex Kabanov) 2,271,000 2,271,000 0 0
Sanders Morris Harris Inc. (Don Sanders) (1a)(A)(C) 1,493,567 1,493,567 0 0
Investors in February 2006
Financing (2):
James Investments Inc. (Robert Alpert) 40,000 40,000 0 0
Joe M. Bailey 15,000 15,000 0 0
William D. Bain Jr. and Peggy Brooks Bain Ten Com 10,000 10,000 0 0
George L. Ball 20,000 20,000 0 0
13
Richard E. Bean (B)(C) 15,000 15,000 0 0
Bill Birdwell & Willie C. Birdwell JTWROS 30,000 30,000 0 0
Thomas Brady & Daniel Brady TTEE E. P. Brady Ltd.
Profit Sharing Plan & Trust 35,000 35,000 0 0
David M. Breen & Shelly P. Breen JTWROS 10,000 10,000 0 0
Tad Buchanan 10,000 10,000 0 0
J. Michael Buchanan 10,000 10,000 0 0
E. Dean Catlett & Jo Ann Catlett Ten In Com 15,000 15,000 0 0
Michael S. Chadwick (B)(D)(E) 27,500 10,000 0 0
Maria Checa 30,000 30,000 0 0
James W. Christmas 30,000 30,000 0 0
W. Roger Clemens, Special Retirement Account 20,000 20,000 0 0
Bobby Smith Cohn 15,000 15,000 0 0
Elizabeth Kirby Cohn McCool 15,000 15,000 0 0
Morton A. Cohn 60,000 60,000 0 0
Anne Lindsay Cohn Holstead 15,000 15,000 0 0
Courtney Cohn Hopson Separate Account 15,000 15,000 0 0
Thomas W. Custer 15,000 15,000 0 0
Bruce A. Davidson and Laura A. Davidson JT TEN 20,000 20,000 0 0
Chip Davis 10,000 10,000 0 0
Jonathan Day and Barbara Day T/I/C 10,000 10,000 0 0
Max Dillard 25,000 25,000 0 0
M. St. John Dinsmore 25,000 25,000 0 0
Richard Domercq 10,000 10,000 0 0
Tanya J. Drury 15,000 15,000 0 0
Leigh Ellis and Mimi G. Ellis JTWROS 15,000 15,000 0 0
Belmont Ventures, Inc. (John Eulich) 75,000 75,000 0 0
Stephen Falk, M.D. and Sheila Falk, T/I/C 20,000 20,000 0 0
Dave Fendrick and Brenda Fendrick JTWROS 10,000 10,000 0 0
IRA FBO Dave Fendrick / Pershing LLC as Custodian 10,000 10,000 0 0
Patrice Leigh Ferguson 10,000 10,000 0 0
Paul F. Ferguson, Jr. 30,000 30,000 0 0
14
Franklin C. Fisher, Jr. 40,000 40,000 0 0
Robert E. Garrison, II (B)(D)(E) 15,000 15,000 0 0
Kevin Richard Gosik & Constance Ann Gosik JT Ten 10,000 10,000 0 0
Moshe Grad 15,000 15,000 0 0
John H. Gray and Sandra A. Gray JTWROS 15,000 15,000 0 0
IRA FBO Linda Lorelle Gregory/Pershing LLC as
Custodian 10,000 10,000 0 0
Tolar N. Hamblen, III 10,000 10,000 0 0
Kenneth L. Hamilton & Teresa R. Hamilton TIC
(B)(D)(E) 5,000 5,000 0 0
Dick Harmon 10,000 10,000 0 0
Steve Harter 20,000 20,000 0 0
John V. Hazleton Jr. & Bonnie C. Hazleton, TIC 10,000 10,000 0 0
Sharetron Limited Partnership (John V. Hazleton) 20,000 20,000 0 0
Edward F. Heil 40,000 40,000 0 0
Richard Hochman Special 10,000 10,000 0 0
Gerald H. Hunsicker and Irene H. Hunsicker JTWROS 15,000 15,000 0 0
Hunter & Co. LLC Defined Pension Plan (John Laurie
Hunter) 20,000 20,000 0 0
Anthony S. Jacobs 105,000 105,000 0 0
John W. Johnson 25,000 25,000 0 0
Brian Keller & Lesley Lipshultz Keller JT TEN 10,000 10,000 0 0
Donald R. Kendall, Jr. 15,000 15,000 0 0
IRA FBO Robert Larry Kinney / Pershing LLC as
Custodian Rollover Account (B)(D)(E) 25,000 25,000 0 0
J. Livingston Kosberg 50,000 50,000 0 0
Dennis Charles Liborio 10,000 10,000 0 0
Robert A. Lurie 35,000 35,000 0 0
John H. Malanga and Jodi F. Malanga, JT Ten (B)(D)(E) 10,000 10,000 0 0
IRA FBO Jeff G. Mallett / Pershing LLC as Custodian
/ Roth Account 20,000 20,000 0 0
15
Vincent Lee Marable III 20,000 20,000 0 0
Larry Martin 55,800 25,000 0 0
Ed McAninch 25,000 25,000 0 0
IRA FBO Thomas W. McBride Pershing LLC as Custodian
Rollover Account 25,000 25,000 0 0
Bruce R. McMaken (B)(D)(E) 12,000 12,000 0 0
Bruce Mendleson 10,000 10,000 0 0
Kendall C. Montgomery 25,000 25,000 0 0
Jackie S. Moore 10,000 10,000 0 0
George Moorehead 20,000 20,000 0 0
Ben T. Morris (B)(D)(E) 25,000 25,000 0 0
Donna Moss 15,000 15,000 0 0
John M. O'Quinn 100,000 75,000 0 0
Stephen S. Oswald 10,000 10,000 0 0
Brian Payne and Heather Payne T/I/C 10,000 10,000 0 0
SEP FBO Rick Pease Pershing LLC as Custodian 10,000 10,000 0 0
Leonard Rauch Special 25,000 25,000 0 0
Caryl R. Reese and Albert L. Reese JTWROS 15,000 15,000 0 0
Jack Richman TTEE of the 2000 Jack Family Trust
U/D/T 02/10/00 10,000 10,000 0 0
IRA FBO: Donald J. Roennigke Pershing LLC As
Custodian Rollover Account 20,000 20,000 0 0
Rosen Family Trust 90,000 90,000 0 0
Nolan Ryan 20,000 20,000 0 0
Frederic L. Saalwachter 12,000 12,000 0 0
Don Sanders and Tanya Drury TTEES FBO Tanya Jo Drury
Trust (B)(D)(E) 25,000 25,000 0 0
IRA FBO Don A. Sanders Pershing LLC as Custodian
(B)(D)(E) 130,000 130,000 0 0
IRA FBO Janet R. Sanders/Pershing LLC as Custodian 10,000 10,000 0 0
IRA FBO: Katherine U. Sanders/Pershing LLC as
Custodian (B)(D)(E) 70,000 70,000 0 0
Laura K. Sanders (B)(D)(E) 35,000 35,000 0 0
Sanders Opportunity Fund (Institutional), L.P. (Brad
Sanders) (B)(D)(E) 363,000 363,000 0 0
16
Sanders Opportunity Fund, L.P. (Brad Sanders)
(B)(D)(E) 112,000 112,000 0 0
IRA FBO Paul H. Sanders, Jr./Pershing LLC as
Custodian Rollover Account 10,000 10,000 0 0
Butler Company, a Partnership (Edwin G. Sandhop) 20,000 20,000 0 0
Edwin G. Sandhop 20,000 20,000 0 0
Wesley Schaffran 15,000 15,000 0 0
Grant E. Sims and Patricia Sims JT TEN 40,000 40,000 0 0
SEP FBO Robert Slanovits Pershing LLC as Custodian 10,000 10,000 0 0
Bruce Slovin 40,000 40,000 0 0
Talbot M. Smith 15,000 15,000 0 0
Robert J. Sproule & Linda M. Sproule TIC 5,000 5,000 0 0
Tanglewood Family Limited Partnership (W. Michael
Stephens) 15,000 15,000 0 0
Fred A. Stone, Jr. 10,000 10,000 0 0
SEP IRA William M. Stradley / Pershing Inc. as
Custodian 5,000 5,000 0 0
Matthew Swarts 10,000 10,000 0 0
Paul Tate and Lara M. Tate TIC 30,000 30,000 0 0
David Towery 20,000 20,000 0 0
P & J Fingerhut Family Trust, Joan Fingerhut
Trustee, John Tuschman Agent UDPA (John Tuschman) 15,000 15,000 0 0
Don Weir and Julie Ellen Weir Ten In Com (B)(D)(E) 59,000 59,000 0 0
Donald V. Weir TTEE Sanders 1998 Children's Trust
DTD 12/01/97 100,000 100,000 0 0
Eric Glenn Weir 30,000 30,000 0 0
Lisa Dawn Weir 30,000 30,000 0 0
Lara M. Tate, Lisa Weir, Eric G. Weir Co TTEES Weir
1997 Grandchildrens Trust UA 04-17-97 10,000 10,000 0 0
Constance O. Welsch/Simple IRA - Pershing LLC
Custodian (Glenn A. Welsch) 10,000 10,000 0 0
Glenn A. Welsch/Simple IRA - Pershing LLC Custodian 10,000 10,000 0 0
J-All Partnership (Dennis J. Wilkerson) 25,000 25,000 0 0
17
IRA FBO Mark E. Wise Pershing LLC as Custodian
Rollover Account 15,000 15,000 0 0
Sharon Perry Wise Separate Property Account 20,000 20,000 0 0
IRA FBO Robert E. Witt Pershing LLC as Custodian
Rollover Account 25,000 25,000 0 0
Zadok Jewelers (Dror Zadok) 30,000 30,000 0 0
Zadok Jewelry Inc. 401K Profit Sharing Plan (Dror
Zadok) 20,000 20,000 0 0
Thomas E. Asarch / Barbara Asarch 9,434 9,434 0 0
Rose Anna Marshall 18,868 18,868 0 0
IRA FBO Scott Marshall / Pershing LLC as Custodian 18,868 18,868 0 0
Leonard Olim 9,434 9,434 0 0
Blake Selig 9,434 9,434 0 0
IRA FBO Friedrich Brenckmann / Pershing LLC as
Custodian 18,868 18,868 0 0
Knox Family Limited Partnership 9,434 9,434 0 0
IRA FBO Marc S. Powell / Pershing LLC as Custodian 11,320 11,320 0 0
Lee Harrison Corbin / Daniel Corbin 45,000 45,000 0 0
Edwin Freedman 66,000 66,000 0 0
Bill Haak / Johnnie S. Haak 18,868 18,868 0 0
Nathan Hagens 20,000 20,000 0 0
IRA FBO Erick Klefos / Pershing LLC as Custodian
(B)(D)(E) 10,000 10,000 0 0
Brian Kuhn 100,000 100,000 0 0
Carter D. Pope 56,604 56,604 0 0
John R. Fox 9,434 9,434 0 0
Steven R. Hall / Rebecca A. Hall 9,434 9,434 0 0
Roy Alan Price 9,434 9,434 0 0
Benedek Investment Group, LLC (A. Richard Benedek) 37,736 37,736 0 0
Ilex Investments LP (Robert George Crawford) 56,604 56,604 0 0
Ron Davi 56,604 56,604 0 0
Superius Securities Group Inc. Profit Sharing Plan
(James Hudgins) 339,622 339,622 0 0
18
Superius Securities Group Inc. Profit Sharing Plan
(James Hudgins) 66,990 66,990 0 0
Stanley Katz 37,736 37,736 0 0
Geriann Sweeney and Louis Paul Lohn Cohn Com Prop. 18,868 18,868 0 0
Alan J Rubin 37,736 37,736 0 0
Howard I Simon 37,736 37,736 0 0
Arthur Sinensky 37,736 37,736 0 0
Louis Stumberg 9,434 9,434 0 0
TWM Associates, LLC (Scott Stone) 37,736 37,736 0 0
IRA FBO Marc W. Evans / Pershing LLC as Custodian
(B)(D)(E) 9,434 9,434 0 0
Sam Ginzburg (B)(D)(E) 9,434 9,434 0 0
The Leland Family Partnership, L.P. (Leland Hirsch) 9,434 9,434 0 0
Mazzei Holding, LLC (Michael Mazzei) 9,434 9,434 0 0
Atlantis Software Co. (Rune Medhus) (B)(D)(E) 15,094 15,094 0 0
Rune Medhus (B)(D)(E) 32,943 32,943 0 0
T. Scott O'Keefe 18,868 18,868 0 0
Jan Rask 18,868 18,868 0 0
Stephen J. Glantz (B)(D)(E) 9,434 9,434 0 0
Donald Moss 15,094 15,094 0 0
Jeffrey J. Orchen P/S Plan DTD 1/1/95 22,641 22,641 0 0
Jeffrey Orchen, DDS 18,868 18,868 0 0
Judith Ricciardi 18,868 18,868 0 0
Arnold Schumsky 9,434 9,434 0 0
Michael J. Gaido, Jr. 20,000 20,000 0 0
Mark N. Davis 9,434 9,434 0 0
Steven R. Elliott 9,434 9,434 0 0
Matthew C. Forrester 9,434 9,434 0 0
John W. Howton 9,434 9,434 0 0
William H. Mildren 9,434 9,434 0 0
David Shadid 9,434 9,434 0 0
Brian Reiner 9,434 9,434 0 0
Gerald Parselle Wilton 37,736 37,736 0 0
19
Capital Ventures International (Martin Kobinger)
(B)(D)(E) 283,019 283,019 0 0
Shepherd Investments International, Ltd. (Michael A.
Roth, Brian J. Stark) (B)(D)(E) 283,019 283,019 0 0
US Global Investors - Global Resources Fund A/C
8144024 377,358 377,358 0 0
Goldman Sachs & Co. 135,000 135,000 0 0
Goldman Sachs & Co. Long ShortFund 543,000 543,000 0 0
Iroquois Master Fund Ltd. (Joshua Silverman) 75,472 75,472 0 0
Basso Fund Ltd. (Howard I. Fischer) 17,000 17,000 0 0
Basso Multi-Strategy Holding Fund Ltd. (Howard I.
Fischer) 63,000 63,000 0 0
Basso Private Opportunities Holding Fund Ltd.
(Howard I. Fischer) 20,000 20,000 0 0
Nite Capital LP (Keith A. Goodman) 94,340 94,340 0 0
DKR Sound Shore Oasis Holding Fund Ltd. (Seth
Fischer) 177,358 177,358 0 0
TRUK International Fund, LP (Michael E. Fein and
Stephen Saltzstein) 9,434 9,434 0 0
TRUK Opportunity Fund, LLC (Michael E. Fein and
Stephen Saltzstein) 90,566 90,566 0 0
Edward Ajootian 20,000 20,000 0 0
Frey Living Trust of 3/20/96 (Philip Frey, Jr.) 20,000 20,000 0 0
Li-San Hwang / Anne H Hwang 100,000 100,000 0 0
George H. Robinette III 10,000 10,000 0 0
Tembo Associates LLC, Series C (Jeffrey Tweedy) 37,500 37,500 0 0
Tembo Associates LLC, Series C (Jeffrey Tweedy) 56,840 56,840 0 0
Cordillera Fund, L.P. (James P. Anderson, Stephen J.
Carter) 377,360 377,360 0 0
Diamondback Master Fund, Ltd. (Chad R. Loweth) 377,360 377,360 0 0
Enable Growth Partners LP (Mitch Levine) (B)(D)(E) 234,234 234,234 0 0
Enable Opportunity Partners LP (Mitch Levine)
(B)(D)(E) 38,505 38,505 0 0
Pierce Diversified Strategy
Master Fund LLC (Mitch Levine) (B)(D)(E) 48,130 48,130 0 0
20
Shepherd Investments International, Ltd. (Michael A.
Roth, Brian J. Stark) (B)(D)(E) 500,000 500,000 0 0
Stilletto Capital Partners, LP (Jonathan Sorensen)
(B)(D)(E) 36,911 36,911 0 0
Capital Ventures International (Martin Kobinger)
(B)(D)(E) 200,000 200,000 0 0
Holders of Stock Options (3):
R. Scott Barter (3a) 250,000 250,000 0 0
Chris Lautenslager (3b) 50,000 50,000 0 0
Wall Street Group (Donald Kirsch) (3c) 133,333 133,333 0 0
Steven Barrenechea (3d) 237,500 75,000 162,500 *
Marshall Lynn Bass (3e) 75,000 75,000 0 0
Amiel David (3f) 906,250 750,000 156,250 *
Hugh Idstein (3g) 175,000 175,000 0 0
Alan Gaines (3h) 3,315,501 625,000 2,690,501 4.3
Pat Donais (3i) 15,000 15,000 0 0
Greg Fox (3j) 30,000 30,000 0 0
Steven Sisselman (3k) 50,000 50,000 0 0
Raissa Frenkel (3k) 50,000 50,000 0 0
Richard Cohen (3k) 50,000 50,000 0 0
Valery Otchertsov (3k) 50,000 50,000 0 0
Totals: 18,855,151 15,845,900 3,009,251 4.8
- ----------
(*) Less than one percent.
(A) Is a registered broker dealer.
(B) Is an affiliate of a registered broker dealer.
(C) Is deemed to be an underwriter.
(D) Is not deemed to be an underwriter.
(E) Acquired its shares of Common Stock in the ordinary business and, at the
time of the acquisition, did not have any arrangements or understandings
with any person to distribute the securities.
21
(1) The investors from our September 2005 Financing are listed below under
this heading. Unless otherwise noted, the shares of Common Stock listed as
beneficially owned by the holder are the shares acquired by the holder in
the September 2005 Financing. We raised an aggregate gross amount of
$6,000,000 in our September 2005 Financing by selling a total of 3,243,243
shares of Common Stock at the price of $1.85 per share. Sanders Morris
Harris Inc. ("SMH") was both an investor and our placement agent in the
September 2005 Financing. We issued to SMH, as our placement agent in our
September 2005 Financing, warrants to purchase 324,324 shares of our
Common Stock at the exercise price of $1.85 per share. The warrants expire
on September 30, 2010 and provide for cashless exercise.
(1a) Of the shares of Common Stock listed as beneficially owned by the holder,
(i) 269,243 are shares purchased by the holder in the September 2005
Financing (ii) 324,324 are shares underlying the warrant issued to the
holder, as placement agent, in connection with the September 2005
Financing, and (iii) 900,000 are shares underlying the warrant issued to
the holder, as a placement agent, in connection with our February 2006
Financing. The first warrant has an exercise price of $1.85 per share and
the second warrant has an exercise price of $2.65 per share. Both warrants
expire five-years after the date of their grant and provide for cashless
exercise. Since the holder is a broker-dealer that acquired the 269,243
shares referenced in (i) above other than as compensation for investment
banking services, such selling securityholder is an underwriter.
(2) The investors from our February 2006 Financing are listed below under this
heading. Unless otherwise noted, the shares of Common Stock listed as
beneficially owned by the holder are the shares acquired by the holder in
the February 2006 Financing. We raised an aggregate gross amount of
$23,850,000 in the February 2006 Financing by selling a total of 9,000,000
shares of Common Stock at the price of $2.65 per share. We issued to SMH,
as a co-placement agent in the February 2006 Financing, warrants to
purchase 900,000 shares of our Common Stock at the exercise price of $2.65
per share. The warrants expire on February 1, 2011 and provide for
cashless exercise.
(3) The Holders of stock options are listed below under this heading. Unless
otherwise noted, all stock options listed below are fully vested and
expire on the fifth anniversary of the date they were granted.
(3a) Represents options, granted as of November 1, 2003, to purchase 250,000
shares of Common Stock at the exercise price of $0.54 per share, granted
for services as a consultant to the Company. The options are held by R.
Scott Barter Defined Contribution Plan.
(3b) Holds options, granted as of December 4, 2003, to purchase 50,000 shares
of Common Stock at the exercise price of $0.90 per share. The holder was a
director of the Company from December 2003 to May 2004.
(3c) Holds options, granted as of November 15, 2004, to purchase 133,333 shares
of Common Stock at the exercise price of $0.75 per share. The holder
provided investor relations services to us from November 2004 to November
2005.
(3d) Holds options, granted as of December 15, 2004, to purchase 25,000 shares
of Common Stock at the exercise price of $0.85 per share. Also holds
options granted, as of October 28, 2005, to purchase 50,000 shares of
Common Stock at the exercise price of $2.35 per share. The holder is one
of our directors.
(3e) Holds options, granted as of December 15, 2004, to purchase 25,000 shares
of Common Stock at the exercise price of $0.85 per share. Also holds
options, granted as of October 28, 2005, to purchase 50,000 shares of
Common Stock at the exercise price of $2.35 per share. The holder is one
of our directors.
22
(3f) Holds options, granted as of February 15, 2005, to purchase 250,000 shares
of Common Stock at the exercise price of $1.25 per share. Also holds
options, granted as of May 12, 2005, to purchase 500,000 shares of Common
Stock at the exercise price of $2.44 per share. The latter options vested
on the date of grant with respect to 250,000 shares and will vest on the
first anniversary of the date of grant with respect to the remaining
250,000 shares. The holder is our President and Chief Operating Officer.
(3g) Holds options, granted as of April 4, 2005, to purchase 75,000 shares of
Common Stock at the exercise price of $2.56 per share. The options vested
on the date of grant with respect to 25,000 shares and vest on each of the
first and second anniversaries of the date of grant with respect to 25,000
shares. The holder is our Chief Financial Officer.
(3h) Holds options, granted as of May 12, 2005, to purchase 625,000 shares of
Common Stock at the exercise price of $2.44 per share. The options vested
on the date of grant with respect to 250,000 shares, will vest on the
first anniversary of the date of grant with respect to 250,000 shares, and
will vest on the second anniversary of the date of grant with respect to
125,000 shares. The holder is our Chairman and CEO.
(3i) Holds options, granted as of July 18, 2005, to purchase 15,000 shares of
Common Stock at the exercise price of $2.30 per share. The options vest on
the first anniversary of the date of grant. The holder is our
geophysicist.
(3j) Holds options, granted as of August 3, 2005, to purchase 30,000 shares of
Common Stock at the exercise price of $2.54 per share. The options will
vest on the first anniversary of the date of grant. The holder is our
operations manager.
(3k) Holds options, granted as of October 28, 2005, to purchase 50,000 shares
of Common Stock at the exercise price of $2.35 per share. The options
became exercisable in full upon our obtaining shareholder approval for
such options. The holder is one of our directors. Mr. Cohen is also our
Secretary.
23
PLAN OF DISTRIBUTION
All fees, costs, expenses and fees in connection with the registration of
the Common Stock offered by this prospectus will be borne by us. Brokerage
commissions, if any, attributable to the sale of the Common Stock will be borne
by the selling security holders.
The selling security holders may sell the Common Stock directly or through
brokers, dealers or underwriters who may act solely as agents or may acquire
Common Stock as principals. The selling stockholders may distribute the Common
Stock in one or more of the following methods:
o ordinary brokers transactions, which may include long or short sales;
o transactions involving cross or block trades or otherwise on the open
market;
o purchases by brokers, dealers or underwriters as principal and resale by
these purchasers for their own accounts under this prospectus;
o "at the market" to or through market makers or into an existing market for
the Common Stock;
o in other ways not involving market makers or established trading markets,
including direct sales to purchasers or sales made through agents;
o through transactions in options, swaps or other derivatives (whether
exchange listed or otherwise); or
o any combination of the above, or by any other legally available means.
Selling security holders will not be restricted as to the price or prices
at which the selling security holders may sell their Common Stock. Sales of
Common Stock by the selling security holders may depress the market price of our
Common Stock since the number of shares which may be sold by the selling
security holders is very large compared to the historical average weekly trading
volume of our Common Stock, which has been quite low. Accordingly, if the
selling security holders were to sell, or attempt to sell, all of such
securities at once or during a short time period, we believe such a transaction
would dramatically adversely affect the market price of our Common Stock.
From time to time a selling security holder may pledge its Common Stock
under margin provisions of customer agreements with its brokers or under loans
with third parties. Upon a default by the selling security holder, the broker or
such third party may offer and sell any pledged securities from time to time.
In effecting sales, brokers and dealers engaged by a selling security
holder may arrange for other brokers or dealers to participate in the sales as
agents or principals. Brokers or dealers may receive commissions or discounts
from the selling security holder or, if the broker-dealer acts as agent for the
purchaser of such Common Stock, from the purchaser in amounts to be negotiated,
which compensation as to a particular broker dealer might be in excess of
customary commissions customary in the types of transactions involved.
Broker-dealers may agree with the selling security holders to sell a specified
number of shares of Common Stock at a stipulated price, and to the extent the
broker-dealer is unable to do so acting as agent for the selling security
holders, to purchase as principal any unsold securities at the price required to
fulfill the broker-dealer commitment to the selling security holder.
Broker-dealers who acquire securities as principal may then resell those
securities from time to time in transactions: in the over-the counter market or
otherwise; at prices and on terms prevailing at the time of sale; at prices
related to the then-current market price; or in negotiated transactions.
These resales may involve block transactions or sales to and through other
broker-dealers, including any of the transactions described above. In connection
with these sales, these broker-dealers may pay to or receive from the purchasers
of the Common Stock commissions as described above. The selling security holders
may also sell the Common Stock in open market transactions under Rule 144 under
the Securities Act, rather than under this prospectus.
24
The selling security holders and any broker-dealers or agents that
participate with the selling security holders in sales of the Common Stock may
be deemed to be "underwriters" within the meaning of the Securities Act in
connection with these sales. In this event, any commissions received by these
broker-dealers or agents and any profit on the resale of the Common Stock
purchased by them may be deemed to be underwriting commissions or discounts
under the Securities Act.
The selling security holders may agree to indemnify any agent, dealer or
broker-dealer that participates in transactions involving sales of the Common
Stock against certain liabilities, including liabilities arising under the
Securities Act.
NASD Notice to Members 88-101 states that in the event a selling
shareholder intends to sell any of the shares registered for resale in this
Prospectus through a member of the NASD participating in a distribution of our
securities, such member is responsible for insuring that a timely filing is
first made with the Corporate Finance Department of the NASD and disclosing to
the NASD the following:
o it intends to take possession of the registered securities or to
o facilitate the transfer of such certificates;
o the complete details of how the selling shareholders shares are and
o will be held, including location of the particular accounts;
o whether the member firm or any direct or indirect affiliates thereof
o have entered into, will facilitate or otherwise participate in any
o type of payment transaction with the selling shareholders, including
o details regarding any such transactions; and
o in the event any of the securities offered by the selling shareholders
o are sold, transferred, assigned or hypothecated by any selling
o shareholder in a transaction that directly or indirectly involves a
o member firm of the NASD or any affiliates thereof, that prior to or at
o the time of said transaction the member firm will timely file all
o relevant documents with respect to such transaction(s) with the
o Corporate Finance Department of the NASD for review.
We have advised the selling shareholders that the anti-manipulation rules
of Regulation M under the Exchange Act may apply to sales of shares in the
market and to the activities of the selling shareholders and their affiliates.
In addition, we will make copies of this Prospectus available to the selling
shareholders for the purpose of satisfying the Prospectus delivery requirements
of the Securities Act. The selling security holders may agree to indemnify any
agent, dealer or broker-dealer that participates in transactions involving sales
of the Common Stock against certain liabilities, including liabilities arising
under the Securities Act.
The selling security holders are subject to applicable provisions of the
Securities Exchange Act of 1934 and the SEC's rules and regulations, including
Regulation M, which provisions may limit the timing of purchases and sales of
the securities by the selling security holders.
In order to comply with certain states' securities laws, if applicable,
the Common Stock may be sold in those jurisdictions only through registered or
licensed brokers or dealers. In certain states the securities may not be sold
unless they have been registered or qualified for sale in such state, or unless
an exemption from registration or qualification is available and is obtained.
25
We have agreed to indemnify each selling stockholder whose shares we are
registering from all liability and losses resulting from any misrepresentations
we make in connection with the registration statement.
LEGAL PROCEEDINGS
None.
DIRECTORS AND EXECUTIVE OFFICERS, PROMOTERS
AND CONTROL PERSONS
The following table sets forth information with respect to our directors
and executive officers.
Name Age Position
- ------------------------ --------- -------------------------------------
Alan Gaines 50 Chairman and Chief Executive Officer
Amiel David 66 President and Chief Operating Officer
Hugh Idstein 47 Chief Financial Officer
Richard M. Cohen 55 Director and Secretary
Steven Barrenechea 46 Director
Valery G. Otchertsov 59 Director
Raissa S. Frenkel 44 Director
Steven M. Sisselman 46 Director
Marshall Lynn Bass 36 Director
Alan Gaines is the Chairman and Chief Executive Officer of the Company and
has served as a Director of the Company since May 2001. For the past five years,
Mr. Gaines has served as President and CEO of Proton Capital LLC, a privately
held merchant and investment banking firm. Since April 2005, Mr. Gaines has
served as Vice Chairman of Baseline Oil & Gas Corp., a public company. In 1983,
Mr. Gaines founded Gaines, Berland Inc., a full service brokerage firm and
investment bank specializing in global energy markets, with particular emphasis
given to small to mid-capitalization exploration and production, pipeline,
midstream, and oilfield services companies. Mr. Gaines served as President of
Gaines, Berland from 1983 to 1998. Mr. Gaines holds a BBA in Finance from Baruch
College, and an MBA ("With Distinction") from the Zarb School, Hofstra
University School of Management.
Amiel David has served as the President/Chief Operating Officer of the
Company since February 2004 and has over 35 years of engineering and investment
banking experience within the energy sector. From 1993- 2001, he was the Senior
Vice President and Chief Engineer for the First City Bank and later First Union
Securities (Wachovia Bank) where he was responsible for the technical viability
of in excess of $3.5 billion of energy credits. From 2001 through 2003, Dr.
David was the Managing Director, Senior Vice President and Chief Engineer of
Duke Capital Partners. Dr. David holds a PhD in Petroleum Engineering from
Stanford University and an MBA from The University of Pittsburgh.
26
Hugh Idstein has served as the Chief Financial Officer of the Company
since April 4, 2005. Prior to joining our Company, Mr. Idstein served as CFO of
Houston based Black Stone Minerals Company, L.P., an oil and gas mineral
exploration company. In addition Mr. Idstein has acted as a consultant for
several oil and gas companies regarding international oil and gas opportunities.
He earned an MBA and a BS in Energy Management from Eastern Illinois University.
Richard M. Cohen has served as a Director of the Company since December
2003. Since 1996, Mr. Cohen has been the President of Richard M. Cohen
Consultants, a private financial services consulting company that assists both
public and private companies with their corporate governance and corporate
finance needs. In 1999, Mr. Cohen was the President of National Auto Credit, a
publicly traded sub-prime auto finance company. From 1992-1995, Mr. Cohen was
the President of General Media Inc., a publicly reporting international
diversified publishing and communications company. Mr. Cohen is a Certified
Public Accountant and worked at Arthur Andersen & Co. from 1975 to 1977. He
received a BS ("With Honors") from The University of Pennsylvania (Wharton) and
an MBA from Stanford University.
Steven Barrenechea has served as a Director of the Company since May 2001.
Mr. Barrenechea is COO of Coast to Coast Catering Company, an upscale catering
service. From April 2005 to January 2006, Mr. Barrenechea served as a Director
of Baseline Oil & Corp., a public company. Mr. Barrenechea is a member of the
Board of Directors of the Creative Coalition, The Milford (Connecticut) Red
Cross, and The Child Guidance Center of Fairfield County. Mr. Barrenechea holds
a BBA from New York University.
Valery Otchertsov has served as a Director of our Company since May 2004.
Since 1999, Mr. Otchertsov has held the position of President of Itera Holding
Ltd and since 2003 Chairman of the Management Board of Itera Oil and Gas Company
Ltd. (Itera). Itera's operating entities are engaged in the business of
production, transportation, marketing and sales of natural gas throughout the
Former Soviet Union. From 1997 -1999, Mr. Otchertsov served as First
Vice-President of Itera International Group of Companies. From 1991 -1996, Mr.
Otchertsov served as Minister of Economics and Finance, Deputy Chairman of the
Cabinet of Ministers of Turkmenistan. He graduated with a Bachelors degree from
Izhevsk Mechanical Institute.
Raissa Frenkel has served as a Director of our Company since May 2004. Dr.
Frenkel has been a member of the Board of Directors of the Itera Oil and Gas
Company Ltd (Itera) since 2002. Itera's operating entities are engaged in the
business of production, transportation, marketing and sales of natural gas
throughout the Former Soviet Union. Since 2003, Dr. Frenkel has been Executive
Vice-President of Itera International Energy Corp. an Itera subsidiary operating
in the US gas, real estate and commodity business. From 1994-2002 Dr. Frenkel
was a Vice-President with Itera International Energy Corp. She graduated from
the Kazan Finance and Economics Institute in 1982 and received her PHD from
Kazan State University in 1989.
Steven Sisselman has served as a Director of our Company since May 2004.
From 1995 to the present, Mr. Sisselman has been a Vice-President of Business
Development with Itera International Energy Corp., an Itera subsidiary operating
in the US gas, real estate and commodity business. From 1992-1994, Mr. Sisselman
was Vice-President of Dalon Inc., a petroleum trading company, responsible for
trading crude oil and petroleum products from the former Soviet Union. For the
12 years prior to 1992, Mr. Sisselman was employed by Charter Oil Company, UBS
AG, and Astra Oil working in various financial and trading positions both in the
US and London, England. He graduated from University of Florida in 1980 with a
BS in Business Administration with a major in Finance.
Marshall Lynn Bass has served as a Director of our Company and a member of
the Company's audit committee since September 29, 2004. From 1998 to December
2001, he served as an associate, and from 2002 to present, he served as a
principal of Weisser, Johnson & Co., a Houston based energy investment bank. He
is also a principal and co-founder of GasRock Capital, LLC, a finance company
which makes direct investments in energy companies or projects. He graduated
from Purdue University in 1992 with a BS in economics and from Rice University
with a Masters in business administration.
27
The Audit Committee
Messrs. Bass and Barrenechea constitute the Audit Committee of our Board
of Directors, established by the Board in accordance with Section 3(a)(58)(A) of
the Exchange Act, for the purpose of overseeing our accounting and financial
reporting processes and the audits of our financial statements.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS, DIRECTORS AND EXECUTIVE
OFFICERS AND RELATED SHAREHOLDER MATTERS
The following table sets forth certain information regarding the
beneficial ownership of our Common Stock as of May 16, 2006 by (i) each person
who, to our knowledge, beneficially owns more than 5% of our outstanding Common
Stock; (ii) each of our current directors and executive officers (titles are set
forth in parentheses next to the names of individuals listed below); and (iii)
all of our current and executive officers and directors as a group:
Percent
Name of Beneficial Owner Amount (1) of Class
------------------------ ---------- --------
Itera Holdings BV 35,464,397 59.9%
Alan Gaines (Chairman and CEO) 3,190,501 (2) 5.3%
Amiel David (President and COO) 906,250 (3)(4) 5.0%
Hugh Idstein (Chief Financial Officer) 75,000 (5) *
Steven Barrenechea (Director) 187,500 (6)(7) *
Richard M. Cohen (Secretary and Director) 328,385 (7) *
Valery G. Otchertsov (Director) 0 (7) --
Raissa S. Frenkel (Director) 0 (7) --
Steven M. Sisselman (Director) 0 (7) --
Marshall Lynn Bass (Director) 25,000 (6)(7) *
All Officers & Directors as a Group (9 persons) 4,687,636 (2)(3)(4)(5)(6)(7) 7.7%
* Indicates ownership of less than 1%.
- ----------
(1) A person is deemed to be the beneficial owner of securities that can be
acquired by such person within 60 days from May 16, 2006. Each beneficial
owner's percentage ownership is determined by assuming that options that are
held by such person (but not held by any other person), and which are
exercisable within 60 days from May 16, 2006, have been exercised.
(2) Includes 500,000 shares underlying a stock option granted May 12, 2005.
(3) Includes 250,000 shares underlying a stock option granted on February 15,
2005.
28
(4) Includes 500,000 shares underlying a stock option granted May 12, 2005.
(5) Includes 50,000 shares underlying a stock option granted on April 4, 2005
and 25,000 shares underlying a stock option granted on March 29, 2006.
(6) Includes 25,000 shares underlying a stock option granted on December 15,
2004.
(7) Excludes 50,000 shares underlying a stock option granted on October 28, 2005
that will vest only upon approval by our stockholders at the next annual
meeting.
29
DESCRIPTION OF SECURITIES
Common Stock
The Company is authorized to issue 100,000,000 shares of common stock,
$.001 par value per share, of which 59,244,859 are outstanding as of May 16,
2006.
Holders of common stock have equal rights to receive dividends when, as
and if declared by the Board of Directors, out of funds legally available
therefore. Holders of common stock have one vote for each share held of record
and do not have cumulative voting rights and are entitled, upon liquidation of
the Company, to share ratably in the net assets available for distribution,
subject to the rights, if any, of holders of any preferred stock then
outstanding. Shares of common stock are not redeemable and have no preemptive or
similar rights. All outstanding shares of common stock are fully paid and
nonassessable.
Preferred Stock
The Company is authorized to issue 1,000,000 shares of preferred stock,
$.001 par value per share, none of which is currently outstanding. The preferred
stock may be issued from time to time in one or more series and with the
designations and preferences for each series as will be stated in the
resolutions providing for the designation and issue of each series adopted by
Dune's board of directors. Dune's board of directors is authorized by Dune's
certificate of incorporation to determine, among other things, the voting,
dividend, redemption, conversion and liquidation powers, rights and preferences
and the limitations thereon pertaining to each series of preferred stock. Dune's
board of directors, without stockholder approval, may issue preferred stock with
voting and other rights that could adversely affect the voting power of the
holders of the common stock and that could have anti-takeover effects. The
Company has no present plans to issue any shares of preferred stock. The ability
of the board of directors to issue preferred stock without stockholder approval
could have the effect of delaying, deferring or preventing a change in control
or the removal of existing management.
LEGAL MATTERS
Our outside counsel, Eaton & Van Winkle LLP, located in New York, New
York, is passing upon the validity of the issuance of the shares of Common Stock
that are being offered pursuant this prospectus.
EXPERTS
Malone & Bailey, PC, independent certified public accountants, located in
Houston, Texas, has audited our Financial Statements included in this
registration statement to the extent, and for the periods set forth in its
reports. We have relied upon such reports, given upon the authority of such firm
as experts in accounting and auditing.
BUSINESS
Barnett Shale Properties
On November 4, 2005, we entered into an Amended and Restated Asset
Purchase and Sale Agreement (the "Voyager Agreement") with Voyager Partners,
30
Ltd. ("Voyager") to acquire 95% of the producing and non-producing oil and
natural gas properties and related property and equipment owned by Voyager
located in the North Texas Fort Worth Basin, with Voyager retaining a 5%
ownership interest in the properties (the "Voyager Acquisition"). The vast
majority of these properties are located in Denton County, with the remainder in
Wise County, both on the fairway of the prolific Barnett Shale in the North
Texas Fort Worth Basin. We expect the Voyager Acquisition to provide significant
production and high impact, low risk extensional drilling opportunities.
The Voyager Agreement divides the Barnett Shale Properties into three
tranches, each of which has a separate closing date. A closing with respect to
the Tranche 1 assets occurred on December 16, 2005. The Tranche 1 assets that we
purchased include working interests (ranging between 92% and 95%) in
approximately 950 gross acres in Denton and Wise Counties, Texas, as well as
four producing wells thereon. The purchase price for the Tranche 1 assets was
$24.6 million.
As part of the Voyager Acquisition, Voyager assigned to us an asset
purchase agreement with a third party relating to certain additional oil and gas
properties in the Barnett Shale. On November 17, 2005, pursuant to the asset
purchase agreement assigned by Voyager and an additional purchase agreement
between us and certain third parties, we acquired working interests (ranging
between 92% and 100%) in certain oil and gas leases covering approximately 320
gross acres in Denton County, Texas, as well as an undivided interest in four
producing wells thereon, and all of the sellers' personal property, equipment
and contract rights with respect thereto (the "Springside Properties"). The
purchase price for the Springside Properties was $5.5 million.
On May 10, 2006, we completed the acquisition of a 455 acre lease located
in Wise County for $380,000. The newly acquired lease is in close proximity to
the properties we acquired from Voyager. Management estimates that there are
three horizontal proved undeveloped locations and one vertical location to drill
on the lease.
As a result of the acquisition of the Voyager Tranche 1 assets, the
Springside Properties and our purchase on May 10, 2006, we have working
interests (ranging between 92% and 100%) in 1,725 gross acres in the Barnett
Shale, as well as interests in eight producing wells and one well undergoing
completion thereon. We have identified 26 future drilling locations on this
acreage.
In accordance with the Voyager Agreement, we have advanced $1.8 million to
Voyager in return for working interests in four wells that were not included in
the Tranche 1 assets. Upon acquiring the property underlying these wells from
Voyager at the closing of the Tranche 2 assets, our working interest in these
wells will increase from approximately 39-41% to approximately 95%.
We and Voyager have agreed to permit rolling closings of Tranche 2 assets.
The allocated values of the Tranche 2 assets equates to approximately $20.0
million. Within seventy-five (75) days after Voyager notifies us that it has
satisfied certain conditions with respect to the Tranche 3 assets, we will be
obligated to close on the Tranche 3 assets. The allocated values of the Tranche
3 assets equate to approximately $23.0 million. The Tranche 2 and Tranche 3
closings are subject to satisfaction of various conditions, including our
ability to obtain financing, and there can be no assurances that any of the
contemplated closings will occur.
Based on current well spacing rules, our management expects that there are
approximately 50 drilling locations on the Tranche 2 and Tranche 3 assets,
assuming as many as one-third of these locations may be drilled horizontally.
As part of the Voyager Acquisition, we are negotiating to become a 16% to
39% limited partner in up to three (3) limited partnerships, the purpose of
which is to design, construct, lay, own, operate and maintain natural gas
gathering pipelines in the same general geographic area as the Barnett Shale
31
Assets. The Voyager Agreement gives us the option, within 90 days after the
later of the closing date for the Tranche 1 assets or the date as of which each
such limited partnership is formed, to acquire 80% of Voyager's interests in
each such limited partnership for a price equal to 100% of the initial
contribution to capital which Voyager is required to make into such limited
partnership. One pipeline is currently in place. The second pipeline system
should be completed by early third quarter, and the third pipeline should be
completed concurrently with the drilling development of the area to be served by
such pipeline. We expect the three pipelines will have aggregate capacity
exceeding 50 MMcf per day, with estimated throughput of 40 MMcf per day within
two years from commencement of operations. We believe our interest in the
pipelines will decrease our overall costs of operations by providing significant
benefits to us, including: (1) the ability to transport our own gas, thereby
enhancing overall economic efficiency through higher prices received; (2)
guaranteed access to a pipeline, reducing our dependency on other companies to
transport our gas; and (3) the ability to transport third party gas, enabling us
to generate additional income.
Presently, Voyager is not selling, and we are not buying, the remaining 5%
of Voyager's interests in the assets involved in the Voyager Acquisition (the
"Retained Interests"). However, for a period of ninety (90) days following the
full and final satisfaction by certain Voyager affiliates of their obligations
under a settlement agreement with the Dan Hughes Group, Voyager has the right
and option to sell to us, and we have the right and option to buy from Voyager,
the designated Retained Interests for a price determined pursuant to the Voyager
Agreement. Similarly, for a period of ninety (90) days after the first
anniversary date of execution of leases comprising the Tranche 3 assets, Voyager
will have the right and option to cause us to purchase from Voyager the Tranche
3 Retained Interests pursuant to the Voyager Agreement. Any purchase of Retained
Interests will relate back to January 1st of the year in which such option to
purchase (or option to cause the purchase) is exercised.
Dune Operating Company ("DOC"), our wholly owned subsidiary, is the
operator of record of the Barnett Shale Properties. We entered into a
Transitional Matters Agreement as of the date of the closing for the Tranche 1
assets whereby Dark Horse Operating Company ("Dark Horse") will operate the
Barnett Shale Properties for us on a contract basis after the Tranche 1 asset
closing. Under the Transitional Matters Agreement, Dark Horse will provide DOC
with certain operating and administrative services with respect to the Barnett
Shale Properties for up to 12 months after the Tranche 1 asset closing, subject
to our right to extend the term on a month-to-month basis.
Prior to the closing date for each Tranche of assets, Voyager is obligated
to use reasonable commercial efforts to obtain, at its cost, the rights to
certain additional oil and gas leases ("Additional Leases") and to transfer them
to us, at such closing or within 120 days after the date of such closing, as
though they were Barnett Shale properties covered by the Voyager Agreement. The
Additional Leases are to cover additional well locations for the development of
proved undeveloped Barnett Shale reserves. For each Additional Lease which
Voyager is unable to obtain within 120 days after the closing date, we will be
entitled under the Voyager Agreement to reduce the base consideration payable to
Voyager by the allocated value for each proposed well location.
At the closing of the Tranche 1 assets, Voyager and certain of its
principals and affiliates, as the assignors (the "Voyager Assignors"), entered
into with us (as the Assignee), an Area of Mutual Interest Agreement (the "AMI
Agreement"). The area of mutual interest or "AMI" defined in the AMI Agreement
includes, as a general matter, the area within approximately two (2) miles of
the exterior boundaries of the existing leases included in the Barnett Shale
Property. The AMI Agreement provides that if, during the period of 24 calendar
months beginning on the closing date for the Tranche 1 assets (the "Effective
Date"), any of the Voyager Assignors acquires an oil or gas lease or an interest
32
therein covering any of the lands located in the AMI (the "Acquired Interest"),
then Voyager Assignors must first offer us the option to acquire 95% of the
Acquired Interest.
During the first nine (9) months following the Effective Date, we may, but
are not obligated, to purchase any Acquired Interests brought to us by Voyager
Assignors. Thereafter, provided that the Voyager Assignors tender sufficient
Qualified Acquired Interests (defined below), we will be obligated to purchase
$2.75 million of such Qualified Acquired Interests in the last three (3) months
of the first twelve (12) months following the Effective Date and an additional
$2.75 million of such Qualified Acquired Interests in the second 12 months
following the Effective Date. In order for our obligation to purchase an
Acquired Interest to arise, the Acquired Interest must (i) cover at least 40
acres in the case of a vertical location and 120 acres in the case of a
horizontal location, (ii) overlay Barnett Shale formation gas reserves that
qualify as "proved" or "proved undeveloped," (iii) not be subject to a drilling
obligation within 180 days after the date of its execution and (iv) have clear
title (a "Qualified Acquired Interest"). The price to be paid for a Qualified
Acquired Interest is based on several factors, including the number of wells and
well types, the reserve category (proved or probable), and the price of natural
gas at the time of acquisition.
The Barnett Shale is one of the largest and most active natural gas fields
in the United States, covering 15 Texas counties. In the first three quarters of
2005, the Barnett Shale was producing in excess of 1,200 Mmcf per day of natural
gas. The Barnett Shale properties reside in the core area of the Barnett Shale
where wells have demonstrated superior economics, and are located in areas that
are not subject to fracture related water encroachment. Within these Barnett
Shale properties, the identified probable well locations are a result of reserve
definitions, and are fundamentally no different from any of the existing proved
undeveloped locations.
Bayou Couba Property
On October 19, 2005, we entered into a definitive Exploration and
Development Agreement (the "ANEC Agreement") with American Natural Energy
Corporation ("ANEC"). Pursuant to the ANEC Agreement, which has an effective
date of August 26, 2005, we acquired certain exclusive exploration and
development rights in ANEC's Joint Development Agreement with ExxonMobil Corp.
(the "Development Agreement"), covering approximately 11,000 contiguous acres in
St. Charles Parish, Louisiana (the "Bayou Couba Field"). ExxonMobil Production
Company delivered its consent to our participation on September 12, 2005.
Of the 11,000 acres covered by the Development Agreement, approximately
1,300 acres pertain to a lease referred to as the Delta Securities Lease. The
ANEC Agreement provides us with the right to participate in 50% of ANEC's
development rights in the Delta Securities Lease in exchange for our payment of
$1 million. Upon the successful drilling of one of the first two exploratory
wells drilled by us and ANEC, we will be required to pay ANEC an additional
$500,000. In addition, we will have the right to participate in all of ANEC's
exploration rights in the remaining 9,700 contiguous acres covered by the
Development Agreement. Each party will pay its respective share of drilling,
completion and operations costs. Pending ANEC's satisfaction of certain
conditions as set forth below, the term of the Development Agreement will be
extended from November 2007 to November 2009.
The Bayou Couba Field was discovered by Gulf Oil in 1942. The field is
situated on a crest of a highly faulted salt dome which is productive from 30
sands. The nature of the faultline system creates traps that in the past were
overlooked or created a potential for bypassed oil and gas production. In
addition, preliminary analysis of reprocessed, state of the art 3-D seismic
indicates numerous hydrocarbon traps at depths ranging between 4,000 and 20,000
feet. There are several leads that indicate significant potential reserves in
the subsalt area. Initial drilling has focused and will continue to focus on
numerous (i) development prospects with updip PUD potential, (ii) extensional
prospects with trapped bypassed hydrocarbons and (iii) near field exploratory
prospects with analog production.
33
Since signing the ANEC Agreement, we have successfully completed three out of
three wells at Bayou Couba:
>> The DSCI 92ST well, drilled to a depth of approximately 6,040 feet, was
completed in November of 2005 and is currently producing approximately 70
boe per day. We have a 15.625% working interest in the DSCI 92ST.
>> The DSCI 51ST well, drilled to a depth of 5,600 feet, was completed in
October of 2005 and is currently producing at a rate of approximately 45
boe per day. We have a 20.625% working interest in the DSCI 51ST.
>> The DSCI 15ST well, completed in December of 2005 at a depth of
approximately 7,600 feet, is currently producing approximately 35 boe per
day. We have a 50% working interest in the DSCI 15ST.
Based upon current 3-D seismic data acquired in conjunction with the ANEC
Agreement, we have identified at least seven development and 14 exploration
drilling prospects at Bayou Couba. On March 8, 2006, ANEC entered into a Seismic
Survey Participation Agreement (the "Participation Agreement") with Seismic
Exchange, Inc. ("SEI"), to acquire a license with respect to the geophysical
data covering 60 square miles of the 3-D Seismic Survey to be conducted pursuant
to the Participation Agreement (the "Licensed Data"). The area to be surveyed by
this shoot covers the 11,000 acres we have exploration and development rights in
under our ANEC Agreement, as well as additional acres surrounding it. The cost
of ANEC acquiring a license to the 3-D survey is $2 million, of which we have
agreed to pay $1 million. The Participation Agreement provides that ANEC has the
one-time right to designate a "Partner" to receive a Partner License from SEI.
Pursuant to an Agreement with ANEC, ANEC has agreed that we shall have the right
to cause ANEC to designate us as a "Partner", if we shall so elect. If we elect
to do so, we have agreed with ANEC to each pay SEI $500,000 for the Partner
License. Upon delivery of the Licensed Data to ANEC, provided that ANEC makes
timely payments to SEI therefor, Exxon Mobil has agreed to extend the term of
the Development Agreement by two years to November 2009.
Subject to rig availability, we anticipate that over the next 12 months,
we will drill two exploration and development wells with the remainder to be
held in inventory. Additionally, we believe that there is significant untested
sub-salt gas potential and, pending results of the 3-D survey constructed by
SEI, we would anticipate drilling an exploratory well beneath the salt dome
during the first half of 2007.
South Texas Properties
The Welder Ranch Property
The Welder Ranch Property consists of 7,950 contiguous acres of land
leased from the Welder family in Victoria County, Texas. The Welder Leases are
held by Vaquero Partners, LLC, our wholly owned subsidiary ("Vaquero Partners"),
and are operated by Dune Operating Company, which is also our wholly-owned
subsidiary. Per the terms of the Welder Leases, Vaquero Partners receives 70% of
net revenue generated on the Welder Ranch Property. Effective as of August 22,
2005, we became the sole owner of Vaquero Partners when Vaquero Partners
redeemed the 15% membership interest previously held by Vaquero Oil and Gas,
Inc.
34
To date, our primary focus on the Welder Ranch Property has been on the
Wilcox Formation. The Wilcox Formation is one of the most prolific formations
along the Texas Gulf Coast. Our primary targets regarding exploration activity
in the area are the geopressured lower and middle sands of the Wilcox formation.
The Wilcox is productive at depths ranging from 8,300 feet to below 17,000 feet.
The upper Wilcox sands have four producing intervals that are normally
pressured. The middle and lower sands, beginning at approximately 9,500 feet,
are geopressured. These geopressured zones are the primary targets on the Welder
Ranch Property. A successful upper Wilcox well will cost between $800,000 and $1
million to drill and complete at the 9,000 foot depth, whereas a deeper
geopressured well (such as Vaquero #1 well) may cost between $4 million and $5
million through completion. We completed the Vaquero #1 and the Vaquero #2
wells, which both targeted the geopressured Wilcox Formation.
Our Vaquero #2 well was completed in the 12,300 foot horizon and put on
production on August 1, 2005. Presently, the well is producing at the rate of
300 Mcfe per day. We hold a 63.5% net working interest in the Vaquero #2 well.
The locations for our Vaquero # 1 and # 2 wells were drilled utilizing
advanced 3D seismic interpretation, in conjunction with extensive geological and
engineering analysis of leases acquired by us during 2003 and 2004. The Vaquero
# 1 was drilled to a total depth of 13,920 feet and encountered gas shows at
depths between 9,300 feet and 13,500 feet. Due to a mechanical casing failure,
we could not complete the well in the 13,000 foot interval. The well was
therefore completed in the 9,300 foot sand and is presently producing
approximately 100 Mcfe per day. We are reviewing various alternatives in the
Vaquero # 1 including, but not limited to, drilling a sidetrack to the original
target depth, where potential gas reserves were evident on electric logs. We
hold a 67.4% net working interest in the Vaquero #1 well. The 9,300 foot payzone
encountered in the Vaquero #1 was also tested to be productive in the Vaquero
#2, and will be categorized as "Proved Behind Pipe."
Our Rob Welder #1 well, completed in the Cook Mountain formation in August
2004, continues to produce at the rate of 275 Mcfe per day. We hold a 100%
working interest in this well.
During the first quarter of 2006, we completed a shallow Frio well and
intend to place it on production shortly. Our geological and geophysical team
has also identified a number of other large, high-quality, high-reserve
potential prospects and leads on the Welder Ranch Property.
The Pearsall Property
Our Pearsall Property presently consists of two leases covering 2,400
acres in the Pearsall Field, located in the Austin Chalk trend in Frio County,
Texas. San Antonio based Alamo Operating Company is currently the contract
operator; however, we expect to take over as operator as soon as practicable. As
of March 15, 2006, the two wells in which we hold a working interest were
producing oil at a combined rate of approximately 100 boe per day. We have a 27%
working interest in the first well, and a 40% working interest in the second and
each subsequent well. We have the right to participate (on similar terms) in the
drilling of future reentry wells on the Pearsall Property on additional leases
covering up to approximately 9,000 acres. Net revenue interest on the leases
averages 76.5%. We are currently evaluating the drilling of additional wells on
the Pearsall Property.
35
The Los Mogotes Property
In May of 2004, we completed the purchase of a small non-operated working
interest (0.7% W.I.) in the Haynes Lease (covering approximately 18,000 acres)
located within Los Mogotes Field in Zapata County for $874,500. The Los Mogotes
Field is an onshore U.S. development project in the South Texas Wilcox trend,
with production averaging approximately 90 Mmcfe of gas per day. Our current
working interest in the Los Mogotes project currently provides approximately
$100,000 per month in cash flow.
Regulation
Our business is or may be affected by numerous laws and regulations,
including those relating to energy, environment, and conservation. Failure to
comply with these laws and regulations may result in the assessment of
administrative, civil and/or criminal penalties, the imposition of injunctive
relief or both. Changes in any of these laws and regulations could have a
material adverse effect on our business. In view of the many uncertainties with
respect to current and future laws and regulations, including their
applicability to us, we cannot predict the overall effect of such laws and
regulations on its future operations.
We believe that current operations comply in all material respects with
applicable laws and regulations, and that they have no more restrictive effect
than on other similar companies in the energy industry.
Our operations are subject to regulation at the state level and, in some
cases, county, municipal and local governmental levels. Such regulation includes
(1) requiring permits for the drilling of wells, (2) maintaining bonding
requirements to drill or operate wells, and (3) regulating the location of
wells, the method of drilling and casing wells, surface use and restoration of
properties upon which wells are drilled, and (4) plugging and abandoning of
wells and the disposal of fluids used and produced in connection with
operations.
Our operations are also subject to various conservation laws and
regulations relating to well spacing, and safety issues for gathering systems.
Environmental Matters
We are subject to extensive federal, state, and local environmental laws
and regulations that, among other things, regulate the discharge or disposal of
substances into the environment and otherwise are intended to protect the
environment. Numerous governmental agencies issue rules and regulations to
implement and enforce such laws, which are often difficult and costly to comply
with and which carry substantial administrative, civil, and/or criminal
penalties and, in some cases, injunctive relief for failure to comply. Some laws
and regulations relating to the protection of the environment may, in certain
circumstances, impose "strict liability" for environmental contamination. Other
laws and regulations may require the rate of oil and natural gas production to
be below the economically optimal rate or may even restrict or prohibit
exploration or production activities in environmentally sensitive areas. In
addition, state laws often require some form of remedial action such as closure
of inactive pits and plugging of abandoned wells to prevent pollution from
former or suspended operations.
We believe that we are in substantial compliance with current applicable
laws and regulations and that continued compliance with existing requirements
will not have a material adverse impact. However, from time to time, legislation
or other initiatives are proposed to place more onerous conditions. Adoption of
such proposals could adversely impact our operating costs, capital expenditures,
earnings, and/or competitive position.
36
Employees
As of May 15, 2006 we have 11 employees, of which 9 are full time
employees and 2 are part time employees.
MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Introduction
We are engaged in the exploration, development, exploitation and
production of oil and natural gas. We sell our oil and gas primarily to domestic
pipelines and refineries. We entered into a number of property acquisitions and
joint ventures during 2004 and 2005 as described in Note 2 to our financial
statements filed with this report. We did not make any dispositions of property
during 2004 and 2005. These acquisitions and joint ventures significantly
affected our results of operations during 2004 and 2005 and had the effect of
significantly increasing both our revenues and expenses. Our financial
statements consolidate our accounts with those of our wholly-owned subsidiary,
Vaquero Partners LLC, and all inter-company balances and transactions between
Dune Energy, Inc. and Vaquero Partners LLC have been eliminated in such
consolidation.
Recent Developments
Barnett Shale Properties
During the first quarter covered by this report, we drilled two wells in
the Barnett Shale. The DCC #8 was successfully completed and placed on
production from the Barnett formation. The well was perforated and fractured in
three different horizons. Initial rates for the first twenty-four hours were 1.1
MMcf/d of natural gas. The well continues to clean up frac water and is
currently producing at a rate of 800 Mcf/d. Given pipeline availability, the
well was turned to sales immediately. The DCC #7 well which we began drilling in
December 2005, has been temporarily abandoned after it encountered mechanical
difficulties due to poor hole condition in the directional section of the well.
Rather than continue operations, management decided to cease drilling operations
and skid the rig over and drill the DCC #8 well.
In other operations we are currently refracing one of our originally
acquired wells, the Springside #1-A and installing pumping equipment on the
Pitts #1. Pending successful refracing, we anticipate increasing combined
production to 400-600 Mcf/d on these two wells.
On May 10, 2006 we completed the acquisition of a 455 acre lease located
in Wise County for $380,000. The newly acquired lease is in close proximity to
our existing acreage position in the Barnett Shale play. Management estimates
that there are three horizontal proved undeveloped (PUD) locations and one
vertical PUD location to drill on the lease.
Bayou Couba Property
On March 8, 2006, our joint-venture partner, American Natural Energy
Corporation ("ANEC") entered into a Seismic Survey Participation Agreement (the
"Participation Agreement") with Seismic Exchange, Inc. ("SEI"), to acquire a
license with respect to the geophysical data covering 60 square miles of the 3-D
Seismic Survey to be conducted pursuant to the Participation Agreement (the
37
"Licensed Data"). The area to be surveyed by this shoot covers the 11,000 acres
we have exploration and development rights in under our existing Exploration and
Development Agreement with ANEC, as well as additional acres surrounding it. The
cost of ANEC acquiring a license to the 3-D survey is $2 million, of which we
have agreed to pay $1 million. The Participation Agreement provides that ANEC
has the one-time right to designate a "Partner" to receive a Partner License
from SEI. Pursuant to a separate Agreement with ANEC, ANEC has agreed that we
shall have the right to cause ANEC to designate us as a "Partner", if we shall
so elect. If we elect to do so, we have agreed with ANEC to each pay SEI an
additional $500,000 for the Partner License. Upon delivery of the Licensed Data
to ANEC, provided that ANEC makes timely payments to SEI therefore, Exxon Mobil
has agreed to extend the term of its Development Agreement with ANEC (under
which ANEC has assigned half of its interest to us) by two years to November
2009. During the First Quarter we paid SEI $600,000 as an initial payment to
begin the 3-D seismic survey.
Welder Ranch Property
During the first quarter we drilled two wells on the Welder Ranch
Property. The Welder Heirs #2 which was drilled to the Frio formation at a total
depth of 3,532 feet and encountered 19 feet of net pay in four potential pay
zones. We own a 100% working interest in the well. The well was originally put
on production from the lowest horizon at a rate of 300 Mcf/d. We have since
added additional zones and presently are producing at a rate of 180 Mcf/d. The
other well drilled on our Welder Ranch Property was the Rob Welder #2. Although
log analysis indicated gas pay, the well was deemed uneconomical and has been
plugged and abandoned.
Pearsall Property
Currently, the 2 wells in which we hold a working interest are producing
oil at an average combined rate of approximately 85 Bbl/d. We have a 27% working
interest in the first well, and a 40% working interest in the second and each
subsequent well.
Los Mogotes Property
For the three months ended March 31, 2006, our Los Mogotes Property
generated approximately $173,000 of revenues net to our working interest.
Results of Operations
Three months ended March 31, 2005 ("First Quarter 2005") compared to three
months ended March 31, 2006 ("First Quarter 2006")
Revenues. Revenues grew from $543,713 in First Quarter 2005 to $1,300,820
in First Quarter 2006. This represents a 139% increase. Although fee income
declined $56,000, oil and gas revenue increased over $700,000 reflecting the
impact of acquisitions and drilling activity undertaken in the last three
quarters of First Quarter 2005.
Operating Expenses. Operating expenses increased from $516,738 in First
Quarter 2005 to $2,374,252 in First Quarter 2006. Every component of operating
expenses contributed to this increase as detailed below. The overall increase is
attributable to increased activity primarily associated with new wells drilled,
the acquisition activity and overall growth of the Company.
General and Administrative Expenses. The increase of $411,072 is
attributable to increased drilling and acquisition activity yielding increases
in all areas of general and administrative expense.
38
Share-based Compensation Expense. In First Quarter 2006 the Company
adopted SFAS No. 123 (R) which requires all share-based payments to employees
and directors be recognized in the financial statements based on their fair
values. Share-based compensation in First Quarter 2006 amounted to $473,388 and
$0 in First Quarter 2005.
Direct Operating Expense. Direct operating expense increased from $65,534
in First Quarter 2005 to $351,684 in First Quarter 2006. This increase of
$286,150 reflects the effect on operating expense of going from two properties
in First Quarter 2005 to seventeen in First Quarter 2006.
Depletion, Depreciation and Amortization. Dune experienced a significant
change in depletion, depreciation and amortization (DD&A) increasing from
$37,480 in First Quarter 2005 to $724,384 in 2006. The two major components of
DD&A relate to amortization of oil and gas properties and amortization of
deferred financing costs. In First Quarter 2006, properties being amortized
increased from $6,801,080 to $49,156,664 yielding an expense of $505,825. Also
in First Quarter 2006, deferred financing costs of $2,493,184 yielded an
amortization expense of $215,932.
Operating Loss. Dune went from operating income of $26,975 in First
Quarter 2005 to an operating loss of ($1,073,432) in First Quarter 2006. As
documented above, all of the components of operating expense experienced
significant increases which were not offset by the increase in revenues.
Other Income (Expense):
Interest Income. Interest income increased from $8,792 in First Quarter
2005 to $97,511 in First Quarter 2006. The increase is attributable to higher
cash balances associated with the February 1, 2006 stock sale.
Minority Interest. Minority interest expense decreased from $40,091 in
First Quarter 2005 to $0 in First Quarter 2006. As a result of Dune's First
Quarter 2005 acquisition of the minority interest in Vaquero Partners, there is
no minority interest in First Quarter 2006.
Interest Expense. Interest expense jumped from $5,575 in First Quarter
2005 to $1,039,703 in First Quarter 2006. Dune increased its debt from
$5,000,000 at March 31, 2005 to $30,889,547 at March 31, 2006. The debt was
incurred primarily to finance the fourth quarter 2005 acquisitions. This
increase in debt explains the additional interest expense in First Quarter 2006.
Accretion Expense. Accretion expense was $0 in First Quarter 2005 and
$1,999 in First Quarter 2006. Dune recorded its asset retirement obligation in
the fourth quarter of 2005 giving rise to the accretion expense in First Quarter
2006.
Gain on Embedded Derivative Liability. Dune recorded a gain on the mark to
market adjustment of the embedded derivatives in First Quarter 2006. This gain
is on participating collars on oil and gas swaps which were entered into in the
fourth quarter of First Quarter 2005. As of March 31, 2006, the mark to market
value reflected a liability of $163,036. There were no embedded derivatives in
First Quarter 2005.
Net Loss. Dune's net loss increased ($1,980,207) from ($9,899) in First
Quarter 2005 to ($1,990,106) in First Quarter 2006. Major components of this
increase are attributable to increased interest expense, increased depreciation,
depletion and amortization expense and the adoption of SFAS 123 (R), requiring
the recognition of share-based payments in the financial statements.
39
Net Loss Per Share. The net loss per share increased from $0.00 per share
in First Quarter 2005 to ($0.04) per share in First Quarter 2006. Although the
weighted average number of shares increased 10,103,536 shares, net loss
increases yielded a loss of ($0.04) per share.
Year ended December 31, 2005 compared to year ended December 31, 2004
Revenues. Our revenues were $3,724,278 in 2005, compared to revenues of
$1,022,297 in 2004. This 364% increase in revenues from 2004 to 2005 was the
result of receiving $1,768,406 from production for existing wells, $1,599,632
from seven wells drilled in 2005 and $356,240 from wells acquired during 2005.
During the first quarter of 2006 we drilled four wells, two of which were
successful and should be on production early in the second quarter of 2006; one
of which requires additional work and one of which was a marginal well that
management decided to plug for economic reasons.
Operating Expenses: The increase in our operating expenses can generally
be attributed to a significant increase in well drilling activity and costs
associated with evaluating and closing several projects including the Voyager
acquisition and our joint venture at Bayou Couba. Excluding our participation in
the drilling at Los Mogotes, Dune participated in the drilling of seven wells in
2005 versus the three we participated in 2004. This increase in activity
resulted in additional operating expenses. We expect operating expenses to
increase as a result of increased drilling activity and continued acquisition
activity.
General and Administrative Expenses. Our general and administrative
expenses increased from $1,935,539 in 2004 to $2,550,549 in 2005, an increase of
approximately 25%. Increased drilling and acquisition activity resulted in
increased general and administrative costs related to salary expense (hiring
additional employees) and accounting expense. We expect general and
administrative expense to increase at a lower rate than 2005.
Production Taxes. Production taxes refer to state assessed severance tax
on the production of oil and gas and also the marketing and transportation costs
of these products. Production net to Dune increased from 47,000 Mcfe in 2004 to
438,000 Mcfe in 2005 a 930% increase. Production taxes increased as a result of
increased production and increases in transportation and marketing costs.
Depletion, Depreciation and Amortization. Depletion, depreciation and
amortization ("DD&A") expenses are on the full cost method of accounting. In
2004 our DD&A was very small at $63,801 due to a much smaller cost basis and
lower production levels. Dune's full cost pool increased from $6.9 million in
2004 to almost $21.0 million in 2005. Depletion and depreciation of oil and gas
properties is on a units of production basis and was $918,438 for 2005.
Depreciation of office equipment is on a straight line basis and was $5,033 for
2005. In addition, loan costs and fees are amortized over the term of the debt
instruments to which they relate. In 2005, amortization expenses was $143,558.
We expect our DD&A expense to increase as production increases.
Lease Operating Expense. Lease operating expense refers to costs incurred
in the direct operation of the wells. Dune's operating expense grew from $37,478
in 2004 to $378,163 in 2005 in direct relation to our increase in well activity.
Lease operating expense is expected to continue to increase as more drilling and
production activity occurs.
Operating Loss. Our aggregate operating loss decreased from $1,079,717 in
2004 to $612,772 in 2005 as the $2,701,981 increase in revenue was greater than
the $2,235,036 increase in operating expenses.
40
Other Income (Expense):
Other Income. Other income of $78,194 in 2004 was related to the
adjustments to accounts payable balances. There were no resulting adjustments in
2005.
Interest Income. Our interest income increased slightly, from $45,395 in
2004 to $48,893 in 2005 due to higher cash balances and higher interest rates.
Minority Interest. Minority interest refers to activity due a minority
interest owner in the Vaquero Partners LLC. Their net income (loss) is reflected
as minority interest on our financial statements. Minority interest expense was
$38,193 and $52,611 in 2004 and 2005 respectively. With respect to Vaquero
Partners LLC, there will be no minority interest expense in the future as Dune
has acquired the minority owner's interest.
Interest Expense. Interest expense increased from $120,640 in 2004 to
$775,427 in 2005. This was the result of increasing debt to $39,097,514 by the
end of 2005. Interest expense will continue to grow in 2006 as debt balances are
anticipated to remain at current or higher levels depending on drilling and
acquisition activity.
Accretion Expense. We incurred accretion expense of $2,173 in 2005 as a
result of recording our asset retirement obligation entry in 2005.
Loss on Embedded Derivative Liability. We recorded a loss on our mark to
market of our embedded derivatives as of December 31, 2005. This is on our
participating collars on oil and gas swaps. As of December 31, 2005, our mark to
market value reflected a liability of $190,553.
Net Loss. Our net loss increased $469,682 from $1,114,961 in 2004 to
$1,584,643 in 2005. A large component of the net loss in 2005 was interest
expense of $775,427 and loss on embedded derivative liability of $190,553.
Net Loss Per Share. Even though our net loss increased from 2004 to 2005,
our net loss per share decreased from $(0.04) in 2004 to $(0.03) in 2005 because
the weighted average shares outstanding in 2005 increased.
Impact of Inflation
Inflation has not had a material effect on our results of operations.
Financial Liquidity and Capital Resources
As a result of the industry-wide shortage of available drilling rigs our
intended drilling program has been delayed. However, in order to return to the
drilling program originally planned, we entered into a rig contract, the terms
of which call for the construction and subsequent long-term contractual
commitment of a drilling rig for our exclusive use on our Barnett Shale
Properties. This rig, which will be capable of drilling deviated and horizontal
wells, is expected to be delivered to us on or about August 1, 2006. In
addition, we signed a second contract for a drilling rig with Big Giant Drilling
LLC, to drill three wells on our Barnett Shale Properties.
The delays in procuring rigs have caused the postponement of the time at
which revenues can be expected from the subject properties. As a consequence, we
41
needed and have obtained waivers through July 31, 2006 from our senior and
subordinated lenders, of compliance with certain covenants in our lending
arrangements requiring certain levels of income from operations. We have agreed
with our senior and subordinated lenders to certain changes in our respective
contractual arrangements as a result of the delay described above, including
suspension of revolving credit availability under the senior facility and the
payment of certain interest amounts in subordinated notes rather than cash under
our subordinated facility. We have also agreed to increase the rate of interest
payable to our senior lenders on outstanding indebtedness by two percent per
annum effective from June 1, 2006.
As a result of the delay in obtaining drilling rigs referred to above and,
consequently, of our inability to produce levels of income from drilling
operations sufficient to meet the tests set forth in our senior credit facility
which we entered into in November, 2005, we and our senior lenders have embarked
on negotiations with a view to reaching agreement on restructuring or
refinancing our senior credit facility on terms and conditions satisfactory to
us, to our subordinated lender and to a majority in interest of our senior
lenders on or before July 31, 2006. In the event a commitment satisfactory to a
majority in interest of our senior lenders is not reached by July 31, 2006, we
will then owe such lenders a fee of $50,000.
Such changes are embodied in a Second Amendment and Third Amendment,
effective as of May 15, 2006 and June 1, 2006, respectively, to the credit
agreement which governs our senior credit facility. Management does not believe
that our operations or our prospects are materially affected by the agreed
suspension of availability under our revolving credit facility or the increase
in the interest rate on outstanding senior indebtedness.
Management believes that our cash requirements in the next twelve months
will be met by our revenues from operations and our cash reserves.
Private Equity Placements
On September 30, 2005, we closed a private equity offering pursuant to
which we received $6,000,000 in gross proceeds. A total of 3,243,243 shares of
Common Stock were sold at a price of $1.85 per share. Sanders Morris Harris Inc.
("SMH") acted as Placement Agent in the offering and received (i) a cash fee
equal to 5% of the gross proceeds and (ii) a warrant exercisable for up to
324,324 shares of our Common Stock at an exercise price of $1.85 per share.
In February 2006, we closed a private equity offering pursuant to which we
sold a total of 9,000,000 shares of our Common Stock at a price of $2.65 per
share. Gross proceeds raised in this offering were $23,850,000. SMH served as
our lead placement agent and C.K. Cooper & Company served as co-placement agent.
From the gross proceeds, we paid our investment bankers a placement agent fee of
$1,192,500 (5% of the gross proceeds) and we paid SMH a financial advisory fee
of $477,000 (2% of the gross proceeds). We also issued to SMH, a warrant
exercisable for up to 900,000 shares our Common Stock, at an exercise price of
$2.65 per share. The price per share in this offering was determined by taking
the thirty (30) day volume weighted average market price of our Common Stock as
of January 17, 2006, and discounting it by approximately 10% to account for
investors' receiving unregistered stock.
Debt Financings
To finance our recent and pending property acquisitions, we entered into a
Credit Agreement dated as of November 17, 2005 (the "Credit Agreement"), with
42
Standard Bank Plc, as Administrative Agent and Lender ("Standard") and Standard
Americas Inc., as Collateral Agent. In accordance with the requirement of
Standard, we also entered into a Swap Agreement ("Swap Agreement") with Standard
providing the notional volumes which are 65% to 70% of the reasonably
anticipated projected production from Proved Developed Producing Reserves (as
defined in the Credit Agreement) for each month through the second anniversary
of November 17, 2005 for each crude oil and natural gas streams, calculated
separately; pursuant to the requirements of the Credit Agreement, separate swap
hedges need to be put in place by us at a number of specific times when the
Proved Developed Producing Reserves are calculated and recalculated.
In addition, we entered into a Term Loan Agreement dated as of November
17, 2005 (the "Term Loan Agreement") with our majority stockholder, Itera
Holdings BV. Amounts borrowed from Itera under the Term Loan Agreement are
subordinated to all obligations under the Credit Agreement and the Swap
Agreement and are evidenced by a convertible subordinated promissory note (the
"Convertible Subordinated Note").
Under the Term Loan Agreement, Itera agreed to make available to us, up to
$25 million of subordinated debt. Effective November 17, 2005, prior promissory
notes evidencing our $8.5 million outstanding subordinated indebtedness to Itera
were refinanced by a Convertible Subordinated Note. In addition, in connection
with the closing of the acquisition of the Voyager Tranche 1 assets, we borrowed
an additional $12 million under the Term Loan Agreement, also evidenced by the
Convertible Subordinated Note. Loans made by Itera under the Term Loan Agreement
accrue interest at a rate between 11.5% and 12.5% per annum. One half of accrued
interest is payable in convertible notes having the same terms and conditions as
the Convertible Subordinated Note and under the terms of the Credit Agreement
must be so paid so long as any obligations under the Credit Agreement and the
Swap Agreement remain unsatisfied. Pursuant to the Convertible Subordinated
Note, Itera may elect to convert all or a portion of the outstanding principal
amount plus accrued and unpaid interest (the "Conversion Amount") due under the
Convertible Subordinated Note, in increments of at least $100,000, into such
number of shares of our Common Stock equal to the quotient of (x) the Conversion
Amount divided by (y) $4.625. We received the opinion of an investment banking
firm, stating that the terms of the Term Loan Agreement and Convertible
Subordinated Note are fair, from a financial point of view, to our stockholders.
Prior to November 17, 2005, we had incurred indebtedness from Itera
totaling $8,500,000. Such indebtedness, described below, were refinanced by our
issuance of a Convertible Subordinated Note to Itera on November 17, 2005.
During the quarter ended September 30, 2005, Itera loaned us the sum of $2.0
million pursuant to the terms of a promissory note dated August 12, 2005. In
addition, Itera advanced $1.5 million to us in June 2005 and $5 million in March
2005. Subject to mandatory prepayment upon the occurrence of certain events, the
promissory notes evidencing all three loans had a three year maturity and bore
interest at the Prime Rate plus 4% per annum.
Subject to the satisfaction of a Borrowing Base formula, numerous
conditions precedent and covenants, the Credit Agreement provides for facilities
of up to $50 million. In connection with the acquisitions of the Springside
Properties and the Voyager Tranche 1 assets, we borrowed $8.5 million under the
revolving credit facility and made the First Term Draw under the term loan
facility in the amount of $10 million. Unless earlier payment is required under
the Credit Agreement, Revolving Loans must be paid on or before November 17,
2007 and Term Loans on or before May 17, 2007. The Second Term Draw, which may
be requested on or before May 31, 2006 and may be up to $19 million, is
conditioned, among other things, the additional convertible subordinated loan by
Itera of the $4.5 million balance of its $25 million commitment under the Term
Loan Agreement and acquisition of additional Oil and Gas Properties.
43
As security for all of our obligations under the Credit Agreement and the
Swap Agreement, we granted Standard a security interest in and a first lien on,
all of our assets including, without limitation, the Barnett Shale properties
that we acquired or will acquire from Voyager. Our two wholly-owned
subsidiaries, Vaquero Partners LLC and Dune Operating Company, have each
guaranteed our obligations. Under the Credit Agreement, interest on Revolving
Loans accrues at the LIBOR Rate plus the Applicable Margin while interest on
Term Loans accrues at a rate between 12% and 13% per annum.
Critical Accounting Policies
Our significant accounting policies are more fully described in Note 1 to
the audited financial statements included with this report. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues
and expenses, and the related disclosures of contingent assets and liabilities.
Actual results could differ from those estimates under different assumptions or
conditions.
We use the full cost accounting method to account for the costs incurred
in the acquisition, exploration, development and production of oil and gas
reserves.
Quantitative and Qualitative Disclosure about Market Risk
Our primary exposure to market risk consists of changes in interest rates
on borrowings under our Credit Agreement with Standard. 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 rate debt. Except with
respect to the interest rates under the Credit Agreement, we do not have debts
or hold instruments that are sensitive to changes in interest rates, foreign
currency exchange rates or commodity prices.
PROPERTIES
Our headquarters are located at 3050 Post Oak Blvd., Suite 695, Houston,
Texas. We presently lease 4,197 square feet at such location at an annual rent
of $79,740. Our office lease expires June 1, 2009.
Additional information relating to our properties appears above in
"Business" and reference is made thereto.
CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
Vaquero Partners and Vaquero Oil & Gas, Inc. ("VOG") entered into an
agreement dated as of August 22, 2003, as subsequently amended on November 17,
2003 and May 18, 2004. Per this agreement, VOG served as the operator on our
Welder Ranch Property until August 22, 2006. For its services, we paid VOG
$37,000 during 2005. Effective August 22, 2005, Vaquero Partners redeemed VOG's
15% membership interest and we became the 100% owner of Vaquero Partners.
On November 15, 2004, we entered into a one year agreement with the Wall
Street Group, Inc. ("WSG"), to assist us with investor relations. Pursuant to
our agreement with WSG, WSG received a monthly fee of $10,000 for the first
three months of its engagement and received a monthly fee of $7,500 for each
44
month of service thereafter. Additionally, on November 15, 2004, we granted WSG
options to acquire up to 133,333 shares of our Common Stock at an exercise price
of $0.75 per share. Such options are fully vested and expire on November 15,
2009. Our agreement with WSG expired on November 15, 2005.
We entered into a Term Loan Agreement dated as of November 17, 2005 with
our majority stockholder, Itera Holdings BV. Amounts borrowed from Itera under
the Term Loan Agreement are subordinated to all obligations under our Credit
Agreement and Swap Agreement with Standard and are evidenced by a Convertible
Subordinated Note.
MARKET FOR COMMON EQUITY
AND RELATED
STOCKHOLDER MATTERS
On May 9, 2005, our Common Stock began trading on the American Stock
Exchange under the symbol "DNE". Prior to May 9, 2005, our Common Stock was
traded on the OTC Bulletin Board under the symbol "DENG." Our Common Stock
became eligible for quotation on the OTC Bulletin Board on May 11, 2004. The
following table sets forth, for periods prior to May 9, 2005, the high and low
bid prices per share of the Common Stock for each of the calendar quarters
identified below as reported by the OTC Bulletin Board. These quotations
represent inter-dealer prices, without retail mark-up, markdown or commission,
and may not represent actual transactions. The following table also sets forth,
for the period from May 9, 2005 to December 31, 2005, the high and low sale
prices of the Common Stock on the American Stock Exchange.
2006: High Low
----- ---- ---
Quarter ended March 31, 2006 ................................... $4.70 $2.65
2005: High Low
----- ---- ---
Quarter ended December 31, 2005................................. $3.00 $1.81
Quarter ended September 30, 2005................................ $2.80 $2.81
Quarter ended June 30, 2005 (May 9, 2005 through June 30, 2005). $2.92 $1.85
Quarter ended June 30, 2005 (through May 8, 2005) .............. $3.05 $2.00
Quarter ended March 31, 2005.................................... $3.00 $0.73
2004: High Low
----- ---- ---
Quarter ended December 31, 2004................................. $1.10 $0.55
Quarter ended September 30, 2004................................ 3.45 0.90
Quarter ended June 30, 2004 (began May 11, 2004)................ 3.75 1.84
The last sales price of our Common Stock as reported on the American Stock
Exchange on December 30, 2005 was $2.84 per share.
As of March 15, 2006, there were approximately 292 holders of record of
our Common Stock.
45
We have not paid any cash dividends to date, and have no intention of
paying any cash dividends on the Common Stock in the foreseeable future. The
declaration and payment of dividends is subject to the discretion of our Board
of Directors and to certain limitations imposed under Delaware corporation law.
The timing, amount and form of dividends, if any, will depend on, among other
things, our results of operations, financial condition, cash requirements and
other factors deemed relevant by our Board of Directors. The agreements and
instruments that we entered into in 2005 in connection with our debt financings
contain significant restrictions on our ability to pay dividends on our Common
Stock.
As of March 31, 2006, approximately 3,502,657 shares of our Common Stock
were subject to issuance upon exercise or conversion of outstanding options or
warrants to purchase shares of Common Stock.
The following table provides information as of December 31, 2005 about our
equity compensation plans and arrangements as of December 31, 2005.
Equity Compensation Plan Information - December 31, 2005
(c)
Number of securities
remaining available for
(a) (b) future issuance under
Number of securities to Weighted-average equity compensation
be issued upon exercise exercise price of plans (excluding
of outstanding options, outstanding options, securities reflected in
Plan Category warrants and rights warrants and rights column (a))
-------------------------- ---------------------- -------------------------
Equity compensation plans
approved by security holders
(1) 1,224,324 $2.44 --
-------------------------- ---------------------- -------------------------
Equity compensation plans not
approved by security holders 2,278,333 $1.93 --
-------------------------- ---------------------- -------------------------
Total 3,502,657 $2.10 --
========================== ====================== =========================
(1) Consists of warrants issued to our placement agent to purchase (a) 324,324
shares of our Common Stock at $1.85 per share, and (b) 900,000 shares of
our Common Stock at $2.65 per share.
(2) Consists of stock options grants to our employees, officers and directors.
Transfer Agent
American Stock Transfer & Trust Company is the registrar and transfer
agent for our Common Stock. Its address is 59 Maiden Lane, New York, New York
10038.
46
EXECUTIVE COMPENSATION
The following table shows for fiscal years ended December 31, 2005, 2004
and 2003, respectively, certain compensation which we awarded or paid to, or
which was earned from us by, our executive officers (collectively, the "Named
Executive Officers").
Summary Compensation Table
Fiscal Long Term
Year Annual Compensation Compensation
------ ---------------------------- --------------------------------------
Name and Principal Position Salary($) Bonus($) Other Annual Securities Under
Compensation Options Granted
or Restricted
Stock Award (#)(3)
Alan Gaines 2005 $408,333(1) $ -- $14,203(2) 625,000
Chairman and Chief
Executive Officer 2004 262,920 -- -- --
2003 30,000 -- -- --
Amiel David, 2005 287,498(1) -- $14,076(2) 750,000
President and Chief
Operating Officer 2004 143,956 -- -- --
2003 -- -- --
Hugh Idstein, 2005 103,631 -- 16,279(2) 75,000
Chief Financial Officer
2004 -- -- -- --
2003 -- -- -- --
- ----------
(1) Includes salary for January 2006 paid in 2005.
(2) Represents amounts paid by the Company for health insurance premiums.
(3) Consist of stock options to purchase shares of Common Stock, the vesting
schedule and other terms of which are set forth in the footnotes to the
table below under the caption "Option Grants In Last Fiscal Year (2005)".
47
Option Grants in Last Fiscal Year
As set forth in the following table, during 2005 we granted the following
stock options to the Named Executive Officers:
Option Grants In Last Fiscal Year (2005)
% of
Number of Total
Securities Options
Underlying Granted to
Options Employees in Exercise Expiration
Year Granted Fiscal Year Price Date
---- ------- ----------- ----- ----
Alan Gaines......................... 2005 625,000 (1) 34.8% $2.44 5/12/10
Amiel David......................... 2005 750,000 (2) 41.8% $2.02 5/12/10
Hugh Idstein........................ 2005 75,000 (3) 4.2% $2.56 4/4/10
Richard Cohen....................... 2005 50,000 (4) 2.8% $2.35 10/28/10
- --------------------------------------------------------------------------------
1. Of the 625,000 options, options to purchase 250,000 shares of Common Stock
vested as of the date of grant (May 12, 2005) and options to purchase
250,000 shares and 125,000 shares, respectively, will vest on each of the
first two anniversaries of May 12, 2005.
2. The exercise price of $2.02 listed in the table represents the
weighted-average exercise price of the options held by Dr. David. On
May12, 2005 options were granted to Dr. David with a five-year term to
purchase up to 500,000 shares of Common Stock at $2.44 per share. Such
options vested immediately upon grant as to 250,000 shares and the
remaining 250,000 shares will vest on May 12, 2006. Dr. David also
received on February 15, 2005 options to purchase 250,000 shares. Such
options are fully vested, expire on February 15, 2010 and have an exercise
price off $1.25 per share.
3. Mr. Idstein received options to purchase 75,000 shares at $2.56 per share.
Such options vested with respect to 25,000 shares immediately as of the
date of grant (April 4, 2005) and will vest with respect to 25,000 shares
on each of the first two anniversaries of April 4, 2005.
4. These options to purchase 50,000 shares will vest at the time that the
issuance of such options is approved by our shareholders.
48
Aggregated Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values
Option Value at December 31, 2005
Number of Securities Value of
Underlying Unexercised Unexercised In-The-Money
Options at December 31, 2005 Options at December 31, 2005
---------------------------- ----------------------------
Exercisable Unexercisable Exercisable Unexercisable
----------- ------------- ----------- -------------
Alan Gaines..... 250,000 375,000 $100,000 $150,000
Amiel David..... 500,000 250,000 $497,500 $100,000
Hugh Idstein.... 25,000 50,000 $ 7,000 $ 14,000
Richard Cohen... 0 50,000 $ 0 $ 24,500
The last sale price of the Common Stock was $2.84 on December 30, 2005,
the last trading day of 2005.
Employment Agreements
Both Alan Gaines, our Chairman and CEO, and Amiel David, our President and
COO, entered into Employment Agreements with us in May 2005 that extended the
term of their employment from May 31, 2005 to June 30, 2007. Per their
respective agreements, Mr. Gaines receives a base salary of $400,000 in year one
and a base salary of $460,000 in year two of his contract. Dr. David receives a
base salary of $300,000 in year one and $330,000 in year two. Mr. Gaines'
agreement provides that, for the twelve months ended June 30, 2006 and 2007, he
will be entitled to receive a performance bonus equal to one percent (1%) of our
"free cash flow" (defined as our earnings before depreciation, depletion,
amortization and capital expenditures) up to $8 million and two percent (2%) of
free cash flow above $8 million. Dr. David shall be entitled to receive a
performance bonus equal to three quarters of one percent (.75%) of our "free
cash flow" up to $8 million and one and one half percent (1.5%) of free cash
flow above $8 million. The agreements provide that in the event Mr. Gaines or
Dr. David are terminated without "cause" (as defined in the agreements), they
are to receive a severance payment equal to the greater of (i) twelve (12)
months base salary and (ii) their base salary for the remainder of the term.
Each agreement contains covenants restricting each of the foregoing officers
from participating in any business which is then engaged in the drilling,
exploration or production of natural gas or oil, within the area contemplated by
that certain Area of Mutual Interest Agreement, dated November 17, 2003, between
us and Voyager. In connection with their Agreements, we granted stock options to
Mr. Gaines and Dr. David to acquire 625,000 and 500,000 shares of our Common
Stock, respectively.
In March of 2006, our board of directors extended the Employment Agreement
of Hugh Idstein (the "Idstein Agreement"), our Chief Financial Officer, for an
additional one year period, until April 2007. In addition, the board awarded Mr.
Idstein a $40,500 bonus for his contributions during 2005. The board also
granted him a five year stock option to purchase up to 100,000 shares of our
Common Stock, at an exercise price of $2.81 per share. The option is immediately
exercisable with respect to 25,000 shares. The option is exercisable for an
additional 50,000 shares on the first anniversary date and 25,000 shares on the
second anniversary date of his employment with us, provided that Mr. Idstein is
employed by us on such dates. Under the terms of the Idstein Agreement, Mr.
Idstein will receive an annual salary of $160,000 and, provided he is still
employed by us at the end of the one year term, a guaranteed bonus of $24,000
and he will be eligible for a discretionary performance bonus up to an
additional $32,000. The Idstein Agreement provides that, in the event Mr.
Idstein is terminated without "cause" (as defined in the Idstein Agreement), he
49
will receive a severance payment equal to six (6) months' base salary. The
Idstein Agreement also contains covenants restricting Mr. Idstein from
participating in any business which is then engaged in the drilling, exploration
or production of natural gas or oil, within the area contemplated by that
certain Area of Mutual Interest Agreement, dated November 17, 2003, between us
and Vaquero Oil & Gas Inc.
Director Compensation
Each of our outside Directors receives $5,000 per quarter for serving on
the Board and $1,000 per quarter for serving on a committee. Except as set forth
above, Directors are not compensated in cash for their services but are
reimbursed for out of pocket expenses incurred in furtherance of our business.
In 2005, we granted stock options to acquire up to 50,000 shares of Common Stock
to each of our outside directors and to Mr. Cohen. Such stock options were
granted on October 28, 2005 and, provided that we obtain shareholder approval
for the issuance of such options at our next annual meeting, may be exercised at
any time prior to October 28, 2010 at an exercise price of $2.35 per share.
50
FINANCIAL STATEMENTS
Index to Financial Statements
Page
----
March 31, 2006 and 2005 (Unaudited)
Consolidated Balance Sheets for Periods ended
March 31, 2006 and December 31, 2005 F-2
Consolidated Statements of Operations for Three
Months Ended March 31, 2006 and 2005 F-3
Consolidated Statements of Cash Flows for Three
Months Ended March 31, 2006 and 2005 F-4
Notes to Consolidated Financial Statements F-5
December 31, 2005 and 2004
Report of Independent Registered Public Accounting Firm F-8
Consolidated Balance Sheet at December 31, 2005 F-9
Consolidated Statements of Operations for the Years
Ended December 31, 2005 and 2004 F-10
Consolidated Statements of Changes in Stockholders' Equity for
The Years Ended December 31, 2005 and 2004 F-11
Consolidated Statements of Cash Flows for the Years
Ended December 31, 2005 and 2004 F-12
Notes to Consolidated Financial Statements F-13
F-1
Dune Energy, Inc.
Consolidated Balance Sheets
For the periods ended March 31, 2006 and December 31, 2005
(Unaudited)
ASSETS March 31,2006 December 31, 2005
------------- -----------------
Current assets:
Cash $ 11,077,647 $ 3,754,120
Accounts receivable 1,481,034 1,595,967
Prepaid assets 631,616 --
------------ ------------
Total current assets 13,190,297 5,350,087
------------ ------------
Property and equipment 56,871 39,127
Less accumulated depreciation (7,581) (5,033)
------------ ------------
Net property and equipment 49,290 34,094
------------ ------------
Oil and gas properties, using full cost accounting:
Properties being amortized 49,156,664 20,984,208
Properties not subject to amortization 5,175,798 28,962,342
Deposits on oil and gas properties 1,820,101 1,820,101
Less accumulated depreciation, depletion and amortization (1,488,144) (982,240)
------------ ------------
Net oil and gas properties 54,664,419 50,784,411
------------ ------------
Deferred financing costs, net of accumulated amortization
of $359,490 and $143,558 2,133,694 2,363,187
------------ ------------
TOTAL ASSETS $ 70,037,700 $ 58,531,779
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities - accounts payable and accrued liabilities $ 3,459,830 $ 4,280,024
Long-term debt 30,889,547 39,097,514
Other long-term liabilities 243,717 269,235
------------ ------------
Total liabilities 34,593,094 43,646,773
------------ ------------
STOCKHOLDERS' EQUITY
Common stock, $.001 par value, 100,000,000 shares authorized,
59,244,859 and 50,244,859 shares issued and outstanding 59,245 50,244
Additional paid-in capital 42,634,376 20,093,671
Accumulated deficit (7,249,015) (5,258,909)
------------ ------------
Total stockholders' equity 35,444,606 14,885,006
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 70,037,700 $ 58,531,779
============ ============
See summary of significant accounting policies
and notes to financial statements.
F-2
Dune Energy, Inc.
Consolidated Statements of Operations
For the three months ended March 31, 2006 and 2005
(Unaudited)
2006 2005
------------ ------------
Revenues $ 1,300,820 $ 543,713
------------ ------------
Operating expenses:
General and administrative expense 824,796 413,724
Direct operating expense 351,684 65,534
Share-based compensation 473,388 --
Depletion, depreciation and amortization 724,384 37,480
------------ ------------
Operating income(loss) (1,073,432) 26,975
------------ ------------
Other income(expense):
Interest income 97,511 8,792
Minority interest -- (40,091)
Interest expense (1,039,703) (5,575)
Accretion expense (1,999) --
Gain on embedded derivative liability 27,517 --
------------ ------------
Net loss $ (1,990,106) $ (9,899)
============ ============
Net loss per share:
Basic and diluted $ (0.04) $ (0.00)
Weighted average shares outstanding:
Basic and diluted 56,144,859 46,041,323
See summary of significant accounting policies
and notes to financial statements.
F-3
Dune Energy, Inc.
Consolidated Statements of Cash Flows
For the three months ended March 31, 2006 and 2005
(Unaudited)
2006 2005
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,990,106) $ (9,899)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depletion, depreciation and amortization 724,384 37,480
Share-based compensation 473,388 --
Accretion of asset retirement obligation 1,999 --
Gain on derivative mark to market adjustment (27,517) --
Minority interest -- 40,091
Changes in:
Accounts receivable 114,933 (1,187,170)
Prepaid assets (631,616) --
Accounts payable and accrued liabilities (528,161) (69,260)
------------ ------------
NET CASH USED IN OPERATING ACTIVITIES (1,862,696) (1,188,758)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in proved and unproved properties (4,385,912) (3,660,999)
Purchase of office equipment (17,744) --
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (4,403,656) (3,660,999)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt -- 5,000,000
Proceeds from sale of common stock 22,103,232 --
Payment on long-term debt issuance cost (13,353) --
Payments on long-term debt (8,500,000) --
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 13,589,879 5,000,000
------------ ------------
NET CHANGE IN CASH BALANCE 7,323,527 150,243
Cash balance at beginning of period 3,754,120 3,746,999
------------ ------------
Cash balance at end of period $ 11,077,647 $ 3,897,242
============ ============
SUPPLEMENTAL DISCLOSURES
Interest paid $ 327,827 $ 13,250
Income taxes paid -- --
NON-CASH DISCLOSURES
Stock issued for conversion of debt $ -- $ 300,000
See summary of significant accounting policies
and notes to financial statements.
F-4
DUNE ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited interim consolidated financial statements of
Dune Energy, Inc. ("Dune") have been prepared in accordance with accounting
principles generally accepted in the United States of America and the rules of
the Securities and Exchange Commission ("SEC"), and should be read in
conjunction with the audited consolidated financial statements and notes thereto
contained in the Dune's Annual Report filed with the SEC on Form 10-KSB for the
year ended December 31, 2005. In the opinion of management, all adjustments,
consisting of normal recurring adjustments, necessary for a fair presentation of
financial position and the results of operations for the interim periods
presented have been reflected herein. The results of operations for interim
periods are not necessarily indicative of the results to be expected for the
full year. Notes to the financial statements that would substantially duplicate
the disclosures contained in the audited financial statements for 2005 as
reported in the 10-KSB have been omitted.
NOTE 2 - SHAREHOLDERS' EQUITY
On February 1, 2006, Dune sold a total of 9,000,000 shares of common stock
at a price of $2.65 per share in a private equity offering. Gross proceeds
raised in the offering were $23,850,000. From the gross proceeds, Dune paid the
investment bankers a placement agent fee of $1,192,500 (5% of the gross
proceeds), a financial advisory fee of $477,000 (2% of the gross proceeds) and
expenses of $104,184, of which $26,916 had been prepaid as of December 31, 2005.
Dune also issued a warrant exercisable for up to 900,000 shares of its common
stock at an exercise price of $2.65 per share. On April 4, 2006, Dune Energy
filed a SB-2, registering both the shares issued to investors and the shares
underlying the warrant for resale. Our private offering was made in reliance
upon Section 4(2) of the Securities Act of 1933, as amended, and Rule 506 of
Regulation D.
NOTE 3 - DEBT FINANCING
As a result of the industry-wide shortage of available drilling rigs
Dune's intended drilling program has been delayed. However, in order to return
to the drilling program originally planned, Dune entered into a rig contract,
the terms of which call for the construction and subsequent long-term
contractual commitment of a drilling rig for Dune's exclusive use on our Barnett
Shale Properties. This rig, which will be capable of drilling deviated and
horizontal wells, is expected to be delivered to Dune on or about August 1,
2006. In addition, we signed a second contract for a drilling rig, to drill
three wells on Dune's Barnett Shale Properties. This contract calls for the rig
to move on to the first location on June 1, 2006.
The delays in procuring rigs have caused the postponement of the time at
which revenues can be expected from the subject properties. As a consequence,
Dune needed and has obtained a waiver through June 15, 2006 from its senior and
subordinated lenders, of compliance with certain covenants in Dune's lending
arrangements requiring certain levels of income from operations. After the
commencement of drilling on Dune's next well in early June, Dune expects such
waivers to be extended to such time as it is in fact able to comply with such
covenants as originally provided. Dune has agreed with its senior and
subordinated lenders to certain changes in the respective contractual
arrangements as a result of the delay described above, including suspension of
revolving credit availability under the senior facility and the payment of
certain interest amounts in subordinated notes rather than cash under our
subordinated facility.
NOTE 4 - STOCK-BASED COMPENSATION
On January 1, 2006, Dune adopted SFAS No. 123(R), "Share-Based Payment"
("SFAS 123(R)"). SFAS 123(R) replaced SFAS No. 123 and supersedes APB Opinion
No. 25. SFAS 123(R) requires all share-based payments to employees, including
grants of employee stock options, to be recognized in the financial statements
based on their fair values. The pro forma disclosures previously permitted under
SFAS 123 are no longer an alternative to financial statement recognition. Dune
adopted
F-5
SFAS 123(R) using the modified prospective method which requires the application
of the accounting standard as of January 1, 2006. The consolidated financial
statements as of and for the quarter ended March 31, 2006 reflect the impact of
adopting SFAS 123(R). In accordance with the modified prospective method, the
consolidated financial statements for prior periods have not been restated to
reflect, and do not include, the impact of SFAS 123(R).
Prior to 2006, Dune accounted for stock-based compensation to employees
and directors under the intrinsic value method under APB Opinion No. 25. Under
this method, Dune had not recognized compensation expense for stock granted when
the underlying number of shares is known and the exercise price of the option is
greater than or equal to the fair market value of the stock on the grant date.
Had Dune determined compensation expense for stock option grants based on their
estimated fair value at their grant date, Dune's net loss and net loss per share
would have been as follows:
Three months ended
March 31, 2005
--------------
Net loss, as reported $ (9,899)
Deduct: stock-based compensation expense determined
under fair value based method (305,927)
---------
Pro forma net loss $(315,826)
=========
Net loss per share, basic and diluted:
As reported $ (0.00)
Pro forma $ (0.01)
The weighted average fair value of the stock options granted during the
three months ended March 31, 2006 and 2005 was $2.44 and $1.22, respectively.
Variables used in the Black-Scholes option-pricing model include (1) risk-free
interest rates of 4.7% and 2.0%, (2) expected option life is the actual
remaining life of the options as of each period end, (3) expected volatility is
129.59% to 204.69% and (4) zero expected dividends.
NOTE 5 - DERIVATIVE FINANCIAL INSTRUMENTS
Dune enters into derivative contracts to provide a measure of stability in
the cash flows associated with Dune's oil and gas production and to manage
exposure to commodity prices. None of the derivative contracts Dune has entered
into have been designated as cash flow hedges or fair value hedges. During 2006,
Dune recorded gains of $27,517 related to its derivative instruments.
The derivative instruments Dune has entered into are described below.
Natural Gas Derivatives
Dune entered into participating collars on natural gas hedges (NG-NYMEX)
whereby Dune receives a floor price and pays a percent of any price in excess of
the floor up to a maximum payment. The following table shows the monthly volumes
hedged, the floor price, percent above the floor price paid (cost) and the
maximum payment for that volume.
Average Average Average Average
Start End Volume Floor Cost Dune Maximum
Month Month MMBTU $/MMBTU % over Floor % Participation Payment
----- ----- ----- ------- ------------ --------------- -------
Apr-06 Apr-06 30,000 $ 8.000 45.000% 55.000% $ 1.800
May-06 Oct-06 37,500 $ 7.867 45.530% 54.470% $ 1.947
Nov-06 Dec-06 35,000 $ 7.854 45.570% 54.430% $ 1.957
Jan-07 May-07 30,000 $ 7.833 45.670% 54.330% $ 1.980
Jun-07 Dec-07 27,500 $ 7.818 45.730% 54.270% $ 2.000
Jan-08 Dec-08 25,000 $ 7.500 47.000% 53.000% $ 2.000
F-6
Crude Oil Derivatives
Dune entered into participating collars on crude oil hedges (WTI-NYMEX)
whereby Dune receives a floor price and pays a percent of any price in excess of
the floor up to a maximum payment. The following table shows the monthly volumes
hedged, the floor price, percent above the floor price paid (cost) and the
maximum payment for that volume.
Average Average Average Average
Start End Volume Floor Cost Dune Maximum
Month Month bbls $/bbls % over Floor % Participation Payment
----- ----- ---- ------ ------------ --------------- -------
Apr-06 Aug-06 1,250 $ 45.000 25.000% 75.000% $ 5.000
Sep-06 Dec-06 1,000 $ 45.000 25.000% 75.000% $ 5.000
Jan-07 Oct-07 750 $ 45.000 25.000% 75.000% $ 5.000
Nov-07 Dec-07 500 $ 45.000 25.000% 75.000% $ 5.000
Jan-08 Dec-08 500 $ 55.000 40.000% 60.000% $ 8.000
NOTE 6 - SUBSEQUENT EVENTS
On April 11, 2006, Dune entered into a definitive contract, the terms of
which call for the construction of and subsequent long-term contract for a
drilling rig for Dune's exclusive use on its Barnett Shale properties. In
addition, Dune is presently engaged in ongoing discussions with the same rig
company regarding an option on a second rig. Both rigs will be capable of
drilling deviated and horizontal wells. Dune's properties are located in Denton
and Wise Counties in the North Texas Fort Worth Basin. Dune expects the first
rig to be available on or about August 1, 2006.
The term of the contract is two years with an extension clause. The day
rate will be fixed with a price renegotiation clause at the end of the initial
twelve months of operation. Dune will retain the right to sublease the rig if
needed.
On May 10, 2006, Dune signed a drilling contract with Big Giant to drill
three vertical wells in the Barnett Shale. The contract calls for the rig to
move on Dune's first location June 1, 2006.
F-7
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors
Dune Energy, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheet of Dune Energy
Inc. as of December 31, 2005, and the related statements of operations,
stockholders' equity, and cash flows for the two years then ended. These
financial statements are the responsibility of Dune's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Dune Energy Inc., as of
December 31, 2005, and the results of its operations and its cash flows for the
periods described in conformity with accounting principles generally accepted in
the United States of America.
/s/ MALONE & BAILEY, PC
MALONE & BAILEY, PC
www.malone-bailey.com
Houston, Texas
March 24, 2006
F-8
Dune Energy, Inc.
Consolidated Balance Sheet
December 31, 2005
ASSETS
Current assets:
Cash $ 3,754,120
Accounts receivable 1,595,967
------------
Total current assets 5,350,087
------------
Property and equipment 39,127
Less accumulated depreciation (5,033)
------------
Net property and equipment 34,094
------------
Oil and gas properties, using full cost accounting:
Properties being amortized 20,984,208
Properties not subject to amortization 28,962,342
Deposits on oil and gas properties 1,820,101
Less accumulated depreciation, depletion and amortization (982,240)
------------
Net oil and gas properties 50,784,411
------------
Deferred financing costs, net of accumulated amortization
of $143,558 2,363,187
------------
TOTAL ASSETS $ 58,531,779
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities - accounts payable and accrued liabilities $ 4,280,024
Long-term debt 39,097,514
Other long-term liabilities 269,235
------------
Total liablities 43,646,773
------------
STOCKHOLDERS' EQUITY
Common stock, $.001 par value, 100,000,000 shares
authorized, 50,244,859 shares issued and outstanding 50,244
Additional paid-in capital 20,093,671
Accumulated deficit (5,258,909)
------------
Total stockholders' equity 14,885,006
------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 58,531,779
============
See summary of significant accounting policies and notes to financial
statements.
F-9
Dune Energy, Inc.
Consolidated Statements of Operations
Years ended December 31, 2005 and 2004
2005 2004
------------ ------------
Revenues $ 3,724,278 $ 1,022,297
------------ ------------
Operating expenses:
General and administrative expense 2,550,549 1,935,539
Production taxes 341,309 65,196
Depletion, depreciation and amortization 1,067,029 63,801
Lease operating expense 378,163 37,478
------------ ------------
Operating loss (612,772) (1,079,717)
------------ ------------
Other income (expense):
Other income -- 78,194
Interest income 48,893 45,395
Minority interest (52,611) (38,193)
Interest expense (775,427) (120,640)
Accretion expense (2,173) --
Loss on embedded derivative liability (190,553) --
------------ ------------
Net loss $ (1,584,643) $ (1,114,961)
============ ============
Net loss per share:
Basic and diluted $ (0.03) $ (0.04)
Weighted average shares outstanding:
Basic and diluted 47,557,242 30,443,387
See summary of significant accounting policies and notes to financial
statements.
F-10
Dune Energy, Inc.
Consolidated Statements of Changes in Stockholders' Equity
Years ended December 31, 2005 and 2004
Preferred Stock - Series A Common Stock
-------------------------- ------------
Paid-In Accumulated Total
Shares Amount Shares Amount Capital Deficit Equity
-------- --------- --------- ----------- ----------- ----------- -----------
Balance at
December 31, 2003 -- $ -- 7,119,127 $ 7,119 $ 2,103,505 $(2,559,305) $ (448,681)
Stock issued for:
Services -- -- 522,917 523 219,435 -- 219,958
Cash 222,222 222 35,464,432 35,465 10,964,313 -- 11,000,000
Commissions -- -- 476,323 476 (476) -- --
Conversion of preferred to common (111,111) (111) 222,222 222 (111) -- --
Debt -- -- 1,792,150 1,792 764,708 -- 766,500
Net loss -- -- -- -- -- (1,114,961) (1,114,961)
-------- ----------- ---------- ----------- ----------- ----------- -----------
Balance at December 31, 2004 111,111 111 45,597,171 45,597 14,051,374 (3,674,266) 10,422,816
Stock issued for:
Debt -- -- 1,182,223 1,182 443,818 -- 445,000
Conversion of preferred to common (111,111) (111) 222,222 222 (111) -- --
Cash paid to consultant for stock
subscription -- -- -- -- (398,167) -- (398,167)
Cash received for stock subscription -- -- 3,243,243 3,243 5,996,757 -- 6,000,000
Net loss -- -- -- -- -- (1,584,643) (1,584,643)
-------- ----------- ---------- ----------- ----------- ----------- -----------
Balance at December 31, 2005 -- $ -- 50,244,859 $ 50,244 $20,093,671 $(5,258,909) $14,885,006
======== =========== ========== =========== =========== =========== ===========
See summary of significant accounting policies and notes to financial
statements.
F-11
Dune Energy, Inc.
Consolidated Statements of Cash Flows
Years ended December 31, 2005 and 2004
2005 2004
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,584,643) $ (1,114,961)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depletion, depreciation and amortization 1,067,029 63,801
Minority interest (17,201) 17,201
Stock for services and interest -- 219,958
Changes in:
Accounts receivable (1,059,638) (444,392)
Other current assets -- 42,690
Accounts payable and accrued liabilites 4,002,084 (9,196)
Other long-term liabilities 269,235 --
------------ ------------
NET CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES 2,676,866 (1,224,899)
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in proved and unproved properties (43,003,119) (5,800,842)
Deposits on oil and gas properties (1,820,101) --
Purchase of office equipment (39,127) --
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (44,862,347) (5,800,842)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from long-term debt 39,097,514 --
Proceeds from sale of common stock 5,601,833 10,800,000
Payment of loan origination fees (2,506,745) --
Proceeds from sale of preferrred stock -- 200,000
Proceeds from sale of convertible debentures -- 45,000
Payments on notes payable -- (500,000)
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 42,192,602 10,545,000
------------ ------------
NET CHANGE IN CASH BALANCE 7,121 3,519,259
Cash balance at beginning of period 3,746,999 227,740
------------ ------------
Cash balance at end of period $ 3,754,120 $ 3,746,999
============ ============
SUPPLEMENTAL DISCLOSURES
Interest paid $ 553,236 $ 99,351
Income taxes paid -- --
NON-CASH DISCLOSURES
Stock issued for conversion of debt $ 450,000 $ 724,000
Conversion of preferred stock to common stock 222 100,000
Increase in oil and gas property for note payable -- 140,000
Reduction in oil and gas property for adjustment in purchase price -- 91,937
Stock issued for debt to related party -- 42,500
See summary of significant accounting policies and notes to financial
statements.
F-12
DUNE ENERGY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of operations and organization
Dune Energy, Inc., a Delaware corporation ("Dune" or the "Company"), is an
independent energy company that was formed in 1998. Since May 2004, Dune has
been engaged in the exploration, development, exploitation and production of oil
and natural gas. Dune sells its oil and gas products primarily to domestic
pipelines and refineries. Its operations are presently focused in the States of
Texas and Louisiana. Dune, through its 100% owned subsidiary, Vaquero Partners
LLC ("Vaquero"), acquired interests in certain oil and natural gas leases
located in Victoria County, Texas. Dune also directly holds interests in other
properties discussed in this 10-KSB.
Consolidation
The accompanying consolidated financial statement includes all accounts of
Dune and Vaquero. All significant inter-company balances and transactions have
been eliminated in consolidation.
Oil and gas properties
Dune follows the full cost accounting method to account for the costs
incurred in the acquisition, exploration, development and production of oil and
gas reserves. Under this method, all costs, including internal costs directly
related to acquisition, exploration and development activities are capitalizable
as oil and gas property costs.
Amortization of unproved property costs begins when the properties become
proved or their values become impaired. Dune assesses the realizability of
unproved properties on at least an annual basis or when there has been an
indication that an impairment in value may have occurred. Impairment of unproved
properties is assessed based on management's intention with regard to future
exploration and development of individually significant properties and the
ability of Dune to obtain funds to finance such exploration and development. If
the results of an assessment indicate that the properties are impaired, the
amount of the impairment is added to the capitalized costs to be amortized.
The fair value of an asset retirement obligation is recognized in the
period in which it is incurred if a reasonable estimate of fair value can be
made. The present value of the estimated asset retirement costs is capitalized
as part of the carrying amount of the long-lived asset. For Dune, asset
retirement obligations relate to the abandonment of oil and gas producing
facilities. The amounts recognized are based upon numerous estimates and
assumptions, including future retirement costs, future recoverable quantities of
oil and gas, future inflation rates and the credit-adjusted risk-free interest
rate.
Under full cost accounting rules for each cost center, capitalized costs
of proved properties, less accumulated amortization and related deferred income
taxes, shall not exceed an amount (the "cost ceiling") equal to the sum of (a)
the present value of future net cash flows from estimated production of proved
oil and gas reserves, based on current economic and operating condition,
discounted at 10 percent, plus (b) the cost of properties not being amortized,
plus (c) the lower of cost or estimated fair value of any unproved properties
included in the costs being amortized, less (d) any income tax effects related
to differences between the book and tax basis of the properties involved. If
capitalized costs exceed this limit, the excess is charged as an impairment
expense. Costs of oil and gas properties will be amortized using the units of
production method.
Revenue recognition
Dune records oil and gas revenues following the entitlement method of
accounting for production, in which any excess amount received above Dune's
share is treated as a liability. If less than Dune's share is received, the
underproduction is recorded as an asset. Dune did not have an imbalance position
in terms of volumes or values at December 31, 2005.
F-13
Cash and cash equivalents
Cash and cash equivalents include cash in banks and certificates of
deposit which mature in within three months of the date of purchase.
Use of estimates
The preparation of these financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amount of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Property and equipment
Property and equipment is valued at cost. Additions are capitalized and
maintenance and repairs are charged to expense as incurred. Gains and losses on
dispositions of equipment are reflected in other revenues.
Deferred financing costs
In connection with debt financings, Dune has paid $2,506,745 in fees.
These fees were recorded as deferred financing costs and are being amortized
over the life of the loans using the straight-line method.
Long-lived assets
Long-lived assets to be held and used or disposed of other than by sale
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. When required, impairment
losses on assets to be held and used or disposed of other than by sale are
recognized based on the fair value of the asset. Long-lived assets to be
disposed of by sale are reported at the lower of the asset's carrying amount or
fair value less cost to sell.
Derivatives
Derivative financial instruments, utilized to manage or reduce commodity
price risk related to Dune's production and interest rate risk related to Dune's
long-term debt, are accounted for under the provisions of SFAS No. 133,
"Accounting for Derivative Instruments and for Hedging Activities", and related
interpretations and amendments. Under this statement, derivatives are carried on
the balance sheet at fair value. If the derivative is designated as a fair value
hedge, the changes in the fair value of the derivative and of the hedged item
attributable to the hedged risk are recognized in earnings. If the derivative is
designated as a cash flow hedge, the effective portions of changes in the fair
value of the derivative are recorded in other comprehensive income and are
recognized in the statement of operations when the hedged item affects earnings.
If the derivative is not designated as a hedge, changes in the fair value are
recognized in other expense. Ineffective portions of changes in the fair value
of cash flow hedges are also recognized in other expense.
Stock-based compensation
Dune records as compensation expense as the excess of the fair value of
such shares over the exercise price as calculated pursuant to Statement of
Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation
("SFAS No. 123"), recognized over the related service period. Dune accounts for
stock-based compensation issued to non-employees in accordance with the
provisions of SFAS No. 123 and EITF No. 96-18, "Accounting for Equity
Investments That Are Issued to Non-Employees for Acquiring, or in Conjunction
with Selling Goods or Services". For expensing purposes, the value of common
stock issued to non-employees and consultants is determined based on the fair
value of the services received or the fair value of the equity instruments
issued, whichever value is more reliably measurable.
F-14
Had compensation expense for 2005 and 2004 been determined under the fair
value provisions of SFAS No. 123, as amended by SFAS No. 148, Dune's net loss to
common shareholders and net loss per share would have been:
2005 2004
------------- -------------
Net loss, as reported $ (1,584,643) $ (1,114,961)
Add: Stock-based employee compensation expense included in
reported net income determined under APB No. 25 -- --
Deduct: Total stock-based employee compensation expense determined
under fair-value based method for all awards 2,234,056 --
-------------------------------
Pro forma net loss $ (3,818,699) $ (1,114,961)
===============================
Loss per share, basic and diluted:
As reported $ (0.03) $ (0.04)
Pro forma $ (0.08) $ (0.04)
These pro forma amounts may not be representative of future disclosures
since the estimated fair value of stock options is amortized to expense over the
vesting period and additional options may be issued in future years. The
estimated fair value of each option granted was calculated using the
Black-Scholes option pricing model. The following summarizes the weighted
average of the assumptions used in the model.
2005 2004
------ ------
Risk free rate 2.0% --%
Expected years until
exercise 5.0 --
Expected stock volatility 135.72% --%
Dividend yield N/A N/A
Income taxes
Dune recognizes deferred tax assets and liabilities based on differences
between the financial reporting and tax bases of assets and liabilities using
the enacted tax rates and laws that are expected to be in effect when the
differences are expected to be recovered. Dune provides a valuation allowance
for deferred tax assets for which it does not consider realization of such
assets to be more likely than not.
Loss per share
Basic and diluted net loss per share calculations are presented in
accordance with Financial Accounting Standards Statement 128, and are calculated
on the basis of the weighted average number of common shares outstanding during
the year. They include the dilutive effect of common stock equivalents in years
with net income. Basic and diluted loss per share is the same due to the absence
of common stock equivalents.
New Accounting Standards
In December 2004, the FASB issued SFAS No. 123R, "Accounting for
Stock-Based Compensation". SFAS No. 123R establishes standards for the
accounting of transactions in which an entity exchanges its equity instruments
for goods or services. This statement focuses primarily on accounting for
transactions in which an entity obtains employee services in share-based payment
transactions. SFAS No. 123R requires that the fair value of such equity
instruments be recognized as expense in the historical financial statements as
services are performed. Prior to SFAS No. 123R, only certain pro forma
disclosures of fair value were required. SFAS No. 123R shall be effective for
small business issuers as of the beginning of the first interim or annual
reporting period that begins after December 15, 2005. The adoption of this new
accounting pronouncement is not currently expected to have a material impact on
the financial statements of Dune during the calendar year 2006.
Dune does not expect the adoption of any other recently issued accounting
pronouncements to have a significant impact on its results of operations,
financial position or cash flows.
F-15
NOTE 2 - PROPERTY ACQUISITIONS
On June 3, 2004, Dune closed its purchase of 34.98% of Penroc Oil
Corporation's approximately 2% working interest in the Los Mogotes Field located
in Zapata County, Texas. The effective date of the closing was May 28, 2004.
Total consideration consisted of 25,000 shares of Dune common stock and cash of
$874,500.
On December 13, 2004, Dune Energy announced that it entered into a Joint
Venture Participation Agreement covering 2,309 acres plus various agreements
covering approximately 16,695 additional acres, in the Pearsall Field, located
in Frio County, Texas. The Agreement calls for Dune, at its option on a well by
well basis, to drill up to 24 locations on the various leases underlying this
transaction. During 2004, Dune paid $409,050 for its working interest (27%) cost
of drilling the initial well and $133,782 for leasehold and geophysical and
geological costs.
On October 19, 2005, Dune acquired certain exclusive exploration and
development rights from American Natural Energy Corporation ("ANEC"), with an
effective date of August 26, 2005, in ANEC's Joint Development Agreement with
ExxonMobil Corp., covering approximately 11,000 contiguous acres in St. Charles
Parish, Louisiana. Dune has the right to participate in 50% of ANEC's
development rights in the Delta Securities Lease in exchange for $1 million.
Upon the successful drilling of one of the first two exploratory wells drilled,
Dune will be required to pay ANEC an additional $500,000.
On November 17, 2005, Dune acquired the interests in certain oil and gas
properties (the "Springside Properties") from Voyager Partners, Ltd.
("Voyager"). Dune paid a total of $5,451,362 for the Springside Properties with
an effective date of July 1, 2005.
On December 16, 2005, Dune acquired the interests in certain producing and
non-producing natural gas properties and related property and equipment located
in the Barnett Shale play in the North Texas Fort Worth Basin from Voyager
("Voyager Tranche 1"). The purchase price for the properties was $24.6 million
with an effective date of May 1, 2005.
NOTE 3 - CONVERTIBLE DEBENTURES
In March 2004, Dune issued a convertible debenture with a face value of
$45,000. The debenture was convertible into Dune common stock at $0.45 per share
at the option of the holder.
During the year ended December 31, 2004, nineteen holders converted
$766,500 of convertible debentures into 1,792,150 shares of common stock. During
the year ended December 31, 2005, the remaining holders converted $445,000 in
convertible debentures into 1,182,223 shares of common stock. As of December 31,
2005, there are no remaining convertible debentures outstanding.
Dune analyzed these convertible debentures for derivative accounting
consideration under SFAS No. 133 and EITF 00-19. The Company determined that
derivative accounting is not applicable for the convertible debentures.
NOTE 4 - DEBT FINANCINGS
To finance the Company's recent and pending property acquisitions, Dune
entered into a Credit Agreement dated as of November 17, 2005 (the "Credit
Agreement"), with Standard Bank Plc, as Administrative Agent and Lender
("Standard") and Standard Americas Inc., as Collateral Agent. In accordance with
the requirement of Standard, Dune also entered into a Swap Agreement ("Swap
Agreement") with Standard. The Standard agreements requires the company to enter
into swap arrangements equal to 65% to 70% of the reasonably anticipated
projected production from Proved Developed Producing Reserves (as defined in the
Credit Agreement) for each month through the second anniversary of November 17,
2005 for each crude oil and natural gas streams, calculated separately. Pursuant
to the requirements of the Credit Agreement, separate swap hedges need to be put
in place by Dune at a number of specific times when the Proved Developed
Producing Reserves are calculated and recalculated.
In addition, Dune entered into a Term Loan Agreement dated as of November
17, 2005 (the "Term Loan Agreement") with its majority stockholder, Itera
Holdings BV. Amounts borrowed from Itera under the Term Loan Agreement are
subordinated to all obligations under the Credit Agreement and the Swap
Agreement and are evidenced by a convertible subordinated promissory note (the
"Convertible Subordinated Note").
F-16
Under the Term Loan Agreement, Itera agreed to make available to Dune, up
to $25 million of subordinated debt. Effective November 17, 2005, prior
promissory notes evidencing $8.5 million outstanding subordinated indebtedness
to Itera were refinanced by a Convertible Subordinated Note. In addition, in
connection with the closing of the acquisition of the Voyager Tranche 1 assets,
Dune borrowed an additional $12 million under the Term Loan Agreement, also
evidenced by the Convertible Subordinated Note. Loans made by Itera under the
Term Loan Agreement accrue interest at a rate between 11.5% and 12.5% per annum.
One half of accrued interest is payable in convertible notes having the same
terms and conditions as the Convertible Subordinated Note and under the terms of
the Credit Agreement must be so paid so long as any obligations under the Credit
Agreement and the Swap Agreement remain unsatisfied. Pursuant to the Convertible
Subordinated Note, Itera may elect to convert all or a portion of the
outstanding principal amount plus accrued and unpaid interest (the "Conversion
Amount") due under the Convertible Subordinated Note, in increments of at least
$100,000, into such number of shares of Dune's common stock equal to the
quotient of (x) the conversion amount divided by (y) $4.625. Dune received the
opinion of an investment banking firm stating that the terms of the Term Loan
Agreement and Convertible Subordinated Note are fair, from a financial point of
view, to our stockholders.
Prior to November 17, 2005, Dune had incurred indebtedness from Itera
totaling $8,500,000. Such indebtedness, described below, was refinanced by our
issuance of a Convertible Subordinated Note to Itera on November 17, 2005.
During the quarter ended September 30, 2005, Itera loaned Dune the sum of $2.0
million pursuant to the terms of a promissory note dated August 12, 2005. In
addition, Itera advanced $1.5 million to the Company in June 2005 and $5 million
in March 2005. Subject to mandatory prepayment upon the occurrence of certain
events, the promissory notes evidencing all three loans had a three year
maturity and bore interest at the prime rate plus 4% per annum.
Subject to the satisfaction of a Borrowing Base formula, numerous
conditions, precedent and covenants, the Credit Agreement provides for
facilities of up to $50 million. In connection with the acquisitions of the
Springside Properties and the Voyager Tranche 1 assets, Dune borrowed $8.5
million under the revolving credit facility and made the First Term Draw under
the term loan facility in the amount of $10 million. Unless earlier payment is
required under the Credit Agreement, Revolving Loans must be paid on or before
November 17, 2007 and Term Loans on or before May 17, 2008. The Second Term
Draw, which may be requested on or before May 31, 2006 and may be up to $19
million, is conditioned, among other things, on the additional convertible
subordinated loan by Itera of the $4.5 million balance of its $25 million
commitment under the Term Loan Agreement and acquisition of additional Oil and
Gas Properties.
As security for all of the Company's obligations under the Credit
Agreement and the Swap Agreement, Dune granted Standard a security interest in
and a first lien on all of our assets including, without limitation, the Barnett
Shale properties that Dune acquired or will acquire from Voyager. The Company's
two wholly-owned subsidiaries, Vaquero Partners LLC and Dune Operating Company,
have each guaranteed the obligations. Under the Credit Agreement, interest on
Revolving Loans accrues at the LIBOR Rate plus the Applicable Margin while
interest on Term Loans accrues at a rate between 12% and 13% per annum.
NOTE 5 - DERIVATIVE FINANCIAL INSTRUMENTS
Dune enters into derivative contracts to provide a measure of stability in
the cash flows associated with Dune's oil and gas production and to manage
exposure to commodity prices. None of the derivative contracts Dune has entered
into have been designated as cash flow hedges or fair value hedges. During 2005,
Dune recorded losses of $190,553 related to its derivative instruments.
The derivative instruments Dune has entered into are described below.
F-17
Natural Gas Derivatives
Dune entered into participating collars on natural gas hedges (NG-NYMEX)
whereby Dune receives a floor price of $8.00/MMbtu and pays 45% of any price in
excess of $8.00/MMbtu up to a maximum payment of $1.80/MMbtu. The following
table shows the monthly volumes hedged.
Monthly
Start End Volume
Month Month MMbtu
----- ----- -----
December 2005 May 2006 30,000
June 2006 October 2006 27,500
November 2006 December 2006 25,000
January 2007 May 2007 20,000
June 2007 December 2007 17,500
Crude Oil Derivatives
Dune entered into participating collars on crude oil hedges (WTI-NYMEX)
whereby Dune receives a floor price of $45/BBL and pays 25% of any price in
excess of $45/BBL up to a maximum of $5/BBL. The following table shows the
monthly volumes hedged.
Monthly
Start End Volume
Month Month BBL
----- ----- ---
December 2005 January 2006 1,500
February 2006 August 2006 1,250
September 2006 December 2006 1,000
January 2007 October 2007 750
November 2007 December 2007 500
NOTE 6 - ASSET RETIREMENT OBLIGATION
Dune had no asset retirement obligations prior to 2005. Asset retirement
obligations are included in other long term liabilities on Dune's balance sheet.
The following table is a reconciliation of the asset retirement obligation
liability for 2005:
For the year ended December 31, 2005:
Asset retirement obligation at beginning of year $ --
Liabilities incurred 76,509
Liabilities settled --
Accretion expense 2,173
Revisions in estimated liabilities --
-------
Asset retirement obligation at end of year $78,682
-------
NOTE 7 - PREFERRED STOCK
In April 2004, Dune issued a total of 222,222 shares of Series A
Convertible Preferred Stock to two individuals for an aggregate of $200,000.
Each share of preferred stock is convertible into two shares of common stock at
the option of the holder.
During the year ended December 31, 2004, 111,111 shares of Series A
Convertible Preferred Stock were converted into 222,222 shares of common stock.
During the year ended December 31, 2005, the remaining 111,111 shares of
Series A Convertible Preferred Stock were converted into 222,222 shares of
common stock.
F-18
As of December 31, 2005 there are no remaining Series A Convertible
Preferred shares outstanding.
NOTE 8 - COMMON STOCK
On May 19, 2004, Dune sold 35,464,432 shares to Itera Holdings BV for the
aggregate purchase price of $12,000,000. Also on May 19, 2004, Dune issued
476,323 shares and paid $1,200,000 in cash to the Altitude Group LLC for
services in assisting with this transaction.
During the year ended December 31, 2004, Dune issued an aggregate of
522,917 shares valued at $219,958 to several individuals for services rendered.
Also during the same twelve month period, holders converted $766,500 of
convertible debentures into 1,792,150 shares of common stock.
During the year ended December 31, 2005, the remaining note holders
converted $445,000 in convertible notes payable into 1,182,223 shares of common
stock.
During the year ended December 31, 2005, the remaining 111,111 shares of
Series A Convertible Preferred Stock were converted into 222,222 shares of
common stock.
On September 30, 2005, Dune closed a $6 million private equity offering. A
total of 3,243,243 shares of common stock were sold at a price of $1.85 per
share. Dune paid the investment banker, Sanders Morris Harris Inc., a placement
agent fee consisting of (i) cash equal to 5% of the gross proceeds and (ii) a
warrant exercisable for up to 324,324 shares our common stock, at an exercise
price of $1.85 per share. Dune has agreed to register both the shares issued to
investors and the shares underlying the warrant for resale upon the earlier of
(i) six months or (ii) the next registration statement filed by Dune (other than
on Form S-8 or S-4). The private offering was made in reliance upon Section 4(2)
of the Securities Act of 1933, as amended and Rule 506 of Regulation D.
NOTE 9 - STOCK OPTIONS
During 2004 and 2005, Dune's Board of Directors granted stock options, all
of which are immediately exercisable. The following table summarizes stock
option activity:
Weighted
Average
Options Price
------- -----
Outstanding as of January 1, 2004 350,000 $ 0.47
Granted during 2004 50,000 0.85
Cancelled or Expired -- --
Exercised -- --
--------- ---------
Outstanding as of December 31, 2004 400,000 0.56
Granted during 2005 1,795,000 2.26
Cancelled or Expired -- --
Exercised -- --
--------- ---------
Outstanding as of December 31, 2005 2,195,000 $ 1.95
========= =========
F-19
Options outstanding and exercisable at December 31, 2005 are as follows:
Outstanding
----------------------------------
Exercisable
Number Number
Exercise Price Of Shares Remaining life of Shares
- -------------- --------- -------------- ----------
0.45 100,000 3.9 years 100,000
0.54 250,000 3.8 years 250,000
0.85 50,000 4.0 years 50,000
1.25 250,000 4.1 years 250,000
2.30 15,000 4.5 years 15,000
2.35 300,000 4.8 years 300,000
2.44 1,125,000 4.4 years 1,125,000
2.54 30,000 4.6 years 30,000
2.56 75,000 4.3 years 75,000
--------- ---------
2,195,000 2,195,000
========= =========
NOTE 10 - COMMITMENTS AND CONTINGENCIES
Effective as of the closing of the stock sale to Itera Holdings BV on May
19, 2004, Dune amended its Operating Agreement with Vaquero Oil & Gas Inc.
("VOG") with respect to certain matters relating to Vaquero Partners LLC. VOG
fixed its Membership Interest in Vaquero at 15% with Dune holding the other 85%.
Dune also amended its drilling agreement with VOG to provide that VOG will be
paid (i) $25,000 a month for its services through November 2004, and (ii)
$12,500 a month for its services through May 2005. In August of 2005, Dune
became the 100% owner of Vaquero Partners, LLC as a result of the redemption by
Vaquero Partners, LLC of VOG's 15% membership interest.
Dune signed new Employment Agreements with Alan Gaines (CEO) and Amiel
David (President/COO). Each of the agreements is for an initial term of twenty
five (25) months, commencing May 12, 2005 and expiring on June 30, 2007. The
agreements provide for base salaries as follows: Mr. Gaines - $400,000 for the
first thirteen (13) months and $460,000 for the next twelve (12) months; Dr.
David - $300,000 for the first thirteen (13) months and $330,000 for the next
twelve (12) months. Mr. Gaines' agreement provides that for each of the 12
months ended June 30, 2006 and 2007, he will be entitled to receive a
performance bonus equal to one percent (1%) of Dune's "free cash flow" (defined
as Dune's earnings before depreciation, depletion, amortization and capital
expenditures) up to $8 million and two percent (2%) of free cash flow above $8
million. Dr. David shall be entitled to receive a performance bonus equal to
three quarters of one percent (.75%) of Dune's "free cash flow" up to $8 million
and one and one half percent (1.5%) of free cash flow above $8 million. The
agreements provide that in the event Mr. Gaines or Dr. David are terminated
without "cause" (as defined in the agreements), they are to receive a severance
payment equal to the greater of (i) twelve (12) months base salary and (ii)
their base salary for the remainder of the term. Each agreement contains
covenants restricting each of the foregoing officers from participating in any
business which is then engaged in the drilling, exploration or production of
natural gas or oil, within the area contemplated by that certain Area of Mutual
Interest Agreement dated November 17, 2003 between Dune and VOG. In connection
with their extensions, Dune granted stock options to Mr. Gaines and Dr. David to
acquire 625,000 and 500,000 shares of Dune's common stock, respectively. Of the
625,000 options granted to Mr. Gaines, 250,000 vested immediately, with an
additional 250,000 and 125,000 vesting on each of the next two anniversary
dates. Of the 500,000 options granted to Dr. David, 250,000 vested immediately
and 250,000 vest on the first anniversary date.
On April 4, 2005, Dune entered into an Employment Agreement with Hugh
Idstein to serve as the Company's Chief Financial Officer. The agreement was for
an initial term of one year and provides for a base salary of $135,000 per
annum. In addition, upon completion of the initial term, Mr. Idstein will
receive a guaranteed bonus of $20,250 and will be eligible for a discretionary
performance bonus up to an additional $20,250. The Agreement provides that in
the event Mr. Idstein is terminated without "cause" (as defined in the
Agreement), he will receive a severance payment equal to six (6) months base
salary. His agreement also contains covenants restricting him from participating
in any business which is then engaged in the drilling, exploration or production
of natural gas or oil, within the area contemplated by that certain Area of
Mutual Interest Agreement dated November 17, 2003 between Dune and Vaquero Oil &
Gas, Inc.
F-20
In September 2005, Dune amended the lease for office space in Houston,
Texas to expand its space to 4,197 square feet. The monthly rent is now $6,645
per month and expires June 1, 2009.
NOTE 11 - INCOME TAXES
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
2005 and 2004 are as follows:
2005 2004
Federal income taxes:
Current $ -- $ --
Deferred 1,738,659 440,301
Less: Valuation allowance (1,738,659) (440,301)
----------- -----------
Total $ -- $ --
----------- -----------
Dune had net operating loss carryforwards of approximately $5,113,703 as
of December 31, 2005. Available carryforwards expire 15 to 20 years from when
incurred.
NOTE 12 - SUBSEQUENT EVENTS
On February 1, 2006, Dune sold a total of 9,000,000 shares of our common
stock at a price of $2.65 per share in a private equity offering. Gross proceeds
raised in the offering were $23,850,000. From the gross proceeds, Dune paid the
investment bankers a placement agent fee of $1,192,500 (5% of the gross
proceeds) and a financial advisory fee of $477,000 (2% of the gross proceeds).
Dune also issued a warrant exercisable for up to 900,000 shares its common stock
at an exercise price of $2.65 per share.
NOTE 13 - SUPPLEMENTAL OIL AND GAS INFORMATION (UNAUDITED)
Capitalized Costs
Capitalized costs incurred in property acquisition, exploration and
development activities as of December 31, 2005 are as follows:
Total capitalized costs $51,766,651
Less: Accumulated depletion (982,240)
-----------
Net capitalized costs $50,784,411
===========
Costs incurred for property acquisition, exploration and development
activities for the year ended December 31, 2005 are as follows:
Acquisition of properties:
Proved $ 5,010,468
Unproved 24,520,637
Exploration and development activities 14,373,676
------------
Total Costs $43,904,781
============
Oil and Reserve Data
An independent petroleum engineer estimated proved developed and
undeveloped reserves for Dune's properties. Reserve definitions and pricing
requirements prescribed by the Securities and Exchange Commission were used. The
determination of oil and gas reserve quantities involves numerous estimates
F-21
which are highly complex and interpretive. The estimates are subject to
continuing re-evaluation and reserve quantities may change as additional
information becomes available. Estimated value of proved reserves was computed
by applying prices in effect at December 31, 2005. The average price used was
$59.29 per barrel of oil at $9.49 per mcf of gas.
2005 2004
-------------------------------- --------------------------------
Oil Gas Oil Gas
(Mbbls) (Mmcf) Mmcfe (MBbls) (MMCF) Mmcfe
-------------------------------- --------------------------------
Proved developed and undeveloped reserves
Beginning of year 1,309 5,534 13,388 142 12,415 13,267
Purchases 75 18,307 18,758 1 791 797
Discoveries and extensions -- -- -- -- -- --
Improved recovery -- -- -- -- -- --
Revisions of previous estimates (794) 2,570 (2,194) 1,166 (7,625) (629)
Production (12) (364) (438) -- (47) (47)
------------------------------- ------------------------------
End of year 578 26,047 29,514 1,309 5,534 13,388
=============================== ==============================
Proved developed reserves:
Beginning of year 3 965 983 -- -- --
End of year 131 5,432 6,218 3 965 983
Standardized measure of discounted future net cash flows are as follows:
Year Ended December 31,
2005 2004
--------- ---------
(In Thousands)
------------------------
Future cash inflows $ 281,497 $ 87,033
Future production costs 57,336 6,079
Future development costs 46,266 12,190
Future income tax expense 34,285 7,165
--------- ---------
Future gross cash flows 143,611 61,599
Less: 10% annual discount of
estimated timing of cash flows (48,135) (24,409)
--------- ---------
Standardized measure of discounted future net
cash flows relating to proved oil and gas reserves $ 95,476 $ 37,190
--------- ---------
The following reconciles the change in the standardized measure for
discounted future net cash flows as of the years ended:
2005 2004
-------- --------
(In Thousands)
--------------------------
Beginning of year $ 37,190 $ 30,508
Sales of oil and gas
produced, net of production costs (3,005) (90)
Net changes in prices and
production costs 18,836 7,495
Improved recovery, less
related costs -- --
Net changes in estimated
future development costs (2,947) 9,100
Revisions (10,347) (9,823)
Purchase of reserves 48,326 --
Net change in timing (2,130) --
Accretion discount 3,719 --
Future income tax expense 5,834 --
-------- --------
End of year $ 95,476 $ 37,190
-------- --------
F-22