**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| ý                                                                                                                                                                                                              |       | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|
| **For the  Quarterly Period Ended March 31, 2006**                                                                                                                                                                  |
| ** **                                                                                                                                                                                                          |
| **OR**                                                                                                                                                                                                              |
| ** **                                                                                                                                                                                                          |
| **o**                                                                                                                                                                                                               | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES****EXCHANGE ACT OF 1934** |
| **For the  transition period from                  to                ** |
| **Commission  File No. 000-33275**                                                                                                                                                                                  |

** **

**WARREN RESOURCES, INC.**

(Exact Name of Registrantas Specified in its Charter.)

 

| **Maryland**                              |       | **11-3024080**         |
|-------------------------------------------|------------|------------------------|
| (State or other  jurisdiction of          |       | (I.R.S. Employer       |
| incorporation or  organization)           | ** ** | Identification Number) |
|                                      |       |                   |
| **489  Fifth Avenue, New York,**          |       |                   |
| **New  York**                             | ** ** | **10017**              |
| (Address of Principal  Executive Offices) |       | (Zip Code)             |

 

Registrant’s telephonenumber, including area code:

** **

**(212) 697-9660**

 

Indicate by check mark whether the Registrant (1) has filed all reportsrequired to be filed by Section 13 and 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months and (2) has been subject to such filingrequirements for the past 90 days.

 

Yes ýNo o

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 
| Large  accelerated filer o | Accelerated  filer ý | Non-accelerated  filer o |
|----------------------------|---------------------------|--------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

Yes oNo ý

 

The aggregate number of Registrant’soutstanding shares on May 3, 2006 was 53,336,730 shares of Common Stock,$0.0001 par value.

** **

** **

----

 

**WARREN RESOURCES, INC.**

** **

**INDEX**

 
| PART I—  | FINANCIAL  INFORMATION                                                                                |   |
|---------------|-------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                  |   |
|          | Item 1.  Financial Statements                                                                         |   |
|          |                                                                                                  |   |
|          | Consolidated  Balance Sheets as of March 31, 2006 and December 31, 2005                               |   |
|          |                                                                                                  |   |
|          | Consolidated  Statements of Operations for three months ended March 31, 2006 and 2005                 |   |
|          |                                                                                                  |   |
|          | Consolidated  Statements of Cash Flows for the three months ended March 31, 2006 and 2005             |   |
|          |                                                                                                  |   |
|          | Notes  to the Consolidated Financial Statements                                                       |   |
|          |                                                                                                  |   |
|          | Item  2. Management’s Discussion and Analysis of Financial Conditions and Results  of Operations |   |
|          |                                                                                                  |   |
|          | Item  3. Quantitative and Qualitative Disclosures About Market Risk                                   |   |
|          |                                                                                                  |   |
|          | Item  4. Evaluation of Disclosure Controls and Procedures                                             |   |
|          |                                                                                                  |   |
| PART II— | OTHER  INFORMATION                                                                                    |   |
|          |                                                                                                  |   |
|          | Item 1.  Legal Proceedings                                                                            |   |
|          |                                                                                                  |   |
|          | Item 1A. Risk  Factors                                                                                |   |
|          |                                                                                                  |   |
|          | Item  2. Unregistered Sales of Equity Securities and Use of Proceeds                                  |   |
|          |                                                                                                  |   |
|          | Item  3. Defaults upon Senior Securities                                                              |   |
|          |                                                                                                  |   |
|          | Item  4. Submission of Matters to a Vote of Security Holders                                          |   |
|          |                                                                                                  |   |
|          | Item 5.  Other Information                                                                            |   |
|          |                                                                                                  |   |
|          | Item 6. Exhibits                                                                                      |   |
|          |                                                                                                  |   |
|          | Signatures                                                                                            |   |

 

2

----

 

**PARTI—FINANCIAL INFORMATION**

###### ** **

###### **ITEM 1.FINANCIAL STATEMENTS**

** **

**Warren Resources, Inc.and Subsidiaries**

**CONSOLIDATEDBALANCE SHEETS**

**(Unaudited)**

** **
| ** **                                                                                                                                                                                                                                | ** ** | **March 31,  2006** | ** **      | **December 31,  2005** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|-----------------|------------------------|------------|
| ASSETS                                                                                                                                                                                                                                    |       |                |            |                   |       |
| Current Assets                                                                                                                                                                                                                            |       |                |            |                   |       |
| Cash and cash  equivalents                                                                                                                                                                                                                |       | $                   | 94,425,152      |                   | $          | 114,632,099 |   |
| Accounts  receivable – trade                                                                                                                                                                                                         |       | 3,486,796           |            | 3,945,862              |       |
| Accounts  receivable from affiliated partnerships                                                                                                                                                                                         |       | 51,016              |            | 118,356                |       |
| Trading  securities                                                                                                                                                                                                                       |       | 242,548             |            | —                 |       |
| Restricted  investments in U.S. Treasury Bonds—available-for-sale, at fair value  (amortized cost of $438,169 in 2006 and $96,959 in 2005)                                                                                           |       | 558,875             |            | 125,771                |       |
| Other current  assets                                                                                                                                                                                                                     |       | 3,605,940           |            | 2,356,583              |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Total current  assets                                                                                                                                                                                                                     |       | 102,370,327         |            | 121,178,671            |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Other Assets                                                                                                                                                                                                                              |       |                |            |                   |       |
| Oil and gas  properties—at cost, based on successful efforts method of accounting, net of  accumulated depreciation, depletion and amortization                                                                                      |       | 208,320,744         |            | 185,904,194            |       |
| Property and  equipment—at cost, net                                                                                                                                                                                                 |       | 678,301             |            | 559,612                |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value  (amortized cost of $860,647 in 2006 and $1,387,910 in 2005)                                                                                        |       | 1,035,577           |            | 1,821,181              |       |
| Deferred bond  offering costs (net of accumulated amortization of $259,161 in 2006 and  $253,537 in 2005)                                                                                                                                 |       | 272,075             |            | 277,700                |       |
| Goodwill                                                                                                                                                                                                                                  |       | 3,430,246           |            | 3,430,246              |       |
| Other assets                                                                                                                                                                                                                              |       | 4,333,473           |            | 7,592,799              |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Total other  assets                                                                                                                                                                                                                       |       | 218,070,416         |            | 199,585,732            |       |
|                                                                                                                                                                                                                                      | ** ** | **$**               | **320,440,743** | ** **             | **$**      | **320,764,403** | ** ** |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                                                 |       |                |            |                   |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Current  Liabilities                                                                                                                                                                                                                      |       |                |            |                   |       |
| Current  maturities of debentures                                                                                                                                                                                                         |       | $                   | 253,100         |                   | $          | 260,600 |   |
| Current  maturities of other long-term liabilities                                                                                                                                                                                        |       | 328,449             |            | 325,994                |       |
| Accounts payable  and accruals                                                                                                                                                                                                            |       | 24,607,816          |            | 25,042,379             |       |
| Deferred  income—turnkey drilling contracts with affiliated partnerships                                                                                                                                                             |       | 1,194,865           |            | 1,765,829              |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Total current  liabilities                                                                                                                                                                                                                |       | 26,384,230          |            | 27,394,802             |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Long-Term  Liabilities                                                                                                                                                                                                                    |       |                |            |                   |       |
| Debentures, less  current portion                                                                                                                                                                                                         |       | 2,277,900           |            | 2,345,400              |       |
| Other long-term  liabilities, less current portion                                                                                                                                                                                        |       | 6,102,144           |            | 5,974,493              |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
|                                                                                                                                                                                                                                      |       | 8,380,044           |            | 8,319,893              |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Minority  Interest                                                                                                                                                                                                                        |       | —              |            | 7,009,634              |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Commitments and  Contingencies                                                                                                                                                                                                            |       |                |            |                   |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Stockholders’  Equity                                                                                                                                                                                                                |       |                |            |                   |       |
| 8% convertible preferred stock, par value $.0001; authorized 10,000,000  shares, issued and outstanding, 615,706 shares in 2006 and 652,336 shares in  2005 (aggregate liquidation preference $7,388,472 in 2006 and $7,828,032 in  2005) |       | 7,221,222           |            | 7,629,622              |       |
| Common stock —  $.0001 par value; authorized, 100,000,000 shares; issued 53,305,812 in 2006  and 52,738,384 shares in 2005                                                                                                           |       | 5,331               |            | 5,274                  |       |
| Additional  paid-in-capital                                                                                                                                                                                                               |       | 361,002,391         |            | 353,714,161            |       |
| Accumulated  deficit                                                                                                                                                                                                                      |       | (82,005,264         | )               | (82,861,220            | )          |
| Accumulated  other comprehensive income, net of applicable income taxes of $118,000 in  2006 and $185,000 in 2005                                                                                                                         |       | 180,844             |            | 280,292                |       |
|                                                                                                                                                                                                                                      |       | 286,404,524         |            | 278,768,129            |       |
|                                                                                                                                                                                                                                      |       |                |            |                   |       |
| Less common  stock in Treasury—at cost; 632,250 shares in 2006 and 2005                                                                                                                                                              |       | 728,055             |            | 728,055                |       |
| Total  stockholders’ equity                                                                                                                                                                                                          |       | 285,676,469         |            | 278,040,074            |       |
|                                                                                                                                                                                                                                      | ** ** | **$**               | **320,440,743** | ** **             | **$**      | **320,764,403** | ** ** |

 

The accompanying notesare an integral part of these financial statements

 

3

----

 

**Warren Resources, Inc.and Subsidiaries**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

** **
| ** **                                                             | ** ** | **Three Months Ended  March 31, (Unaudited)** | ** ** |
|------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                             | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| Revenues                                                               |       |                                          |       |   |   |
| Oil and gas  sales                                                     |       | $                                             | 6,809,441  |   | $ | 2,176,587 |   |
| Turnkey  contracts with affiliated partnerships                        |       | 426,597                                       |       | 2,279,317 |   |
| Oil and gas  sales from marketing activities                           |       | 1,015,045                                     |       | 2,196,074 |   |
| Well services                                                          |       | 248,289                                       |       | 540,659 |   |
| Net gain (loss)  on investments                                        |       | (22,924                                       | )          | 31,460 |   |
| Interest and  other income                                             |       | 1,356,002                                     |       | 892,701 |   |
|                                                                   |       |                                          |       |   |   |
|                                                                   |       | 9,832,450                                     |       | 8,116,798 |   |
|                                                                   |       |                                          |       |   |   |
| Expenses                                                               |       |                                          |       |   |   |
| Production &  exploration                                          |       | 2,979,621                                     |       | 673,162 |   |
| Turnkey  contracts                                                     |       | 705,716                                       |       | 2,021,001 |   |
| Cost of marketed  oil and gas purchased from affiliated partnerships   |       | 992,006                                       |       | 2,165,092 |   |
| Well services                                                          |       | 295,483                                       |       | 194,389 |   |
| Depreciation,  depletion, amortization and impairment                  |       | 1,473,432                                     |       | 761,895 |   |
| General and  administrative                                            |       | 2,273,119                                     |       | 1,465,344 |   |
| Interest                                                               |       | 190,117                                       |       | 1,106,754 |   |
| Retirement of  debt                                                    |       | —                                        |       | 1,175,233 |   |
|                                                                   |       | 8,909,494                                     |       | 9,562,870 |   |
|                                                                   |       |                                          |       |   |   |
| Income (loss)  before provision for income taxes and minority interest |       | 922,956                                       |       | (1,446,072 | ) |
|                                                                   |       |                                          |       |   |   |
| Deferred income  tax expense                                           |       | 67,000                                        |       | 114,000 |   |
|                                                                   |       |                                          |       |   |   |
| Income (loss)  before minority interest                                |       | 855,956                                       |       | (1,560,072 | ) |
|                                                                   |       |                                          |       |   |   |
| Minority  interest                                                     |       | —                                        |       | (168,034 | ) |
|                                                                   |       |                                          |       |   |   |
| Net income  (loss) before preferred dividends                          |       | 855,956                                       |       | (1,728,106 | ) |
|                                                                   |       |                                          |       |   |   |
| Less dividends  and accretion on preferred shares                      |       | 170,925                                       |       | 1,640,432 |   |
|                                                                   |       |                                          |       |   |   |
| Net income  (loss) applicable to common stockholders                   |       | $                                             | 685,031    |   | $ | (3,368,538 | ) |
|                                                                   |       |                                          |       |   |   |
| Earnings (loss)  per share - Basic                                     |       | $                                             | 0.01       |   | $ | (0.10 | ) |
| Earnings (loss)  per share - Diluted                                   |       | 0.01                                          |       | (0.10 | ) |
|                                                                   |       |                                          |       |   |   |
| Weighted average  common shares outstanding - Basic                    |       | 52,199,474                                    |       | 33,358,796 |   |
| Weighted average  common shares outstanding - Diluted                  |       | 54,314,040                                    |       | 33,358,796 |   |

 

The accompanying notesare an integral part of these financial statements

 

4

----

 

**WarrenResources, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| ** **                                                                                           | ** ** | **For the three months ended  March 31, (Unaudited)** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **2006**                                              | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                                               |       |                                                  |       |   |   |
| Net income  (loss)                                                                                   |       | $                                                     | 855,956    |   | $ | (1,728,106 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                                                  |       |   |   |
| Accretion of  discount on available-for-sale debt securities                                         |       | (23,731                                               | )          | (202,277 | ) |
| Amortization and  write-off of deferred bond offering costs                                          |       | 5,625                                                 |       | 833,885 |   |
| Gain on sale of  US treasury bonds—available for sale                                           |       | —                                                |       | (22,777 | ) |
| Depreciation,  depletion, amortization and impairment                                                |       | 1,473,432                                             |       | 761,895 |   |
| Accretion of  asset retirement obligation                                                            |       | 84,945                                                |       | 13,959 |   |
| Common stock  cancelled                                                                              |       | (1,478                                                | )          | — |   |
| Stock based  compensation                                                                            |       | 32,119                                                |       | — |   |
| Deferred tax  expense                                                                                |       | 67,000                                                |       | 114,000 |   |
| Change in assets  and liabilities:                                                                   |       |                                                  |       |   |   |
| (Increase)  decrease in trading securities                                                           |       | (242,548                                              | )          | 130,452 |   |
| (Increase)  decrease in accounts receivable—trade                                               |       | 494,066                                               |       | (253,741 | ) |
| Decrease in  accounts receivable from affiliated partnerships                                        |       | 67,340                                                |       | 7,525 |   |
| Decrease in  other assets                                                                            |       | 2,009,968                                             |       | 140,657 |   |
| Decrease in  accounts payable and accruals                                                           |       | (568,909                                              | )          | (4,219,079 | ) |
| Decrease in  deferred income from affiliated partnerships                                            |       | (570,964                                              | )          | (2,279,317 | ) |
| Decrease in  other long term liabilities                                                             |       | —                                                |       | (30,166 | ) |
|                                                                                                 |       |                                                  |       |   |   |
| Net cash provided  by (used in) operating activities                                                 |       | 3,682,821                                             |       | (6,733,090 | ) |
|                                                                                                 |       |                                                  |       |   |   |
| Cash flows from  investing activities:                                                               |       |                                                  |       |   |   |
| Purchase,  exploration and development of oil and gas properties                                     |       | (24,604,427                                           | )          | (21,333,221 | ) |
| Purchase of  property and equipment                                                                  |       | (175,982                                              | )          | (77,878 | ) |
| Proceeds from  U.S. Treasury Bonds—available-for-sale                                           |       | 209,784                                               |       | 5,110,394 |   |
|                                                                                                 |       |                                                  |       |   |   |
| Net cash used in  investing activities                                                               |       | (24,570,625                                           | )          | (16,300,705 | ) |
|                                                                                                 |       |                                                  |       |   |   |
| Cash flows from  financing activities:                                                               |       |                                                  |       |   |   |
| Payments on debt  and debentures                                                                     |       | (95,765                                               | )          | (14,104,797 | ) |
| Issuance of  common stock, net                                                                       |       | 776,622                                               |       | — |   |
| Dividends paid  on preferred stock                                                                   |       | —                                                |       | (1,574,594 | ) |
|                                                                                                 |       |                                                  |       |   |   |
| Net cash  provided by (used in) financing activities                                                 |       | 680,857                                               |       | (15,679,391 | ) |
|                                                                                                 |       |                                                  |       |   |   |
| Net decrease in  cash and cash equivalents                                                           |       | (20,206,947                                           | )          | (38,713,186 | ) |
| Cash and cash  equivalents at beginning of period                                                    |       | 114,632,099                                           |       | 99,920,885 |   |
|                                                                                                 |       |                                                  |       |   |   |
| Cash and cash  equivalents at end of period                                                          |       | $                                                     | 94,425,152 |   | $ | 61,207,699 |   |
| Supplemental  disclosure of cash flow information                                                    |       |                                                  |       |   |   |
| Cash paid for  interest, net of amount capitalized                                                   |       | $                                                     | 99,548     |   | $ | 952,523 |   |
| Cash paid for  income taxes                                                                          |       | $                                                     | —     |   | $ | — |   |
|                                                                                                 |       |                                                  |       |   |   |   |   |
| Noncash  investing and financing activities                                                          |       |                                                  |       |   |   |
| Accrued  preferred stock dividend                                                                    |       | $                                                     | 147,766    |   | $ | 1,564,310 |   |
| Common stock  issued for acquisition of property                                                     |       | 6,185,389                                             |       | — |   |

 

The accompanying notesare an integral part of these financial statements

** **

**5**

----

** **

**WARREN RESOURCES, INC.AND SUBSIDIARIES**

** **

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

** **

**NOTE 1—ORGANIZATION**

 

Warren Resources, Inc. (the “Company” or “Warren”), was originallyformed on June 12, 1990 for the purpose of acquiring and developing oil and gasproperties. The Company is incorporated under the laws of the state of Maryland.The Company’s properties are primarily located in Wyoming, California, NewMexico, North Dakota and Texas. In addition, the Company serves as the managinggeneral partner (the “MGP”) to affiliated partnerships and joint ventures.

 

The accompanying unaudited financialstatements and related notes present the Company’s consolidated financialposition as of March 31, 2006 and December 31, 2005, the consolidated resultsof operations for the three months ended March 31, 2006 and 2005 and consolidatedcash flows for the three months ended March 31, 2006 and 2005. The unauditedfinancial statements have been prepared in accordance with accountingprinciples generally accepted in the United States of America for interimfinancial information and with the instructions of Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements. In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included. Operatingresults for the three months ended March 31, 2006, are not necessarilyindicative of the results that may be expected for the fiscal year endingDecember 31, 2006. The accounting policies followed by the Company are setforth in Note A to the Company’s financial statements included in Form 10-K forthe year ended December 31, 2005. These interim financial statements and notesthereto should be read in conjunction with the consolidated financialstatements presented in the Company’s 2005 Annual Report on Form 10-K.

 

##### **NOTE 2**—STOCK OPTIONS

 

Prior to January 1, 2006, we accounted for our nonqualified stockoptions using the intrinsic value method under Accounting Principles BoardOpinion No. 25, *Accounting for Stock Issued to Employees*(“APB 25”).  Under APB 25, if theexercise price of employee stock options equaled the market price of theunderlying stock on the grant date, no compensation expense was recorded.  We had adopted the disclosure-only provisionsof Statement of Financial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation* (“SFAS 123”).  No stock-based compensation cost for our nonqualifiedstock options was recognized in the Consolidated Statements of Operations forthe three months ended March 31, 2005. Effective January 1, 2006, we adopted the fair value recognitionprovisions of Statement of Financial Accounting Standards No. 123(R) *Accounting for Stock-Based Compensation* (“SFAS 123(R)”),using the modified-prospective-transition method.  Under that transition method, compensationcost recognized in the first three months of 2006 includes:  (a) compensation cost for all share-based paymentsgranted prior to, but not yet vested as of January 1, 2006 and (b) compensationcost for all share-based payments granted subsequent to January 1, 2006.  The compensation cost is based on thegrant-date fair value calculated using a Black-Scholes-Merton option-pricingformula and is amortized over the vesting period in accordance with provisionsof Statement 123(R).  For the threemonths ended March 31, 2006, we recognized approximately $32,000 incompensation expense related to our non-qualified stock option plans.

 

The following table illustrates the effect on netincome and earnings per share if we had applied the fair value recognitionprovisions of SFAS 123 to options granted under our stock option plans for thethree months ended March 31, 2005.  Forpurposes of the pro forma disclosure, the fair value of each option grant isestimated on the date of grant and amortized to expense over the options’vesting periods.

 

6

----

 
| ** **                                                                                                                                    | ** ** | **Three months ended March 31,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
|                                                                                                                                          |       |                                   |       |
| Net loss  applicable to common stockholders, as reported                                                                                      |       | $                                      | (3,368,538 | ) |
| Deduct: Total  stock-based employee compensation expense determined under fair-value-based  method for all awards, net of related tax effects |       | (2,614,482                             | )          |
|                                                                                                                                          |       |                                   |       |
| Pro forma net  loss applicable to common Stockholders                                                                                         |       | $                                      | (5,983,020 | ) |
|                                                                                                                                          |       |                                   |       |
| Basic and  diluted loss per share:                                                                                                            |       |                                   |       |
| As reported -                                                                                                                                 |       | $                                      | (0.10      | ) |
| Pro forma -                                                                                                                                   |       | $                                      | (0.18      | ) |

 

The following assumptions were used to value theoutstanding stock options:

 
| ** **               | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------|------------|----------------------------------|------------|
| ** **               | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| Dividend yield           |       | 0                                | %          | 0 | % |
| Expected  volatility     |       | 48.2                             | %          | 28.68 | % |
| Risk-free  interest rate |       | 4.66                             | %          | 3.65 | % |
| Expected life            |       | 3.5 years                        |       | 5 years |   |

 
| ** **                        | ** ** | **Number  of Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term (in years)** | ** ** | **Aggregate  Intrinsic Value  (in thousands)** | ** ** |
|-----------------------------------|------------|------------------------|------------|----------------------------------------|------------|----------------------------------------------------------------|------------|------------------------------------------------|------------|
|                              |       |                   |       |                                   |       |                                                           |       |                                           |       |
| Outstanding at  December 31, 2005 |       | 2,510,721              |       | $                                      | 7.23       |                                                           |       |                                           |       |   |
| Granted                           |       | 417,250                |       | 13.85                                  |       |                                                           |       |                                           |       |
| Exercised                         |       | (91,489                | )          | 7.08                                   |       |                                                           |       |                                           |       |
| Forfeited or  expired             |       | 0                      |       | 0                                      |       |                                                           |       |                                           |       |
| Outstanding at  March 31, 2006    |       | 2,836,482              |       | $                                      | 8.21       |                                                           | 3.06       |                                           | $          | 18,982 |   |
|                              |       |                   |       |                                   |       |                                                           |       |                                           |       |
| Exercisable at  March 31, 2006    |       | 2,406,381              |       | $                                      | 7.19       |                                                           | 3.74       |                                           | $          | 18,547 |   |

 

The weighted average fair value of options granted during the threemonths ended March 31, 2006 and 2005 was $13.85 and $9.05 respectively. Thetotal intrinsic value of options exercised during the first three months of2006 was $0.8 million. During the first quarter of 2005 there were no optionsexercised.

 

As of March 31, 2006 there was $2.4 million of total unrecognizedcompensation cost related to non vested stock options granted under the Plans.That cost is expected to be recognized over a weighted average period of 3years.

 

Cash received from option exercise under all stock-based paymentarrangements for the three months ended March 31, 2006 was $0.6 million.

 

We issue new shares of common stock to settle option exercises.

 

7

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The following table summarizes information about the Company’s stockoptions outstanding at March 31, 2006.

 
| **Options Outstanding** | ** ** | **Options Exercisable**  | ** ** |
|-------------------------|------------|--------------------------|------------|
| **Exercise  Price**     | ** ** | **Options  Outstanding** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Life (Years)** | ** ** | **Options  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|                    |       |                     |       |   |   |   |   |   |   |   |   |
| 4.00                    |       | 728,783                  |       | $ | 4.00 |   | 2.15 |   | 728,783 |   | $ | 4.00 |   |
| 7.00                    |       | 621,000                  |       | 7.00 |   | 3.02 |   | 621,000 |   | 7.00 |   |
| 9.05                    |       | 692,500                  |       | 9.05 |   | 3.86 |   | 692,500 |   | 9.05 |   |
| 10.00                   |       | 326,949                  |       | 10.00 |   | 0.81 |   | 326,949 |   | 10.00 |   |
| 11.00                   |       | 10,000                   |       | 11.00 |   | 4.47 |   | 10,000 |   | 11.00 |   |
| 14.85                   |       | 40,000                   |       | 14.85 |   | 4.63 |   | 3,395 |   | 14.85 |   |
| 13.85                   |       | 417,250                  |       | 13.85 |   | 4.97 |   | 23,754 |   | 13.85 |   |
|                    |       | 2,836,482                |       | $ | 8.21 |   | 3.06 |   | 2,406,381 |   | $ | 7.19 |   |

 

#### **NOTE 3**—CHANGES INSTOCKHOLDERS’ EQUITY

 

During the three months ended March 31, 2006 holders of 36,630 sharesof convertible preferred stock have converted into common stock on a basis of0.75 shares of common stock for one share of convertible preferred stock.During the three months ended March 31, 2005, holders of 5,614,025 shares of convertiblepreferred stock converted into common stock on a one-for-one share basis. As ofMarch 31, 2006, 615,706 shares of convertible preferred stock remainoutstanding.  Preferred dividends ofapproximately $0.5 million and $0.4 million were accrued at March 31, 2006 andDecember 31, 2005, respectively. The accrued dividends at March 31, 2006 andDecember 31, 2005 have not been paid as of the date of this filing. Thepreferred stock pays an 8% cumulative dividend and is treated as a deduction inadditional paid in capital. The holders of the preferred stock are not entitledto vote except as defined by the agreement or as provided by applicablelaw.  The preferred stock may bevoluntarily converted, at the election of the holder into common stock of theCompany based on the table below.  Theconversion rate is subject to adjustment from time to time as defined by theagreement.

 

| **Period**                          | ** ** | **Preferred to Common** | ** ** |
|-------------------------------------|------------|-----------------------------------|------------|
| July 1, 2005  through June 30, 2006 |       | 1 to .75                          |       |
| July 1, 2006  through redemption    |       | 1 to .50                          |       |

 

Additionally, commencing seven years after the date of issuance(October 1, 2009), holders of the preferred stock may elect to require theCompany to redeem their preferred stock at a redemption price equal to theliquidation value of $12.00 per share, plus accrued but unpaid dividends, ifany (“Redemption Price”).  Upon thereceipt of a redemption election, the Company, at its option, shall either: (1)pay the holder cash in the amount equal to the Redemption Price or (2) issue toholder shares of common stock in an amount equal to 125% of the redemptionprice and any accrued and unpaid dividends, based on the weighted averageclosing “bid” price of the Company’s common stock for the thirty trading daysimmediately preceding the date of the written redemption election by the holderup to a maximum of 1.5 shares of common stock for each one share of preferredstock redeemed. The Company is accreting the carrying value of its preferredstock to its redemption price using the effective interest method with changesrecorded to additional paid in capital. The accretion of preferred stockresults in a reduction of earnings per share applicable to common stockholders.

 

Notwithstanding the forgoing, if the closing “bid” price of the Company’spublicly traded common stock as reported by the NASDAQ stock market, or anyexchange on which the shares of common stock are traded, exceeds 133% of theconversion price then in effect for the convertible preferred shares for atleast 10 days during any 30-day trading period, the Company has the right toredeem in whole or in part the convertible preferred stock at a redemptionprice of $12 per share (plus any accrued unpaid dividends) or convert theconvertible preferred shares (plus any accrued unpaid dividends) into commonstock at the then applicable conversion rate.

 

8

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At March 31 2006, there were 615,706 preferred shares outstanding thatthe Company may be required to redeem at the aggregate redemption price of $7,388,472between July 1, 2010 and January 1, 2011. As noted above, the Company could, atits option, settle the redemption requests in shares of its stock.

 

During the three months ended March 31, 2006, employees exercised atotal of 91,489 options at exercise prices between $4 and $10 per share. Additionallyfor the three months ended March 31, 2006, investors exercised a total of16,215 warrants at $10 per share. The Company received proceeds ofapproximately $777,000 from these exercises.

 

During the first quarter of 2006, the investor partners of the 1998drilling partnerships voted to approve the sale of all of the oil and gasassets of the drilling partnerships to us. As a result, the Company issued383,072 restricted shares of common stock under Regulation D (restricted for atleast one year) in exchange for both producing and non-producing properties. Thenumber of shares issued was determined based upon a 20% discount from theweighted average sales price for Warren’s publicly traded common stock for theforty-five (45) calendar days ending March 31, 2006. The Company booked thetransaction based on the undiscounted weighted average price of its commonstock for the forty-five (45) calendar days ending March 31, 2006. The Company alsoissued 44,691 shares to an individual in exchange for his interest in onedrilling partnership during the three months ended March 31, 2006. These shareswere valued at $680,644 based on the price of our stock on the date ofissuance.

 

Also, during the three months ended March 31, 2006, the Company acquiredall minority interests in the 1994 thru 1997 drilling partnerships forapproximately $1.4 million in cash. The minority interest relating to these partnershipswas recorded as a reduction in the cost basis of the assets acquired.

 

**NOTE 4—INCOME (LOSS) PER SHARE**

 

Basic income (loss) per share is computed by dividing net income (loss)applicable to common stockholders by the weighted average number of shares ofcommon stock outstanding during the period. Diluted income (loss) per share isbased on the assumption that stock options and warrants are converted intocommon shares using the treasury stock method and convertible bonds, debenturesand preferred stock are converted using the if-converted method. Conversion isnot assumed if the results are anti-dilutive. Potential common shares at March 31, 2006 and March 31, 2005 of 563,019 and11,053,011 respectively, relating to convertible bonds, debentures andpreferred stock, were excluded from the computation of diluted income (loss)per share because they are anti-dilutive. Potential common shares of 3,343,706 and3,161,681, relating to stock options and warrants, respectively, were excludedfrom the computation of diluted income (loss) per share at March 31, 2005 becausethey are anti-dilutive. Stock options have a weighted average exercise price of$8.14 and $6.39 at March 31, 2006 and March 31, 2005, respectively. Warrantshave a weighted average exercise price of $11.17 and $11.18 at March 31, 2006and March 31, 2005, respectively. At March 31, 2006, the convertible bonds anddebentures may be converted from the date of issuance until maturity at 100% ofprincipal amount into common stock of the Company at prices ranging from $25 to$50.  The preferred stock may beconverted at the discretion of the holder or upon meeting certain conditions atthe discretion of the Company (see Note 3).

 

Basic and diluted net income (loss) per share is computed based on thefollowing information:

 
| ** **                                         | ** ** | **Three Months  Ended  March 31, 2006** | ** ** | **Three Months  Ended  March 31, 2005** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------|------------|-----------------------------------------|------------|
|                                               |       |                                    |       |                                    |       |
| Net income (loss) available to shareholders        |       | $                                       | 685,031    |                                    | $          | (3,368,538 | ) |
|                                               |       |                                    |       |                                    |       |
| Weighted average shares outstanding - basic        |       | 52,199,474                              |       | 33,358,796                              |       |
| Effect of dilutive securities – stock options |       | 1,289,048                               |       | —                                  |       |
| Effect of dilutive securities – warrants      |       | 825,518                                 |       | —                                  |       |
|                                               |       |                                    |       |                                    |       |
| Weighted average shares outstanding - diluted      |       | 54,314,040                              |       | 33,358,796                              |       |
|                                               |       |                                    |       |                                    |       |
| Basic and diluted net income (loss) per share      |       | $                                       | 0.01       |                                    | $          | (0.10 | ) |

 

9

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**NOTE 5—LONG-TERM DEBT**

 

The convertible bonds may beconverted from the date of issuance until maturity at 100% of principal amountinto common stock of the Company at prices ranging from $25 to $50. Each yearthe holders of the convertible debentures may tender to the Company up to 10%of the aggregate debentures issued and outstanding.

Bonds and debentures outstanding areas follows:

 
| ** **                                            | ** ** | **March 31, 2006** | ** ** | **December 31,  2005** | ** ** |
|-------------------------------------------------------|------------|--------------------|------------|------------------------|------------|
|                                                  |       |               |       |                   |       |
| 12% Secured  Convertible Bonds, due December 31, 2020 |       | $                  | 1,395,000  |                   | $          | 1,470,000 |   |
| 12% Secured Convertible  Bonds, due December 31, 2022 |       | 1,136,000          |       | 1,136,000              |       |
|                                                  |       |               |       |                   |       |
|                                                  |       | 2,531,000          |       | 2,606,000              |       |
| Less current  portion                                 |       | 253,100            |       | 260,600                |       |
|                                                  |       |               |       |                   |       |
| Long-term  portion                                    |       | $                  | 2,277,900  |                   | $          | 2,345,400 |   |

#### ** **

#### **NOTE 6—CONTINGENCIES**

 

**Litigation**

 

*GothamInsurance Company v. Warren.*  In 1998, the Company and its subsidiary,Warren E&P, Inc., were sued in the 81st Judicial District Courtof Frio County, Texas by Stricker Drilling Company, Inc. and ManningSafety Systems to recover the value of lost equipment based on a well blow-out.As a result of the lawsuit, Gotham Insurance Company, Warren E&P’s wellblow-out insurer, intervened. The suit was settled in 1999 with all partiesexcept Gotham and other insurers. The insurers paid approximately$1.8 million under the insurance policy and Gotham has sought a refund ofapproximately $1.8 million. In the summer and fall of 2000, summaryjudgments were entered in favor of Warren E&P on essentially all claimsexcept its bad faith claims against Gotham, and Gotham’s claims were rejected.Final judgment was rendered by the District Court on May 14, 2001 inWarren E&P’s favor for the remaining policy proceeds, interest andattorneys’ fees. Gotham appealed the final judgment to the San AntonioCourt of Appeals, seeking a refund of approximately $1.5 million. OnJuly 23, 2003, the San Antonio Court of Appeals reversed, in Gotham’sfavor, the trial court’s earlier summary judgment for Warren E&P andremanded the case to the trial court for further proceedings consistent withthe San Antonio Court of Appeals’ decision. On January 4, 2005, theCompany received an order of the trial court that Warren and Warren E&Pwere obligated to repay Gotham $1.8 million, along with attorneys’ feesand statutory interest estimated at $966,000. At December 31, 2004, Warrenrecorded a provision for $1.8 million relating to this judgment. OnApril 11, 2005, Warren filed to appeal the order of the trial court to theTexas Court of Appeals.

 

On April 26, 2006, theTexas Court of Appeals rendered a decision in Warren’s favor which reversed thetrial court’s judgment awarding Gotham’s attorney’s fees and held that, becausethe trial court erred in failing to conduct “further proceedings” on the amountof restitution that Gotham may be entitled to be awarded, the entirerestitution award of $1.8 million and the interest thereon is reversed, withthe matter remanded to the trial court for further proceedings.

 

We are also a party to legal actions arising in theordinary course of our business. In the opinion of our management, based inpart on consultation with legal counsel, the liability, if any, under theseclaims is either adequately covered by insurance or would not have a materialadverse effect on the Company’s financial condition or results of operations.

 

**Repurchase Agreements**

 

For repurchase agreements relating topartnerships formed from 1999 to 2001, investor partners have a right to havetheir interests repurchased by the Company at a formula price seven years fromthe date of the original partnership formation. In determining the amount of the repurchase obligation, the obligationis computed based on the lesser of a formula purchase price or the estimatedcash flows discounted at 10% (“PV-10”) from proved developed and undevelopedreserves of each partnership. At March 31, 2006, the formula purchase pricewith respect to these partnerships was approximately $74.8 million. However,this amount is limited to approximately $36.4 million

 

10

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based on the PV-10 of the assets inthese partnerships at December 31, 2005. This limitation does not includereserves for 1.7 net wells remaining to be drilled or 54 net wells awaiting tobe placed on production on behalf of these seven drilling partnerships, andwill fluctuate due to the variables in determining discounted cash flows, suchas price changes, reserve revisions, etc. In the event of repurchase, the Company receives the investor’s interestin the partnership and the investor’s pro rata share of the partnerships reservesand related future cash flows.

 

**NOTE 7—BUSINESS SEGMENT INFORMATION**

 

The Company’s operating activities can be divided into four majorsegments: turnkey contracts, oil and gas marketing, oil and gas exploration andproduction operations and well services. The Company drills oil and natural gaswells for Company-sponsored drilling partnerships and retains an interest ineach well. Also, the Company markets natural gas for affiliated drilling partnerships.The Company charges Company-sponsored drilling partnerships and other thirdparties competitive industry rates for well operations and gas gathering.Segment information is as follows:

 
| ** **              | ** ** | **Three Months Ended** | ** ** |
|-------------------------|------------|------------------------|------------|
| ** **              | ** ** | **March 31,  2006**    | ** ** | **March 31,  2005** | ** ** |
| ** **              | ** ** | ** **             | ** ** | ** ** | ** ** |
| **Revenue**             |       |                   |       |   |   |
| Oil and Gas  Operations |       | $                      | 6,809,441  |   | $ | 2,176,587 |   |
| Turnkey  Contracts      |       | 426,597                |       | 2,279,317 |   |
| Oil and Gas  Marketing  |       | 1,015,045              |       | 2,196,074 |   |
| Well Services           |       | 248,289                |       | 540,659 |   |
| Other                   |       | 1,333,078              |       | 924,161 |   |
|                    |       |                   |       |   |   |
|                    |       | $                      | 9,832,450  |   | $ | 8,116,798 |   |

 
| ** **                     | ** ** | **March 31  2006** | ** ** | **March 31,  2005** | ** ** |
|--------------------------------|------------|-------------------------|------------|--------------------------|------------|
| ** **                     | ** ** | ** **              | ** ** | ** **               | ** ** |
| **Operating  Income / (Loss)** |       |                    |       |                     |       |
| Oil and Gas  Operations        |       | $                       | 2,377,888  |                     | $          | 763,495 |   |
| Turnkey  Contracts             |       | (304,923                | )          | 231,113                  |       |
| Oil and Gas  Marketing         |       | 23,039                  |       | 30,982                   |       |
| Well Services                  |       | (47,194                 | )          | 346,270                  |       |
| Other                          |       | (1,125,854              | )          | (2,817,932               | )          |
|                           |       |                    |       |                     |       |
|                           |       | $                       | 922,956    |                     | $          | (1,446,072 | ) |

 

**NOTE 8—COMPREHENSIVE INCOME (LOSS)**

 

Other comprehensive income (loss) consists primarily of net unrealizedinvestment gains and losses, net of income tax effect. Total comprehensive income(loss) for the periods are as follow:

 
| ** **                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
|                           |       |     |       |     |       |
| Three Months  ending March 31, |       | $        | 756,508    |     | $          | (1,898,238 | ) |
|                                |            |          |            |          |            |  |  |

 

11

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**NOTE 9—GOODWILL**

 

The Company accountsfor goodwill under SFAS No. 142, *Goodwill and OtherIntangible Assets,*and only adjusts the carrying amount of goodwillor indefinite life intangible assets upon an impairment. During the three monthsended March 31, 2006 no events occurred which would indicate that an impairmentof goodwill existed.

 

**Item 2. *Management’sdiscussion and analysis of financial conditions and results of operations***

 

**FORWARD-LOOKINGINFORMATION**

 

Forward-looking statements for 2006 and later periods are made in thisdocument. Such statements represent estimates by management based on theCompany’s historical operating trends, its proved oil and gas reserves andother information currently available to management. The Company cautions thatthe forward-looking statements provided herein are subject to all the risks anduncertainties incident to the acquisition, development and marketing of, andexploration for oil and gas reserves. These risks include, but are not limitedto, oil and natural gas price risk, environmental risks, drilling risk, reservequantity risk and operations and production risk. For all the above reasons,actual results may vary materially from the forward-looking statements andthere is no assurance that the assumptions used are necessarily the most likelyto occur.

 

**OVERVIEW:**

 

During 2005, we began to transition ourselves frombeing a provider of turnkey contract services into more of a traditionalexploration and production company.  As aresult, we expect oil and gas sales and production and exploration expense tobecome more material in future years. Additionally, we anticipate that turnkey contract revenues and expenseswill become less material in future years.

 

Our future success depends upon the development of ourcore acreage.  During 2006 and subsequentyears, we plan to continue to develop our core acreage, which includes our coalbedmethane (“CBM”) acreage in the Atlantic Rim and Pacific Rim in the WashakieBasin in Wyoming.  Additionally, our coreacreage includes our secondary recovery water flood projects in the WilmingtonTownlot Unit and the North Wilmington Townlot Unit in southern California.  As of March 31, 2006, we owned natural gasand oil leasehold interests in approximately 274,682 gross (152,773 net) acres,93% of which is undeveloped.  Substantiallyall of our undeveloped acreage is located in the Rocky Mountains.  Our total net proved reserves are located onless than 10% of our net acreage.

 

**LIQUIDITY AND CAPITALRESOURCES:**

 

During December 2005, we sold 6.9 million shares in a secondaryoffering raising net proceeds of $95.0 million.

 

Our cash and cash equivalents decreased $20.2 million during the firstquarter of 2006. Cash used in investing activities of $24.6 million resultsprimarily from expenditures on oil and gas properties.  Cash provided by operating activities of $3.7million primarily relates to increased profits relating to higher oil and gasproduction. Cash provided by financing activities of $0.7 million results fromthe exercise of stock options and warrants.

 

Currently our assets areunencumbered, except for restricted investments in US Treasury Bonds whichsecure our debentures. As a result the Company may seek to obtain bankfinancing to fund future activities.

 

Cash used in investing activities of $24.6 million results primarilyfrom expenditures on oil and gas properties. Cash provided by operating activities of $3.7 million primarily relatesto increased profits relating to higher oil and gas production. Cash providedby financing activities of $0.7 million results from the exercise of stockoptions and warrants.

 

Another commitment of funds relates to the drilling partnerships. Ourdeferred revenue balance relating to our drilling commitments totaled $1.2million at March 31, 2006. This commitment approximates 2.3 net wells,primarily in the Washakie Basin, to be drilled on behalf of our drilling partnershipsformed in 2003 and prior.

 

12

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During the first quarter of 2006, effective as of the last drilling partnershipdistribution date in the fourth quarter of 2005 and closing on March 31, 2006,the investor partners of the 1998 drilling partnerships voted to approve thesale of all of the oil and gas assets of the drilling partnerships to us.  The aggregate purchase price was $8.2 million.  As a result, net of our interest, the Companyissued 383,072 shares of restricted common stock and paid $2.7 million in cashin exchange for both producing and non-producing properties. The number ofshares issued was determined based upon a 20% discount from the weightedaverage sales price for Warren’s publicly traded common stock for theforty-five (45) calendar days ending March 31, 2006. The Company booked thetransaction based on the undiscounted weighted average price of its commonstock for the forty-five (45) calendar days ending March 31, 2006. The Companyreceived oil and gas properties having a PV-10 value of approximately $7.6million as determined by Williamson Petroleum Consultants, Inc., as well assome unproved properties.

 

Additionally during the first quarter of 2006, we purchased for cashthe remaining minority oil and gas interests not already owned by Warren fromthe drilling program LLC’s originally formed between 1994 and 1997 based upontheir PV-10 value as determined by Williamson Petroleum Consultants, Inc.,independent petroleum engineers.  We paidan aggregate cash purchase price of $1.1 million. The remaining minorityinterest relating to these partnerships was recorded as a reduction in the costbasis of the assets acquired.

 

The Company had net income of $0.7 million (including preferreddividends of $0.2 million) for the first quarter of 2006, as compared to a netloss of $3.4 million (including preferred dividends of $1.6 million) for thecomparable period of 2005. At March 31, 2006, current assets exceeded currentliabilities by approximately $76.0 million. We expect our cash and cashequivalents and cash flows from operating activities to be sufficient to fundour operations for more than the next twelve months.

 

At March 31, 2006, we had approximately 2.4 millionvested outstanding stock options issued under our stock based equitycompensation plans. Of the total 2.4 million outstanding vested options, allhad exercise prices below the closing market price ($14.90) of our common stockon March 31, 2006. If such options are exercised by the holders, we would receive$17.3 million in cash.

 

*Contractual Obligations*

 

The contractual obligations table below assumes the maximum amount istendered each year. The table does not give effect to the conversion of anybonds to common stock which would reduce payments due. All debentures aresecured at maturity, or partially secured at maturity, by zero couponU.S. treasury bonds deposited into an escrow account equaling the parvalue of the debentures maturing on or before the maturity of the debentures.The table below reflects the release of U.S. treasury bonds to us uponredemption.

 
| ** **                                         | ** ** | ** ** | ** ** | **Payments due by period** | ** ** |
|----------------------------------------------------|------------|------------|------------|----------------------------|------------|
| **Contractual Obligations   As of March 31, 2006** | ** ** | **Total**  | ** ** | **Less Than  1 Year**      | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** |
|                                               |       |       |       |                       |       |   |   |   |   |   |   |
| Debentures                                         |       | $          | 2,531,000  |                       | $          | 253,100 |   | $ | 432,801 |   | $ | 350,569 |   | $ | 1,494,530 |   |
| Drilling  Commitments                              |       | 2,796,000  |       | 2,796,000                  |       | — |   | — |   | — |   |
| Leases                                             |       | 551,301    |       | 163,580                    |       | 304,775 |   | 82,946 |   | — |   |
| Total                                              |       | $          | 5,878,301  |                       | $          | 3,212,680 |   | $ | 737,576 |   | $ | 433,515 |   | $ | 1,494,530 |   |

 

The contractual obligation schedule above does not reflect $2.5 millionprincipal amount of zero coupon U.S. treasury bonds held by us in escrowto secure the repayment of the debentures upon maturity. SuchU.S. treasury bonds had a fair market value of $1.2 million at March 31,2006.

 

**Off-Balance Sheet Arrangements**

 

Under the terms of our drilling partnerships formedfrom 1999 to 2001, investors have the right to tender their interest back tothe drilling partnership and other program investors during the periodseven years after the date of the partnership’s formation. The tenderrights were included to make such partnerships more attractive to potentialinvestor partners, thereby enabling the Company to obtain more capital to drillmore oil and gas wells. To the extent that an investor tenders a drilling partnershipinterest for sale and the drilling partnership and other investors elect not torepurchase the withdrawing partner’s

 

13

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interest, we will be required to repurchase the interest from theinvestor. The price of our repurchase is fixed by the drilling partnershipagreement to be the lower of the PV-10 value of the assets of the partnershipand a formula based on the amount of the investor’s cash investment reduced bythe amount of any cash distributions received. As of March 31, 2006, based onthe December 31, 2005 reserve reports of the respective drilling partnerships,the aggregate PV-10 value of the assets in these partnerships is $36.4 million.Because this PV-10 value is less than the formula price of $74.8 million atMarch 31, 2006, the maximum repurchase price obligation at March 31, 2006 was$36.4 million based on the December 31, 2005 reserve report. This PV-10 valuewould be higher if current prices for crude oil and natural gas were toincrease when we drill the remaining 1.7 net wells or place the remaining 54net wells on production on behalf of these seven drilling partnerships. In theevent of repurchase, we receive the investor’s interest in the partnership,which includes the investor’s beneficial share of the partnership’s reservesand related future net cash flows. There are no known events that would resultin termination of the material benefits of our off-balance sheet arrangementsexcept for a decrease in oil and gas pricing that occurs after an acquisition.The only material off-balance sheet benefit of this arrangement is theacquisition of proved reserves. To the extent that we acquire interests fortheir PV-10 value based on this arrangement, and declining oil and natural gasprices, or other factors, render those interests less valuable, a materialreduction in the benefits of this arrangement to the Company would occur.

 

The table below presents the projected timing of ourmaximum potential repurchase commitment associated with these partnerships asof March 31, 2006:

 
| ** **                                   | ** ** | ** **                    | ** ** | **Amount of repurchase commitment per period** | ** ** |
|----------------------------------------------|------------|-------------------------------|------------|------------------------------------------------|------------|
| ** **                                   | ** ** | **Total**                     | ** ** | **Less Than  1 Year**                          | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                                   | ** ** | **(in thousands )** | ** ** |
|                                         |       |                          |       |                                           |       |   |   |   |   |   |   |
| Maximum  potential repurchase commitment (1) |       | $                             | 36,439     |                                           | $          | 4,530 |   | $ | 31,909 |   | $ | — |   | $ | — |   |
|                                              |            |                               |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1)          Based on thepartnership reserves taken from the Williamson partnership reserve report as ofDecember 31, 2005 and using pricing at that date. This report does not includereserves for 1.7 net wells that are scheduled to be drilled for these partnershipsor for the 54 net wells drilled and waiting to be placed on production.

 

Commencing January 1, 2007, we are obligated tocommence purchasing drilling partnership interests at their PV-10 value ifrequested by the investor.  As a result,the following factors may affect the liquidity and capital resources of theCompany:

 

•                  Anincrease in the price of oil and natural gas, or an increase in the amount ofproved reserves (from drilling the remaining 1.7 net wells that are scheduledto be drilled for these drilling partnerships during 2006, from the 54 netwells drilled and waiting to be placed on production, or from other factors)may increase the PV-10 value of the drilling partnerships and, as a result,increase the price of our repurchase. After the acquisition of the drilling partnership interests, oil andnatural gas prices may decline resulting in a decline in the expected futurenet cash flow or fair market value of the assets acquired in the repurchase anda possible recording of impairment expense.

 

•                  Ifour existing working capital is inadequate to fund the repurchase of drilling partnershipinterests, we may be unable to obtain financing, or obtain financing on termsacceptable to us, to purchase the drilling partnership interests at their PV-10value.

 

14

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**RESULTS OF OPERATIONS:**

 

**Three months Ended March 31, 2006 Compared to ThreeMonths Ended March 31, 2005**

 

*Oil and gas sales.* Revenue fromoil and gas sales increased $4.6 million in the first quarter of 2006 to $6.8million, a 213% increase compared to the same quarter in 2005.  This increase in production resulted fromsignificantly increasing our 2005 drilling activity in the Wilmington TownlotUnit (“WTU”) in southern California. Additionally, this increase results from acquiring the North WilmingtonUnit (“NWU”) which is adjacent to the WTU. Prior to July 2005, all wells were syndicated to our drilling partnershipswhich resulted in lower working interest percentages allocated us.  Net oil production for the three months endedMarch 31, 2006 and 2005 was 93 Mbbls and 30 Mbbls, respectively.  Net gas production for three months endedMarch 31, 2006 and 2005 was 309 and 243 Mmcf, respectively.  The average realized price per barrel of oilfor the three months ended March 31, 2006 and 2005 was $52.47 and $35.08,respectively.  Additionally, the averagerealized price per Mcf of gas for the three months ended March 31, 2006 and2005 was $6.28 and $4.65, respectively.

 

*Production & exploration.*Production and exploration expense increased $2.3 million in the first quarterof 2006 to $3.0 million, a 343% increase compared to the same quarter in2005.  This increase resulted from anincrease in production.  Productionincreased to 422 Mmcfe for the first quarter of 2005 to 866 Mmcfe for the firstquarter of 2006, an increase of 105%. Additionally, we incurred increases in lease operating expenses relatedto the Wilmington Field in California. The Company has incurred significantstart up, repair and maintenance costs associated with the implementation ofour drilling plan.

 

*Turnkey contract revenue and expenses.*Turnkey contract revenue decreased $1.9 million in the first quarter of 2006 to$0.4 million, an 81% decrease compared to the corresponding quarter of thepreceding year. Additionally, turnkey contract expense decreased $1.3 millionduring the first quarter to $0.7 million, a 65% decrease compared to the same periodin 2005  The drilling activity on behalfof the drilling partnerships was less active during the first quarter of 2006compared to the corresponding quarter of 2005.

 

Net loss from turnkey activities was$0.3 million for the first quarter of 2006. This compares to a net gain of $0.3million for the corresponding quarter in 2005. The net loss from turnkeyactivities during 2006 results from higher than anticipated drilling costsrelating to one well.

 

*Oil and gas sales and costs from marketing activities.*Oil and gas sales from marketing activities decreased $1.2 million in the firstquarter of 2006 to $1.0 million, a 54% decrease compared to the same periodlast year. Cost of oil and gas marketing activities decreased $1.2 million inthe quarter to $1.0 million, a 54% decrease compared to the same quarter in 2005.The decrease results from acquiring the assets in our 1998 drilling partnerships.  Additionally, we acquired all of theremaining assets in our drilling partnerships formed between 1994 and 1997.  Gas production from the wells in the drillingpartnerships in which we earn a marketing fee for the three months ended March31, 2006 and 2005 was 0.1 Bcfe and 0.6 Bcfe, respectively. The average priceper Mcfe during the first quarter of 2006 and 2005 was $8.87 and $3.71,respectively.

 

The gross profit from marketing activities for the first quarter of2006 was $23 thousand as compared to $31 thousand in the same period last year.

 

*Well services activities.* Wellservices revenue decreased $0.3 million in the first quarter of 2006 to $0.2million, a 54% decrease compared to the corresponding quarter of the precedingyear. Well services expense increased $0.1 million in the first quarter to $0.3million. The decrease in well services revenue results from drilling more wellsfor our own account and not charging our personnel to third parties.  Additionally, revenue decreased because we acquiredall investor’s interests in oil and gas properties in our 1998 drilling partnership,resulting in a reduction in overhead income.

 

Net loss from well services activities was $47 thousand for the firstquarter of 2006. This compared to net profit of $346 thousand for thecorresponding quarter of last year.  Theincrease in net loss during 2006 results from the decrease in well servicesrevenue discussed above.

 

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*Net gain (loss) on investments.*Netloss on investments was $23 thousand for the first quarter of 2006 compared toa net gain of $31 thousand for the same period of 2005.  Primarily, investments represent zero couponU.S. treasury bonds. Fluctuations in net gain or loss on investments resultedfrom changes in long-term interest rates.

 

*Interest and other income.*Interest and other income increased $0.5 million in the first quarter of 2006to $1.4 million, a 52% increase compared to the same quarter in 2005. Thisrepresents an increase in interest earned on cash and cash equivalents.

 

*Depreciation, depletion, amortization and impairment.*Depreciation, depletion, amortization and impairment expense increased $0.7million for the first quarter of 2006 to $1.5 million, a 94% increase comparedto the corresponding quarter last year. This increase results from increasedproduction during the first quarter of 2006 compared to the correspondingperiod of 2005.  Production increased105% during this period.

 

*General and administrative expenses.*General and administrative expenses increased $0.8 million in the first quarterof 2006 to $2.3 million, a 55% increase compared to the corresponding quarterlast year.  This reflects a decrease inthe allocation of certain general and administrative expenses to turnkeyexpenses during 2006.  Additionally, thisresults from an increase in personnel as a result of increased drilling activities.

 

*Interest expense.* Interestexpense decreased $0.9 million in the first quarter of 2006 to $0.2 million, an83% decrease compared to the same quarter last year.  The Company reduced long term debt byapproximately $44 million during 2005. As a result, interest expense decreased significantly.

 

*Retirement of debt.* Retirement ofdebt expense was $1.2 million during the first quarter of 2005.  This expense represents a premium paid on theredemption of debentures and the write off of unamortized deferred offeringcosts associated with the retired debentures during the first quarter of 2005.

 

**CRITICAL ACCOUNTING POLICIES**

 

Our discussion and analysis of our financial condition and results ofoperations are based on consolidated financial statements that have beenprepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires us tomake estimates and judgments that affect the reported amounts of assets,liabilities, revenues and expenses. We believe that certain accounting policiesaffect our more significant judgments and estimates used in the preparation ofour consolidated financial statements. Our 2005 Form 10-K, as amended, includesa discussion of our critical accounting policies.

 

**Item 3. *Quantitative and qualitative disclosure about market risk***

## *** ***

## ***Commodity Risk***

** **

**Ourmajor market risk exposure is the commodity pricing applicable to our naturalgas and oil production. Realized commodity prices received for our productionare primarily driven by the prevailing worldwide price for crude oil and spotprices applicable to natural gas. The effects of price volatility are expectedto continue as we do not hedge any of our future production.**

** **

## ***Interest Rate Risk***

 

**Wehold investments in U.S. treasury bonds available for sale, which representssecurities held in escrow accounts on behalf of the drilling partnerships andpurchasers of certain debentures. Additionally, we hold U.S. treasury bonds trading securities, whichpredominantly represent U.S. treasury bonds released from escrow accounts.  The fair market value of these securitieswill generally increase if the federal discount rate decreases and decrease ifthe federal discount rate increases.  Allof our convertible debt has fixed interest rates, so consequently we are notexposed to cash flow risk from market interest rate changes on this debt.**

** **

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** **

## ***Inflation and Changes in Prices***

#### ** **

#### **The general level of inflation affects our costs.  Salaries and other general and administrativeexpenses are impacted by inflationary trends and the supply and demand ofqualified professionals and professional services.  Inflation and price fluctuations affect thecosts associated with exploring for and producing natural gas and oil, whichhave a material impact on our financial performance.**

#### ** **

#### **Item 4. *Evaluation of Disclosure Controls and Procedures***

 

Our management,under the supervision and with the participation of our Chief Executive Officer(“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness ofour disclosure controls and procedures as defined in Securities and ExchangeCommission (“SEC”) Rule 13a-15(e) and 15d-15(e) as of the end of the periodcovered by this report.  Based upon thatevaluation, management  has concludedthat our  disclosure  controls and  procedures  are effective  to ensure  that information  we are required to disclose in reports thatwe file or submit under the Securities Exchange Act is communicated tomanagement, including the CEO and CFO, as appropriate to allow timelydecisions  regarding required disclosureand is  recorded,  processed, summarized  and  reported within the time periods specified in the SEC’s rules and forms.

 

In addition, there have been no changes in our internal controls overfinancial reporting or in other factors that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

## **PART II—OTHER INFORMATION**

 

**Item 1. *LegalProceedings***

 

*GothamInsurance Company v. Warren.*  In 1998, the Company and its subsidiary,Warren E&P, Inc., were sued in the 81st Judicial District Courtof Frio County, Texas by Stricker Drilling Company, Inc. and ManningSafety Systems to recover the value of lost equipment based on a well blow-out.As a result of the lawsuit, Gotham Insurance Company, Warren E&P’s wellblow-out insurer, intervened. The suit was settled in 1999 with all partiesexcept Gotham and other insurers. The insurers paid approximately$1.8 million under the insurance policy and Gotham has sought a refund ofapproximately $1.8 million. In the summer and fall of 2000, summaryjudgments were entered in favor of Warren E&P on essentially all claimsexcept its bad faith claims against Gotham, and Gotham’s claims were rejected.Final judgment was rendered by the District Court on May 14, 2001 inWarren E&P’s favor for the remaining policy proceeds, interest andattorneys’ fees. Gotham appealed the final judgment to the San AntonioCourt of Appeals, seeking a refund of approximately $1.5 million. OnJuly 23, 2003, the San Antonio Court of Appeals reversed, in Gotham’sfavor, the trial court’s earlier summary judgment for Warren E&P andremanded the case to the trial court for further proceedings consistent withthe San Antonio Court of Appeals’ decision. On January 4, 2005, theCompany received an order of the trial court that Warren and Warren E&Pwere obligated to repay Gotham $1.8 million, along with attorneys’ feesand statutory interest estimated at $966,000. At December 31, 2004, Warrenrecorded a provision for $1.8 million relating to this judgment. OnApril 11, 2005, Warren filed to appeal the order of the trial court to theTexas Court of Appeals.

 

On April 26, 2006, theTexas Court of Appeals rendered a decision in Warren’s favor which reversed thetrial court’s judgment awarding Gotham’s attorney’s fees and held that, becausethe trial court erred in failing to conduct “further proceedings” on the amountof restitution that Gotham may be entitled to be awarded, the entirerestitution award of $1.8 million and the interest thereon is reversed, withthe matter remanded to the trial court for further proceedings.

 

We are also a party to legal actions arising in theordinary course of our business.  In theopinion of our management, based in part on consultation with legal counsel,the liability, if any, under these claims is either adequately covered byinsurance or would not have a material adverse effect on us.

 

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**Item 1A. Risk Factors**

 

For information regarding risk factors, please referto Item 1A in the Company’s Annual Report on Form 10-K for the year endedDecember 31, 2005.

 

**Item 2. *Unregistered Sales ofEquity Securities and Use of Proceeds***

 

a.     Inconnection with the acquisition of certain oil and gas properties (“Properties”)from two affiliated Delaware limited (the “Sellers”), which acquisition was closed on March 31, 2006 , Warrenissued an aggregate of 383,072 shares of our unregistered common stock (“CommonStock”) to the two Sellers. The number of shares issued was determined basedupon a 20% discount from the weighted average sales price for Warren’s publiclytraded common stock for the forty-five (45) calendar days ending March 31,2006. During that period, the weighted average sales price was $14.37 pershare, and the 20% discounted price was $11.49 per share. The Common Stock wasissued pursuant to the private placement exceptions from registration providedin Regulation D, Rule 506, under Section 4(2) of the SecuritiesAct of 1933, as amended (the “Act”).

 

Warren also granted certain registration rights to theSellers of the Properties in which we have agreed to file and use ourreasonable efforts to cause to be declared effective by the U.S. Securities andExchange Commission (the “SEC”) a registration statement covering resales ofour Common Stock issued to the Sellers within one (1) year after the closing ofthe Properties acquisition.

 

b.     Notapplicable

 

c.     Notapplicable

 

**Item 3. *Defaultsupon Senior Securities***

 

Not applicable.

 

**Item 4. *Submissionof Matters to a Vote of Security Holders***

 

Not applicable.

 

**Item 5. *OtherInformation***

 

Not applicable.

 

**Item 6. *Exhibits***

 

**a)****        ****Exhibits**

 

Exhibits not incorporated by reference to a priorfiling are designated by an (*) and are filed herewith; all exhibits not sodesignated are incorporated herein by reference to a prior filing as indicated.

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                 |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                            |
| 31.1*               |       | Certification of Chief Executive Officer pursuant to  Rule 13a-15(e)/15d-15(e)                                                                  |
| 31.2*               |       | Certification of Chief Financial Officer pursuant to  Rule 13a-15(e)/15d-15(e)                                                                  |
| 32.1*               |       | Certification of Chief Executive Officer Pursuant to  18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley  Act of 2002 |
| 32.2*               |       | Certification of Chief Financial Officer Pursuant to  18 U.S.C. Section 1350, as adopted by Section 906 of the Sarbanes-Oxley  Act of 2002 |

 

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| * |   | Filed herewith. |
|---|--------|-----------------|

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|              | WARREN RESOURCES, INC. |
|-------------------|------------------------|
|              | (Registrant)           |
|              |                   |
|              |                   |
|              |                   | /s/ Timothy A. Larkin |   |
| Date: May 4, 2006 | By:                    | Timothy A. Larkin *  * |
|              |                   | *Executive Vice President,* |
|              |                   | *Chief Financial Officer and* |
|              |                   | *Principal Accounting Officer* |

 

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