**UNITED STATES**

**SECURITIES 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 September 30, 2005**                                                                                                                                |
| ** **                                                                                                                                                                            | ** ** | ** **                                                               |
| **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 ofRegistrant as 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’stelephone number, including area code:

**(212)697-9660**

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed bySection 13 and 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months and (2) has been subject to such filing requirements forthe past 90 days.

 

Yes  ýNo  o

 

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).

 

Yes oNo ý

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act) o  Yes  ý  No.

 

Theaggregate number of Registrant’s outstanding shares on November 7, 2005 was 43,884,959shares of Common Stock, $0.0001 par value.

 

 

----

 

**WARRENRESOURCES, INC.**

 

**INDEX**

 
| PART I—  | FINANCIAL INFORMATION                                                                                           |   |
|---------------|-----------------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                            |   |
|          | Item 1. Financial Statements                                                                                    |   |
|          |                                                                                                            |   |
|          | Consolidated Balance Sheets as of  September 30, 2005 (Unaudited) and December 31, 2004                         |   |
|          |                                                                                                            |   |
|          | Consolidated Statements of  Operations (Unaudited) for three and nine months ended September 30, 2005 and  2004 |   |
|          |                                                                                                            |   |
|          | Consolidated Statements of  Cash Flows (Unaudited) for the nine months ended September 30, 2005 and 2004        |   |
|          |                                                                                                            |   |
|          | Notes to the Consolidated  Financial Statements (Unaudited)                                                     |   |
|          |                                                                                                            |   |
|          | 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 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**

 

**WarrenResources, Inc. and Subsidiaries**

**CONSOLIDATEDBALANCE SHEETS**

** **
| ** **                                                                                                                                                                                                                                          | ** ** | **September 30,  2005** | ** **      | **December 31,  2004** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-----------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                          | ** ** | **(Unaudited)**         | ** **      | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                                          |       |                    |            |                   |       |
| CURRENT ASSETS                                                                                                                                                                                                                                      |       |                    |            |                   |       |
| Cash and cash  equivalents                                                                                                                                                                                                                          |       | $                       | 50,361,024      |                   | $          | 99,920,885 |   |
| Accounts  receivable – trade, net                                                                                                                                                                                                              |       | 2,076,427               |            | 1,481,925              |       |
| Accounts  receivable from affiliated partnerships                                                                                                                                                                                                   |       | 120,624                 |            | 143,297                |       |
| Trading  securities                                                                                                                                                                                                                                 |       | 373,689                 |            | 174,247                |       |
| Restricted  investments in U.S. Treasury Bonds—available-for-sale, at fair value  (amortized cost of $4,837,380 in 2005 and $5,944,587 in 2004)                                                                                                |       | 5,487,523               |            | 6,099,968              |       |
| Other current  assets                                                                                                                                                                                                                               |       | 721,309                 |            | 211,509                |       |
|                                                                                                                                                                                                                                                |       |                    |            |                   |       |
| Total current  assets                                                                                                                                                                                                                               |       | 59,140,596              |            | 108,031,831            |       |
|                                                                                                                                                                                                                                                |       |                    |            |                   |       |
| OTHER ASSETS                                                                                                                                                                                                                                        |       |                    |            |                   |       |
| Oil and gas  properties—at cost, based on successful efforts method of accounting, net of  accumulated depreciation, depletion and amortization                                                                                                |       | 145,936,879             |            | 116,595,306            |       |
| Property and  equipment—at cost, net                                                                                                                                                                                                           |       | 608,641                 |            | 395,444                |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value  (amortized cost of $1,387,883 in 2005 and $10,778,899 in 2004)                                                                                               |       | 1,819,427               |            | 12,062,085             |       |
| Deferred bond  offering costs (net of accumulated amortization of $1,277,031 in 2005 and  $4,080,257 in 2004)                                                                                                                                       |       | 986,001                 |            | 2,360,812              |       |
| Goodwill                                                                                                                                                                                                                                            |       | 3,430,246               |            | 3,430,246              |       |
| Other assets                                                                                                                                                                                                                                        |       | 6,491,345               |            | 4,034,937              |       |
|                                                                                                                                                                                                                                                |       |                    |            |                   |       |
| Total other  assets                                                                                                                                                                                                                                 |       | 159,272,539             |            | 138,878,830            |       |
| ** **                                                                                                                                                                                                                                          | ** ** | **$**                   | **218,413,135** | ** **             | **$**      | **246,910,661** |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                      |       |                    |            |                   |       |
| CURRENT  LIABILITIES                                                                                                                                                                                                                                |       |                    |            |                   |       |
| Current  maturities of debentures                                                                                                                                                                                                                   |       | $                       | 14,574,600      |                   | $          | 17,316,070 |   |
| Current  maturities of other long-term liabilities                                                                                                                                                                                                  |       | 279,529                 |            | 353,516                |       |
| Accounts payable  and accruals                                                                                                                                                                                                                      |       | 20,155,623              |            | 16,153,851             |       |
| Deferred income—turnkey  drilling contracts with affiliated partnerships                                                                                                                                                                       |       | 5,237,461               |            | 11,908,389             |       |
|                                                                                                                                                                                                                                                |       |                    |            |                   |       |
| Total current  liabilities                                                                                                                                                                                                                          |       | 40,247,213              |            | 45,731,826             |       |
|                                                                                                                                                                                                                                                |       |                    |            |                   |       |
| LONG-TERM  LIABILITIES                                                                                                                                                                                                                              |       |                    |            |                   |       |
| Debentures, less  current portion                                                                                                                                                                                                                   |       | 2,358,900               |            | 29,160,630             |       |
| Other long-term  liabilities, less current portion                                                                                                                                                                                                  |       | 3,682,868               |            | 3,207,809              |       |
|                                                                                                                                                                                                                                                |       |                    |            |                   |       |
|                                                                                                                                                                                                                                                |       | 6,041,768               |            | 32,368,439             |       |
|                                                                                                                                                                                                                                                |       |                    |            |                   |       |
| MINORITY  INTEREST                                                                                                                                                                                                                                  |       | 7,123,478               |            | 11,240,990             |       |
|                                                                                                                                                                                                                                                |       |                    |            |                   |       |
| STOCKHOLDERS’  EQUITY                                                                                                                                                                                                                          |       |                    |            |                   |       |
| 8% convertible preferred stock, par value $.0001; authorized 10,000,000  shares, issued and outstanding, 946,784 shares in 2005 and 6,560,809 shares  in 2004  (aggregate liquidation  preference $11,361,408 in 2005 and $78,729,708 in 2004) |       | 11,090,986              |            | 77,270,413             |       |
| Common stock -  $.0001 par value; authorized, 100,000,000 shares; issued 42,989,774 in 2005  and 34,347,854 shares in 2004                                                                                                                          |       | 4,299                   |            | 3,435                  |       |
| Additional  paid-in-capital                                                                                                                                                                                                                         |       | 235,880,145             |            | 157,847,314            |       |
| Accumulated  deficit                                                                                                                                                                                                                                |       | (81,898,596             | )               | (77,689,476            | )          |
| Accumulated  other comprehensive income, net of applicable income taxes of $433,000 in  2005 and $576,000 in 2004                                                                                                                                   |       | 651,897                 |            | 865,775                |       |
|                                                                                                                                                                                                                                                |       | 165,728,731             |            | 158,297,461            |       |
| Less common  stock in Treasury—at cost; 632,250 shares in 2005 and 2004                                                                                                                                                                        |       | 728,055                 |            | 728,055                |       |
| Total  stockholders’ equity                                                                                                                                                                                                                    |       | 165,000,676             |            | 157,569,406            |       |
| ** **                                                                                                                                                                                                                                          | ** ** | **$**                   | **218,413,135** | ** **             | **$**      | **246,910,661** |   |

 

The accompanying notesare an integral part of these financial statements

 

3

----

 

**WarrenResources, Inc. and Subsidiaries**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

** **
| ** **                                                           | ** ** | **Three Months Ended  September 30, (Unaudited)** | ** ** | **Nine Months Ended  September 30, (Unaudited)** | ** ** |
|----------------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                           | ** ** | ** **                                        | ** ** | ** **                                       | ** ** |
| ** **                                                           | ** ** | **2005**                                          | ** ** | **2004**                                         | ** ** | **2005** | ** ** | **2004** | ** ** |
| **REVENUES**                                                         |       |                                              |       |                                             |       |   |   |   |   |
| Oil and gas  sales                                                   |       | $                                                 | 3,818,082  |                                             | $          | 1,851,845 |   | $ | 8,923,993 |   | $ | 4,532,684 |   |
| Turnkey  contracts with affiliated partnerships                      |       | 2,680,722                                         |       | 3,858,446                                        |       | 6,284,577 |   | 7,108,842 |   |
| Oil and gas  sales from marketing activities                         |       | 2,434,392                                         |       | 1,776,405                                        |       | 6,940,887 |   | 4,571,972 |   |
| Well services                                                        |       | 374,147                                           |       | 287,273                                          |       | 1,199,442 |   | 799,205 |   |
| Net gain on  investments                                             |       | 56,987                                            |       | 48,847                                           |       | 417,888 |   | (39,124 | ) |
| Interest and  other income                                           |       | 653,400                                           |       | 314,954                                          |       | 2,244,010 |   | 1,406,546 |   |
| Gain on sale of  oil and gas properties                              |       | —                                            |       | —                                           |       | 89,441 |   | 120,193 |   |
|                                                                 |       | 10,017,730                                        |       | 8,137,770                                        |       | 26,100,238 |   | 18,500,318 |   |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| **EXPENSES**                                                         |       |                                              |       |                                             |       |   |   |   |   |
| Production &  exploration                                        |       | 2,235,296                                         |       | 1,121,279                                        |       | 4,908,330 |   | 3,167,580 |   |
| Turnkey  contracts                                                   |       | 2,919,731                                         |       | 4,958,450                                        |       | 6,686,941 |   | 8,301,854 |   |
| Cost of marketed  oil and gas purchased from affiliated partnerships |       | 2,400,824                                         |       | 1,740,639                                        |       | 6,844,269 |   | 4,465,040 |   |
| Well services                                                        |       | 475,627                                           |       | 148,877                                          |       | 841,658 |   | 410,232 |   |
| Depreciation,  depletion, amortization and impairment                |       | 1,034,725                                         |       | 1,128,720                                        |       | 2,714,877 |   | 2,662,334 |   |
| General and  administrative                                          |       | 1,792,295                                         |       | 955,245                                          |       | 4,724,646 |   | 3,292,481 |   |
| Interest                                                             |       | 95,863                                            |       | 117,444                                          |       | 1,702,140 |   | 373,649 |   |
| Retirement of  debt                                                  |       | —                                            |       | —                                           |       | 1,524,270 |   | — |   |
|                                                                 |       | 10,954,361                                        |       | 10,170,654                                       |       | 29,947,131 |   | 22,673,170 |   |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Loss before  income taxes and minority interest                      |       | (936,631                                          | )          | (2,032,884                                       | )          | (3,846,893 | ) | (4,172,852 | ) |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Deferred income  tax expense (benefit)                               |       | 143,000                                           |       | (238,000                                         | )          | 143,000 |   | (92,000 | ) |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Net loss before  minority interest                                   |       | (1,079,631                                        | )          | (1,794,884                                       | )          | (3,989,893 | ) | (4,080,852 | ) |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Minority  interest                                                   |       | (18,890                                           | )          | (78,884                                          | )          | (219,227 | ) | (111,097 | ) |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Net loss                                                             |       | (1,098,521                                        | )          | (1,873,768                                       | )          | (4,209,120 | ) | (4,191,949 | ) |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Less dividends  and accretion on preferred shares                    |       | 404,041                                           |       | 1,649,920                                        |       | 3,646,664 |   | 4,940,241 |   |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Net loss  applicable to common stockholders                          |       | $                                                 | (1,502,562 | )                                                | $          | (3,523,688 | ) | $ | (7,855,784 | ) | $ | (9,132,190 | ) |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Basic and  diluted loss per common share                             |       | $                                                 | (0.04      | )                                                | $          | (0.18 | ) | $ | (0.21 | ) | $ | (0.49 | ) |
|                                                                 |       |                                              |       |                                             |       |   |   |   |   |
| Weighted average  common shares outstanding                          |       | 42,001,928                                        |       | 19,523,327                                       |       | 37,325,880 |   | 18,699,514 |   |

 

The accompanyingnotes are an integral part of these financial statements

 

4

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**WarrenResources, Inc. and Subsidiaries**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                                   | ** ** | **For the nine months ended  September 30, (Unaudited)** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                                 | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                       |       |                                                     |       |   |   |
| Net loss                                                                     |       | $                                                        | (4,209,120 | ) | $ | (4,191,949 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                                     |       |   |   |
| Accretion of  discount on available-for-sale debt securities                 |       | (458,908                                                 | )          | (503,108 | ) |
| Amortization and  write-off of deferred bond offering costs                  |       | 973,061                                                  |       | 298,975 |   |
| Gain on sale of  US treasury bonds—available for sale                   |       | (470,268                                                 | )          | — |   |
| Depreciation,  depletion, amortization and impairment                        |       | 2,714,877                                                |       | 2,662,334 |   |
| Accretion of  asset retirement obligation                                    |       | 40,876                                                   |       | 51,292 |   |
| Gain on sale of  oil and gas properties                                      |       | (89,441                                                  | )          | (120,193 | ) |
| Expense on the  issuance of warrants                                         |       | 21,705                                                   |       | — |   |
| Deferred tax  expense (benefit)                                              |       | 143,000                                                  |       | (92,000 | ) |
| Change in assets  and liabilities:                                           |       |                                                     |       |   |   |
| Increase in  trading securities                                              |       | (199,442                                                 | )          | (133,454 | ) |
| Increase in  accounts receivable—trade                                  |       | (449,502                                                 | )          | (603,136 | ) |
| Decrease in  accounts receivable from affiliated partnerships                |       | 22,673                                                   |       | 256,245 |   |
| (Increase)  decrease in other assets                                         |       | (2,966,208                                               | )          | 2,611,546 |   |
| Increase  (decrease) in accounts payable and accruals                        |       | (243,186                                                 | )          | 1,379,333 |   |
| Decrease in  deferred income from affiliated partnerships                    |       | (6,670,928                                               | )          | (7,108,842 | ) |
| Decrease in  other long term liabilities                                     |       | (13,069                                                  | )          | (68,630 | ) |
|                                                                         |       |                                                     |       |   |   |
| Net cash used in  operating activities                                       |       | (11,853,880                                              | )          | (5,561,587 | ) |
|                                                                         |       |                                                     |       |   |   |
| Cash flows from  investing activities:                                       |       |                                                     |       |   |   |
| Purchase,  exploration and development of oil and gas properties             |       | (32,001,917                                              | )          | (16,793,768 | ) |
| Purchase of  property and equipment                                          |       | (342,833                                                 | )          | (7,673 | ) |
| Proceeds from  the sale of oil and gas properties                            |       | 180,000                                                  |       | 120,193 |   |
| Proceeds from  the sale of property and equipment                            |       | —                                                   |       | 24,000 |   |
| Proceeds from  U.S. Treasury Bonds—available-for-sale                   |       | 11,427,399                                               |       | 92,883 |   |
|                                                                         |       |                                                     |       |   |   |
| Net cash used in  investing activities                                       |       | (20,737,351                                              | )          | (16,564,365 | ) |
|                                                                         |       |                                                     |       |   |   |
| Cash flows from  financing activities:                                       |       |                                                     |       |   |   |
| Payments on debt  and debentures                                             |       | (17,006,025                                              | )          | (1,312,344 | ) |
| Issuance of  common stock, net                                               |       | 1,611,989                                                |       | 20,725,724 |   |
| Issuance of  preferred stock, net                                            |       | —                                                   |       | 126,730 |   |
| Dividends paid  on preferred stock                                           |       | (1,574,594                                               | )          | (4,633,741 | ) |
|                                                                         |       |                                                     |       |   |   |
| Net cash  provided by (used in) financing activities                         |       | (16,968,630                                              | )          | 14,906,369 |   |
|                                                                         |       |                                                     |       |   |   |
| Net decrease in  cash and cash equivalents                                   |       | (49,559,861                                              | )          | (7,219,583 | ) |
| Cash and cash  equivalents at beginning of period                            |       | 99,920,885                                               |       | 24,528,999 |   |
|                                                                         |       |                                                     |       |   |   |
| Cash and cash  equivalents at end of period                                  |       | $                                                        | 50,361,024 |   | $ | 17,309,416 |   |
|                                                                         |       |                                                     |       |   |   |   |   |
| Supplemental  disclosure of cash flow information                            |       |                                                     |       |   |   |
| Cash paid for  interest, net of amount capitalized                           |       | $                                                        | 1,386,029  |   | $ | — |   |
| Cash paid for  income taxes                                                  |       | $                                                        | —     |   | $ | — |   |

 

The accompanyingnotes are an integral part of these financial statements

 

5

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**WARRENRESOURCES, INC. AND SUBSIDIARIES**

** **

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

** **

**NOTE 1—ORGANIZATION**

 

Warren Resources, Inc.(the “Company” or “Warren”), was originally formed on June 12, 1990 for thepurpose of acquiring and developing oil and gas properties. The Company isincorporated under the laws of the state of Maryland. The Company’s propertiesare primarily located in Wyoming, California, New Mexico, North Dakota andTexas. In addition, the Company serves as the managing general partner (the “MGP”)to affiliated partnerships and joint ventures.

 

Theaccompanying unaudited financial statements and related notes present theCompany’s consolidated financial position as of September 30, 2005 and December31, 2004, the consolidated results of operations for the three and nine months endedSeptember 30, 2005 and 2004 and consolidated cash flows for the nine monthsended September 30, 2005 and 2004. The unaudited financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and with theinstructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, theydo not include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals) considered necessary for a fair presentation havebeen included. Operating results for the three and nine months ended September 30,2005, are not necessarily indicative of the results that may be expected forthe fiscal year ending December 31, 2005. The accounting policies followed bythe Company are set forth in Note A to the Company’s financial statements onForm 10-K for the year ended December 31, 2004. These interim financialstatements and notes thereto should be read in conjunction with theconsolidated financial statements presented in the Company’s 2004 Annual Reporton Form 10-K.

 

##### **NOTE 2**—STOCK OPTIONS

 

At September 30, 2005,the Company had stock-based compensation plans. The Company accounts for thoseplans under the recognition and measurement principles of Accounting PrinciplesBoard (APB) Opinion No. 25, *Accounting for StockIssued to Employees*, and related interpretations. The followingtable illustrates the effect on net loss per share if the Company had appliedthe fair-value recognition provisions of Financial Accounting Standards Board(FASB) Statement No. 123, *Accounting for Stock-BasedCompensation*, to stock-based employee compensation:

 
| ** **                                                                                                                                    | ** ** | **Three months ended September 30,** | ** ** | **Nine months ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                             | ** ** | **2004**                            | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net loss  applicable to common stockholders, as reported                                                                                      |       | $                                    | (1,502,562 | )                                   | $          | (3,523,688 | ) | $ | (7,855,784 | ) | $ | (9,132,190 | ) |
| Deduct: Total  stock-based employee compensation expense determined under fair-value-based  method for all awards, net of related tax effects |       | —                               |       | (693,875                            | )          | (2,614,482 | ) | (711,373 | ) |
|                                                                                                                                          |       |                                 |       |                                |       |   |   |   |   |
| Pro forma net  loss applicable to common Stockholders                                                                                         |       | $                                    | (1,502,562 | )                                   | $          | (4,217,563 | ) | $ | (10,470,266 | ) | $ | (9,843,563 | ) |
|                                                                                                                                          |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |
| Basic and  diluted loss per share:                                                                                                            |       |                                 |       |                                |       |   |   |   |   |
| As reported -                                                                                                                                 |       | $                                    | (0.04      | )                                   | $          | (0.18 | ) | $ | (0.21 | ) | $ | (0.49 | ) |
| Pro forma -                                                                                                                                   |       | $                                    | (0.04      | )                                   | $          | (0.22 | ) | $ | (0.28 | ) | $ | (0.53 | ) |

 

6

----

 

On February 8, 2005, we accelerated the vesting of all unvested stock options previously awarded to employees, officers and directors of the Company under various stock option plans. As a result of this action, options to purchase approximately 1.0 million shares of our common stock that would otherwise have vested over the next two years became fully vested. This transaction resulted in a nominal expense being booked in the income statement for the first quarter in 2005.

#### ** **

#### **NOTE3**—CHANGESIN STOCKHOLDERS’ EQUITY

 

During the nine monthsended September 30, 2005, holders of 5,614,025 shares of convertible preferredstock have converted into common stock on a one-for-one share basis, and 946,784shares of convertible preferred stock remain outstanding as of September 30,2005. Preferred dividends of approximately $3.6 million and $1.6 million wereaccrued at September 30, 2005 and December 31, 2004, respectively. The accrueddividend at March 31, June 30 and September 30, 2005 has not been paid as of thedate of this filing. The Company has incurred cumulative issuance costs ofapproximately $2.1 million in relation to these shares. The preferred stockpays an 8% cumulative dividend, which is payable quarterly, and is treated as adeduction in additional paid in capital. The holders of the preferred stock arenot entitled to vote except as defined by the agreement or as provided byapplicable law.  The preferred stock maybe voluntarily converted, at the election of the holder into common stock ofthe Company based on the table below. The conversion rate is subject to adjustment from time to time asdefined by the agreement.

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

 

With respect to 227,105 sharesof preferred stock that are not subject to the above conversion rates, all ofwhich consist of series A institutional 8% cumulative convertible preferredstock, the following conversion rates apply. At the election of the holder theseshares can be converted into common shares on a one-for-one basis untilDecember 16, 2005. Thereafter, until June 30, 2006, each share of preferredstock is convertible into 0.75 shares of common stock, and commencing July 1,2006 and thereafter, each share of preferred stock is convertible into 0.50shares of common stock.

 

Additionally, commencingseven years after the date of issuance (October 1, 2009), holders of thepreferred stock may elect to require the Company to redeem their preferredstock at a redemption price equal to the liquidation value of $12.00 per share,plus accrued but unpaid dividends, if any (“Redemption Price”).  Upon the receipt of a redemption election,the Company, at its option, shall either: (1) pay the holder cash in the amountequal to the Redemption Price or (2) issue to holder shares of common stock upto 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.

 

At September 30, 2005,there were 582,384 preferred shares outstanding that the Company may berequired to redeem at the aggregate redemption price of $6,988,608 between January1, 2010 and September 30, 2010 and 364,400 preferred shares outstanding thatthe Company may be required to redeem at the aggregate redemption price of $4,372,800on or after October 1, 2010.

 

During the secondquarter, the Company and the preferred holders agreed by greater than therequisite 66.67% majority that a dividend be paid in kind with Warren Resourcescommon stock for the accrued dividend for the quarters ended March 31 and June30, 2005, amounting to approximately $3.3 million. Accordingly, Warren will beissuing a total of 315,867 shares of its common stock as a dividend after theseshares are registered with the SEC under a Form S-3 registration statement,which is expected to be effective in the forth quarter of 2005.

 

During the nine monthsended September 30, 2005, employees exercised a total of 380,691 options atexercise prices between $4 and $9.05 per share. The Company received proceedsof approximately $1.6 million from these exercises.

 

During the nine monthsended September 30, 2005, the Company issued 2,456,886 shares of common stockto certain convertible debenture holders. Of this amount 2,047,000 sharesrelated to the conversion of the Company’s 2010 Sinking Fund Convertible Bonds inthe second quarter of 2005.

 

7

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During the nine monthsended September 30, 2005, the Company issued 187,500 shares of common stock tocertain individuals in exchange for their partnership interests.

 

**NOTE 4—LOSS PER SHARE**

 

Basic loss per share iscomputed by dividing net loss applicable to common stockholders by the weightedaverage number of shares of common stock outstanding during the period. Dilutedloss per share is based on the assumption that stock options and warrants areconverted into common shares using the treasury stock method and convertiblebonds, debentures and preferred stock are converted using the if-convertedmethod. Conversion is not assumed if the results are anti-dilutive.  Potential common shares at September 30, 2005and September 30, 2004, of 2,789,784 and 11,791,780 respectively, relating toconvertible bonds, debentures and preferred stock, 3,033,015 and 2,636,081,respectively, relating to incentive stock options and 3,161,681and 1,618,125 potentialshares relating to warrants at September 30, 2005 and September 30, 2004,respectively, were excluded from the computation of diluted loss per share becausethey are anti-dilutive. Incentive stock options have a weighted averageexercise price of $6.63 and $5.65 at September 30, 2005 and September 30, 2004,respectively. Warrants have a weighted average exercise price of $11.17 and$11.11 at September 30, 2005 and September 30, 2004, respectively. Theconvertible bonds and debentures may be converted from the date of issuanceuntil maturity at 100% of principal amount into common stock of the Company atprices ranging from $8 to $50.  Thepreferred stock may be converted at the discretion of the holder (see Note 3.

 

**NOTE 5—LONG-TERM DEBT**

 

Theconvertible bonds and debentures may be converted from the date of issuanceuntil maturity at 100% of principal amount into common stock of the Company atprices ranging from $8 to $50. Each year the holders of the convertibledebentures may tender to the Company up to 10% of the aggregate debenturesissued and outstanding. Bonds and debentures outstanding are as follows:

 
| ** **                                                             | ** ** | **September 30, 2005** | ** ** | **December 31, 2004** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                             | ** ** | ** **             | ** ** | ** **            | ** ** |
| 12% Sinking Fund  Debentures, due December 31, 2007 (1)                |       | $                      | —     |                  | $          | 9,036,000 |   |
| 12% Secured  Convertible Debentures, due December 31, 2009 (5)         |       | 735,000                |       | 770,000               |       |
| 12% Secured  Convertible Bonds, due December 31, 2010 (5)              |       | 1,660,000              |       | 1,700,000             |       |
| 13.02% Sinking  Fund Convertible Debentures, due December 31, 2010 (3) |       | —                 |       | 14,372,200            |       |
| 13.02% Sinking  Fund Convertible Debentures, due December 31, 2015 (4) |       | 10,647,500             |       | 11,632,500            |       |
| 12% Secured  Convertible Bonds, due December 31, 2016 (5)              |       | 1,270,000              |       | 1,305,000             |       |
| 12% Sinking Fund  Convertible Debentures, due December 31, 2017 (1)    |       | —                 |       | 5,040,000             |       |
| 12% Secured  Convertible Bonds, due December 31, 2020 (2)              |       | 1,485,000              |       | 1,485,000             |       |
| 12% Secured  Convertible Bonds, due December 31, 2022 (2)              |       | 1,136,000              |       | 1,136,000             |       |
|                                                                   |       |                   |       |                  |       |
|                                                                   |       | 16,933,500             |       | 46,476,700            |       |
| Less current  portion                                                  |       | 14,574,600             |       | 17,316,070            |       |
|                                                                   |       |                   |       |                  |       |
| Long-term  portion                                                     |       | $                      | 2,358,900  |                  | $          | 29,160,630 |   |

 

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(1) In January 2005, theCompany called for full redemption on June 30, 2005, certain sinking funddebentures. The 2007 and 2017 bonds were called at a premium of 2% and 6%,respectively, which resulted in an expense of approximately $482,000 in thefirst quarter of 2005 relating to retirement of this debt. Also in the firstquarter of 2005, the Company wrote off approximately $694,000 of deferredoffering costs relating to these bonds. This redemption resulted in a releaseof restricted U.S. Treasury Bonds to the Company, having a fair market value ofapproximately $4,839,000 and will decrease future annual interest cost byapproximately $1,686,000.

 

(2) Debentures can becalled at par, if the Company’s stock trades at or above 133% of the conversionprice for a period of ninety consecutive trading days.

 

8

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(3) On April 29, 2005,the Company called for full redemption on June 29, 2005 its 2010 sinking fund bonds.Bond holders were given the option to either convert their bonds into shares ofthe Company’s common stock at the conversion rate of $5.00 per share or accepta 10% premium on cash redemption. Accordingly, the Company paid $2.8 million incash resulting in a premium of approximately $280,000 and issued 2,047,000 sharesof Common Stock for conversion of the Bonds. Also in the second quarter of2005, the Company wrote off approximately $68,000 of deferred offering costsrelating to redeemed bonds and allocated approximately $379,000 of deferredoffering costs to additional paid-in capital for bond conversions. Thisredemption resulted in a release of restricted U.S. Treasury Bonds to theCompany, having a fair market value of approximately $5,900,000 and willdecrease future annual interest cost by approximately $1,700,000.

 

(4) On September 21,2005, the Company called for full redemption on November 23, 2005 its 2015sinking fund convertible bonds. Bond holders were given the option to eitherconvert their bonds into shares of the Company’s common stock at the conversionrate of $8.00 per share or accept cash redemption. Assuming no conversions, theexpense in the fourth quarter relating to retirement of this debt would beapproximately $400,000. This redemption will result in a release of restrictedU.S. Treasury Bonds to the Company, having a fair market value of approximately$2,600,000 at September 30, 2005 and will decrease future annual interest cost byapproximately $1,400,000.

 

(5) On October 3, 2005,the Company called for full redemption on December 5, 2005 its 2009 securedconvertible bonds, its 2010 secured convertible bonds and its 2016 securedconvertible bonds. Bond holders were given the option to either convert theirbonds into shares of the Company’s common stock at the conversion rate of $9.00per share or accept cash redemption. The 2016 secured convertible bondholderswere offered a 10% premium on cash redemption. Assuming no conversions, theexpense in the fourth quarter relating to retirement of this debt would beapproximately $403,000. This redemption will result in a release of restrictedU.S. Treasury Bonds to the Company, having a fair market value of approximately$2,700,000 at September 30, 2005 and will decrease future annual interest cost byapproximately $400,000.

 

 

#### **NOTE6**—CAPITALIZEDINTEREST

 

Interestof approximately $491,000 and $1,473,000 was capitalized during the threemonths ended September 30, 2005 and 2004 respectively relating to the Wyomingproperty in 2005 and Wyoming and California properties in 2004. The Company nolonger capitalizes interest on the California property since development ofthis property is no longer subject to litigation. Interest of approximately $1,478,000and $4,451,000 was capitalized during the nine months ended September 30, 2005and 2004 respectively relating to the Wyoming property in 2005 and Wyoming andCalifornia properties in 2004.

 

9

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#### **NOTE7—CONTINGENCIES**

 

**Litigation**

 

*GothamInsurance Company v. Warren.* In 1998, the Company andits subsidiary, Warren E&P, Inc., were sued in the 81st JudicialDistrict Court of Frio County, Texas by Stricker Drilling Company, Inc. andManning Safety Systems to recover the value of lost equipment based on a wellblow-out. As a result of the lawsuit, Gotham Insurance Company, Warren E&P’swell blow-out insurer, intervened. The suit was settled in 1999 with allparties except Gotham and other underwriters. Gotham paid approximately$1.8 million under the insurance policy and has sought a refund ofapproximately $1.8 million, is denying coverage, and alleging fraud andmisrepresentation and a failure of Warren E&P to act with due diligence andpursuant to safety regulations. Warren E&P countersued for the remainingproceeds under the policy coverage. In the summer and fall of 2000, summaryjudgments were entered in favor of Warren E&P on essentially all claims exceptits bad faith claims against Gotham, and Gotham’s claims were rejected. Finaljudgment was rendered by the District Court on May 14, 2001 in WarrenE&P’s favor for the remaining policy proceeds, interest and attorneys’fees. Gotham appealed the final judgment to the San Antonio Court ofAppeals, seeking a refund of approximately $1.5 million. On July 23,2003, the San Antonio Court of Appeals reversed, in Gotham’s favor, thetrial court’s earlier summary judgment for Warren E&P and remanded the caseto the trial court for further proceedings consistent with the San AntonioCourt of Appeals’ decision. A hearing was held on December 17, 2004 toconsider the parties’ motions to determine both the amount of actual lossincurred by Gotham, the amount of judgment liability to be paid by Warren andWarren E&P and Warren’s other claims against Gotham that were pending butunheard by the District Court as a result of the District Court’s granting asummary judgment in Warren E&P’s favor in May 2001. On January 4,2005, the Company received an order of the trial court that Warren and WarrenE&P were obligated to repay Gotham $1.8 million, along with attorneys’fees and statutory interest estimated at $966,000. At December 31, 2004, Warrenrecorded a provision for $1,800,000 relating to this settlement. On April 11,2005, Warren filed to appeal the order of the trial court to the Texas Court ofAppeals. In connection with the appeal, on April 14, 2005 Warren posted asupersedeas bond with the Court of Appeals in the amount of $2.9 million tocover the trial court judgment plus potential legal fees, court costs andstatutory interest for the next two years. The supersedeas bond was secured bya collateral pledge of U.S. Treasury securities owned by Warren in the amountof $2.9 million, which is booked in Other Assets on the Balance Sheet. OnSeptember 7, 2005, Warren submitted its Brief to the Court of Appeals. We arewaiting for the responsive brief from Gotham. No date has been set for oralarguments of the appeal. Although the Company believes that it has meritoriousgrounds for the appeal, if its appeal is unsuccessful, it will be obligated topay the restitution to Gotham as ordered by the trial court.

 

Warren is also a party tolegal actions arising in the ordinary 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.

 

**Repurchase Agreements**

 

Undercertain repurchase agreements, the investor partners in certain affiliatedpartnerships have a right to have their interests repurchased by theCompany.  Such purchase price iscalculated at a formula price and is payable in seven to 25 years from the dateof admission to the partnership.  Forcertain affiliated partnerships formed prior to 1998, the maximum purchaseprice for all such interests was fully secured at maturity by zero coupon U.S.treasury bonds (“securities”) held by an independent trust company.  The face amounts of such securities arereleased to the Company when equal amounts of cash distributions are made toinvestors. As a result of the recapitalizations, any payment made under thisguarantee would be recorded as a reduction to minority interest as shown on theCompany’s balance sheet. At September 30, 2005, the maximum cash outlayrelating to these contingent repurchase obligations is approximately $0.4 million.This amount is collateralized by U.S. treasury bonds with a face value ofapproximately $0.4 million.

 

Forcertain other repurchase agreements relating to partnerships formed from 1998to 2001, investor partners have a right to have their interests repurchased bythe Company at a formula price seven to 25 years from the date of the originalpartnership investment.  In determiningthe amount of the repurchase obligation, the obligation is computed based onthe lesser of a formula purchase price or the estimated cash flows discountedat 10% (“PV-10”) from proved developed and undeveloped reserves of eachpartnership. At September 30, 2005, the formula purchase price with respect tothese partnerships was approximately $91.2 million. However, this amount islimited to

 

10

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approximately$19.0 million based on the PV-10 of the assets in these partnerships atDecember 31, 2004. This limitation does not include reserves for 5 net wells remainingto be drilled or 39 net wells awaiting to be placed on production on behalf ofthese seven drilling programs, and will fluctuate due to the variables indetermining discounted cash flows, such as price changes, reserve revisions,etc.  In the event of repurchase, theCompany receives the investor’s interest in the program and the investor’s prorata share of the programs reserves and related future cash flows.

 

**NOTE 8—BUSINESS SEGMENTINFORMATION**

 

The Company’s operatingactivities can be divided into four major segments: turnkey contracts, oil andgas marketing, oil and gas exploration and production operations and wellservices. The Company drills oil and natural gas wells for Company-sponsoreddrilling programs and retains an interest in each well. Also, the Companymarkets natural gas for affiliated drilling programs. The Company chargesCompany-sponsored drilling programs and other third parties competitiveindustry rates for well operations and gas gathering. Segment information is asfollows:

 
| ** **              | ** ** | **Three Months Ended**  | ** ** | **Nine Months Ended**   | ** ** |
|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **              | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| **Revenue**             |       |                    |       |                    |       |   |   |   |   |
| Oil and Gas  Operations |       | $                       | 3,818,082  |                    | $          | 1,851,845 |   | $ | 9,013,434 |   | $ | 4,652,877 |   |
| Turnkey  Contracts      |       | 2,680,722               |       | 3,858,446               |       | 6,284,577 |   | 7,108,842 |   |
| Oil and Gas  Marketing  |       | 2,434,392               |       | 1,776,405               |       | 6,940,887 |   | 4,571,972 |   |
| Well Services           |       | 374,147                 |       | 287,273                 |       | 1,199,441 |   | 799,205 |   |
| Other                   |       | 710,387                 |       | 363,801                 |       | 2,661,899 |   | 1,367,422 |   |
|                    |       |                    |       |                    |       |   |   |   |   |
|                    |       | $                       | 10,017,730 |                    | $          | 8,137,770 |   | $ | 26,100,238 |   | $ | 18,500,318 |   |

 
| ** **                    | ** ** | **September 30  2005** | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|-------------------------------|------------|------------------------|------------|-------------------------|------------|-------------------------|------------|-------------------------|------------|
| **Operating Income / (Loss)** |       |                   |       |                    |       |                    |       |                    |       |
| Oil and Gas  Operations       |       | $                      | 595,352    |                    | $          | (363,205                | )          | $                       | 1,480,599  |   | $ | (1,028,645 | ) |
| Turnkey  Contracts            |       | (265,344               | )          | (1,125,550              | )          | (481,706                | )          | (1,270,166              | )          |
| Oil and Gas  Marketing        |       | 33,568                 |       | 35,766                  |       | 96,618                  |       | 106,932                 |       |
| Well Services                 |       | (101,481               | )          | 138,396                 |       | 357,783                 |       | 388,973                 |       |
| Other                         |       | (1,198,726             | )          | (718,291                | )          | (5,300,187              | )          | (2,369,946              | )          |
|                          |       |                   |       |                    |       |                    |       |                    |       |
|                          |       | $                      | (936,631   | )                       | $          | (2,032,884              | )          | $                       | (3,846,893 | ) | $ | (4,172,852 | ) |

 

**NOTE 9—COMPREHENSIVE LOSS**

 

Other comprehensive lossconsists primarily of net unrealized investment gains and losses, net of incometax effect. Total comprehensive losses for the periods are as follow:

 
| ** **                         | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------|------------|----------|------------|----------|------------|
|                               |       |     |       |     |       |
| Nine Months  ending September 30,  |       | $        | (4,422,998 | )        | $          | (4,053,663 | ) |
|                               |       |     |       |     |       |
| Three Months  ending September 30, |       | $        | (1,312,173 | )        | $          | (1,517,583 | ) |

 

11

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**NOTE 10—GOODWILL**

 

The Company accounts forgoodwill under SFAS No. 142, *Goodwill and OtherIntangible Assets,*and only adjusts the carrying amount of goodwillor indefinite life intangible assets upon an impairment. Based on an evaluationprepared by management on June 30, 2005, no impairment of goodwill existed.Also, during the three and nine months ended September 30, 2005 and 2004, noevents occurred which would indicate that an impairment of goodwill existed.

 

**NOTE 11—NEW ACCOUNTINGPRONOUNCEMENTS**

** **

In December 2004,the FASB issued SFAS No. 123(R), “Share-Based Payment”. This Statementrevises SFAS No. 123, “Accounting for Stock-Based Compensation” andsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”SFAS No. 123(R) focuses primarily on the accounting for transactions inwhich an entity obtains employee services in share-based payment transactions.SFAS No. 123(R) requires companies to recognize in the statement ofoperations the cost of employee services received in exchange for awards ofequity instruments based on the grant-date fair value of those awards. SFAS123(R) was initially required to be implemented by July 1, 2005, butits effectiveness has been delayed until January 1, 2006 by the Securitiesand Exchange Commission. Accordingly, the Company will adopt SFAS123(R) on January 1, 2006 and is currently in the process ofevaluating the impact of the adoption of SFAS 123(R).

#### ** **

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

 

**FORWARD-LOOKING INFORMATION**

 

Forward-lookingstatements for 2005 and later periods are made in this document. Suchstatements represent estimates by management based on the Company’s historicaloperating trends, its proved oil and gas reserves and other informationcurrently available to management. The Company cautions that theforward-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:**

 

Recently, we began totransition ourselves from being a provider of turnkey contract services intomore of a traditional exploration and production company.  As a result, we expect oil and gas sales andproduction and exploration expense to become more material in futureyears.  Additionally, we anticipate thatturnkey contract revenues and expenses will become less material in futureyears.

 

Our future successdepends upon the development of our core acreage.  During 2005 and subsequent years, we plan tocontinue to develop our core acreage, which includes our coalbed methaneacreage in the Atlantic Rim and Pacific Rim in the Washakie Basin inWyoming.  Also, because our legal issues relatingto the Wilmington Townlot Unit in California have been resolved, we intend tocontinue to develop our secondary recovery project in California.

 

12

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**LIQUIDITYAND CAPITAL RESOURCES:**

 

During the first elevenmonths of 2004, we raised $41.8 million from sales of our common stock andwarrants, and through the exercise of stock options. During December 2004, wesold 10.9 million shares of common stock in an initial public offering raisingnet proceeds of $76.2 million.

 

Our cashand cash equivalents decreased $49.6 million during the nine months ended September30, 2005. This resulted from $20.7 million of cash used in investingactivities, $17.0 million of cash used in financing activities and $11.9million of cash used in operating activities.

 

Currentlyour assets are unencumbered, except for restricted investments in US TreasuryBonds. As a result the Company may seek to obtain bank financing to fund futureactivities.

 

Cash used in investingactivities of $20.7 million results from $32.0 million for expenditures on oiland gas properties offset by the release of $11.4 million in U.S. TreasuryBonds relating to the redemption of debentures discussed above.  Cash used in financing activities of $17.0million primarily relates to redemption of debentures.  During the first nine months of 2005, weredeemed before maturity all of our outstanding debentures due in 2007, 2010and 2017 for cash or common stock.  Thetotal redemption amount paid in cash was $17.0 million.  Additionally, we paid cash dividends onpreferred stock totaling $1.6 million.  Additionally,during September and October of 2005, we called for redemption approximately$14.5 million of our outstanding debentures due in 2009, 2010, 2015 and2016.  These debentures will be eitherconverted into common stock or redeemed for cash during the fourth quarter of2005.  Cash used in operating activitiesof $11.9 million primarily relates to drilling wells on behalf of our drillingprograms and oil and gas operations.

 

Another materialcommitment of funds relates to the drilling programs. Our deferred revenuebalance relating to our drilling commitments totaled $5.2 million at September30, 2005. This commitment approximates 7 net wells, primarily in the WashakieBasin, to be drilled on behalf of our drilling programs formed in 2003 andprior.

 

At September 30, 2005, wehad approximately 3 million vested outstanding stock options issued under ourstock based equity compensation plans. All of the 3 million outstanding vestedoptions had exercise prices below the closing market price $16.75 of our commonstock on September 30, 2005. If such options are exercised by the holders, wewill receive the exercise price in cash amounting to approximately $20 million.

 

TheCompany had a net loss before dividends of $1.1 million for the three monthsended September 30, 2005, as compared to a net loss before dividends of $1.9million for the corresponding period ending September 30, 2004. At September 30,2005, current assets exceeded current liabilities by approximately $18.9 million.During the second quarter of 2005, the Company and the preferred holders agreedby greater than the requisite 66.67% majority that a dividend be paid in kindwith Warren Resources common stock for the accrued dividend for the quartersended March 31 and June 30, 2005, amounting to approximately $3.3 million. Accordingly,Warren will be issuing a total of 315,867 shares of its common stock as adividend after these shares are registered with the SEC under a Form S-3registration statement. Accrued dividends as of September 30, 2005 wereapproximately $3.6 million.

 

*Contractual Obligations*

 

The contractualobligations table below assumes the maximum amount is tendered each year. Thetable does not give effect to the conversion of any bonds to common stock whichwould reduce payments due. All debentures are secured at maturity, or partiallysecured at maturity, by zero coupon U.S. treasury bonds deposited into anescrow account equaling the par value of the debentures maturing on or beforethe maturity of the debentures. The table below reflects the release ofU.S. treasury bonds to us upon redemption.

 

13

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| ** **                                            | ** ** | **Payments due by period** | ** ** |
|-------------------------------------------------------|------------|----------------------------|------------|
| **Contractual Obligations  As of September 30, 2005** | ** ** | **Total**                  | ** ** | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** |
|                                                  |       |                       |       |   |   |   |   |   |   |   |   |
| Debentures                                            |       | $                          | 16,933,500 |   | $ | 14,574,600 |   | $ | 448,191 |   | $ | 363,035 |   | $ | 1,547,674 |   |
| Leases                                                |       | 660,354                    |       | 54,527 |   | 431,016 |   | 147,015 |   | 27,796 |   |
| Total                                                 |       | $                          | 17,593,854 |   | $ | 14,629,127 |   | $ | 879,207 |   | $ | 510,050 |   | $ | 1,575,470 |   |

 

The contractualobligation schedule above does not reflect $10.4 million principal amount ofzero coupon U.S. treasury bonds held by us in escrow to secure therepayment of the debentures upon maturity. Such U.S. treasury bonds had afair market value of $6.6 million at September 30, 2005.

 

**RESULTS OF OPERATIONS:**

 

**Threemonths Ended September 30, 2005 Compared to Three Months Ended September 30,2004**

 

*Oil and gas sales.*Revenue from oil and gas sales increased $2.0 million in the third quarter to$3.8 million, a 108% increase compared to the same quarter in 2004.  This increase resulted from our acquisitionof substantially all of the remaining working interests in the Wilmington Fieldin California.  Additionally, thisincrease reflects drilling wells for our own account.  Prior to the third quarter of 2005, all wellswere syndicated to our drilling programs. Net production for the three months ended September 30, 2005 and 2004was 495 MMcfe and 347 MMcfe, respectively. Additionally, the average realizedprice per MMcfe for the three months ended September 30, 2005 and 2004 was$7.72 and $5.34, respectively.

 

*Production & exploration.*Production and exploration expense increased $1.1 million in the third quarterof 2005 to $2.2 million, a 99% increase compared to the same quarter in2004.  This increased resulted from anincrease in lease operating expenses related to the Wilmington Field inCalifornia. The Company has incurred significant start up, repair andmaintenance costs associated with the implementation of our drilling plan.  Additionally, increases in production andexploration expense result from increases in oil and gas production.

 

*Turnkey contract revenue andexpenses.* Turnkey contract revenue decreased $1.2 million inthe third quarter to $2.7 million, a 31% decrease compared to the correspondingquarter of the preceding year. Additionally, turnkey contract expense decreased$2.0 million during the third quarter to $2.9 million, a 41% decrease comparedto the same period in 2004.  The drillingactivity on behalf of the drilling programs was less active during the thirdquarter of 2005 compared to the corresponding quarter of 2004.

 

Net lossfrom turnkey activities was $0.2 million for the third quarter. This comparesto a net loss of $1.1 million for the corresponding quarter in 2004. The netloss from turnkey activities during 2005 results from increased drilling costs.

 

*Oil and gas sales and costs frommarketing activities.* Oil and gas sales from marketingactivities increased $0.7 million in the third quarter to $2.4 million, a 37%increase compared to the same period last year. Cost of oil and gas marketingactivities increased $0.7 million in the quarter to $2.4 million, a 38%increase compared to the same quarter in 2004. Oil and gas production from thewells in the drilling programs in which we earn a marketing fee for the threemonths ended September 30, 2005 and 2004 was 0.4 Bcfe and 0.3 Bcfe,respectively. The average price per Mcfe during the third quarter of 2005 and2004 was $6.32 and $5.01, respectively.

 

The gross profit frommarketing activities for the third quarter of 2005 was $34 thousand as comparedto $36 thousand in the same period last year.

 

*Well services activities.*Well services revenue increased $87 thousand in the third quarter to $0.4million, a 30% increase compared to the corresponding quarter of the precedingyear. Well services expense increased $0.3 million in the third quarter to $0.5million. The increase in well services revenue and expense results from a jointventure between Anadarko Petroleum Corporation and Warren that commenced during2005.  Under this joint venture, wecharge a fee for the use of our jointly owned compression facilities and saleslines. This increase resulted from expenses related to the compressionfacilities and sales lines.

 

14

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Net loss from wellservices activities was $101 thousand for the third quarter of 2005. Thiscompared to net profit of $138 thousand for the corresponding quarter of lastyear.  The increase in net loss during2005 results from the increase in well services expense discussed above.

 

*Net gain on investments.*Netgain on investments was $57 thousand for the third quarter of 2005 compared toa net gain of $49 thousand for the same period of 2004.  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 $0.3 million in the third quarter to $0.7million, a 107% increase compared to the same quarter in 2004. This representsan increase in interest earned on idle cash balances.

 

*Depreciation, Depletion,Amortization and Impairment.* Depreciation, depletion, amortizationand impairment expense decreased $0.1 million for the quarter to $1.0 million,an 8% decrease compared to the corresponding quarter last year. This decreaseresults from the recording of impairment expense of $0.6 million during the thirdquarter of 2004.  This decrease wasoffset by an increase in depletion expense during 2005 resulting from anincrease in oil and gas production from our Wilmington Field in California andan increase in the cost basis of the Wilmington field.

 

*General and administrativeexpenses.* General and administrative expenses increased $0.8million in the third quarter of 2005 to $1.8 million, a 88% increase comparedto the corresponding quarter last year. This reflects a decrease in the allocation of certain general and administrativeexpenses to turnkey expenses during 2005. Additionally, this results from an increase in personnel as a result ofincreased drilling activities.

 

*Interest expense.*Interest expense decreased $22 thousand in the third quarter to $96 thousand, an18% decrease compared to the same quarter last year.  The Company capitalized interest totaling$0.5 million during the third quarter of 2005 compared to $1.5 million duringthe comparable period of 2004.

 

**RESULTS OF OPERATIONS:**

 

**Ninemonths Ended September 30, 2005 Compared to Nine Months Ended September 30,2004**

 

*Oil and gas sales.*Revenue from oil and gas sales increased $4.4 million during the first ninemonths of 2005 to $8.9 million, a 97% increase compared to the same period in2004.  This increase resulted from ouracquisition of substantially all of the remaining working interests in theWilmington Field in California. Additionally, this increase reflects drilling wells for our own account.  Prior to the third quarter of 2005, all wellswere syndicated to our drilling programs. Net production for the nine months ended September 30, 2005 and 2004 was1,380 MMcfe and 907 MMcfe, respectively. Additionally, the average realizedprice per Mmcfe for the nine months ended September 30, 2005 and 2004 was $6.47and $5.00, respectively.

 

*Production & exploration.*Production and exploration expense increased $1.7 million during the first ninemonths of 2005 to $4.9 million, a 55% increase compared to the same period in2004.  This increased resulted from an increasein lease operating expenses related to the Wilmington Field in California. TheCompany has incurred significant start up repair and maintenance costsassociated with the implementation of our drilling plan.  Additionally, increases in production andexploration expense result from increases in oil and gas production.

 

*Turnkey contract revenue andexpenses.* Turnkey contract revenue decreased $0.8 million duringthe first nine months of 2005 to $6.3 million, a 12% decrease compared to thecorresponding period of the preceding year. Additionally, turnkey contractexpense decreased $1.6 million during the first nine months of 2005 to $6.7million, a 19% decrease compared to the same period in 2004.  The drilling activity on behalf of thedrilling programs was less active during the first nine months of 2005 comparedto the corresponding period of 2004.

 

Net lossfrom turnkey activities was $0.4 million for the first nine months of 2005.This compares to a net loss of $1.2 million for the corresponding period in2004.  The net loss from turnkeyactivities during 2005 results from increased drilling costs.

 

15

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*Oil and gas sales and costs frommarketing activities.* Oil and gas sales from marketingactivities increased $2.4 million during the first nine months of 2005 to $6.9million, a 52% increase compared to the same period last year. Cost of oil andgas marketing activities increased $2.4 million during this period in 2005 to $6.8million, a 53% increase compared to the same period in 2004. Oil and gasproduction from the wells in the drilling programs in which we earn a marketingfee for the nine months ended September 30, 2005 and 2004 was 1.4 Bcfe and 1.0Bcfe, respectively. The average price per Mcfe during the third quarter of 2005and 2004 was $4.94 and $4.48, respectively.

 

The gross profit frommarketing activities for the first nine months of 2005 was $97 thousand ascompared to $107 thousand in the same period last year.

 

*Well services activities.*Well services revenue increased $0.4 million during the first nine months of2005 to $1.2 million, a 50% increase compared to the corresponding period ofthe preceding year. Well services expense increased $0.4 million during thisperiod in 2005 to $0.8 million. The increases in well services revenue andexpense results from a joint venture between Anadarko Petroleum Corporation andWarren that commenced during 2005.  Underthis joint venture, we charge a fee for the use of our jointly ownedcompression facilities and sales lines.

 

Gross profit from wellservices activities was $0.4 million for the first nine months of 2005 and 2004.

 

*Net gain on investments.*Net gain on investments was $0.4 million for the first nine months of2005.  Net loss on investments was $39thousand for the corresponding period in 2004. Primarily, investments represent zero coupon U.S. treasury bonds.Fluctuations in net gain or loss on investments resulted from changes inlong-term interest rates.

 

*Interest and other income.*Interest and other income increased $0.8 million in the first nine months of2005 to $2.2 million, a 60% increase compared to the same period in 2004. Thisrepresents an increase in interest earned on idle cash balances.

 

*Depreciation, Depletion,Amortization and Impairment.* Depreciation, depletion,amortization and impairment expense increased $52 thousand for the first ninemonths of 2005 to $2.7 million, a 2% increase compared to the corresponding periodlast year. This increase results from an increase in depletion expenseresulting from an increase in oil and gas production from the Wilmington Fieldin California and an increase in the cost basis of the Wilmington Field. Thisincrease was offset by the recording of impairment expense of $1.2 millionduring the nine months ended September 30, 2004.

 

*General and administrativeexpenses.* General and administrative expenses increased $1.4million during the first nine months of 2005 to $4.7 million, a 43% increasecompared to the corresponding period last year. This reflects a decrease in the allocation of certain general andadministrative expenses to turnkey activities during 2005.  Additionally, this results from an increasein personnel as a result of increased operating activities.

 

*Interest expense.*Interest expense increased $1.3 million during the first nine months of 2005 to$1.7 million, a 356% increase compared to the same period last year.  Interest expense increased significantlyduring 2005 because we are no longer capitalizing interest costs related to theWilmington Field in California.  TheCompany capitalized interest totaling $1.5 million during the nine months endedSeptember 30, 2005 compared to $4.5 million during the comparable period of2004.

 

*Retirement of debt.*Retirement of debt expense was $1.5 million during the first nine months of2005.  There was no retirement of debtexpense in 2004.  This expense representsa premium paid on redemption of the debentures and the write off of unamortizeddeferred offering costs associated with the early redemption of the 2010 debenturesduring the 2nd quarter of 2005 and the early redemption of the 2007and 2017 debenture during the 1st quarter of 2005.

##### ** **

**Off-Balance Sheet Arrangements**

 

Under the terms of our drilling programs formed from1998 to 2001, investors have the right to tender their interest back to thedrilling program and other program investors during the period from seven to25 years after the date of the partnership’s formation. The tender rightswere included to make such

 

16

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programs more attractive to potential investor partners, therebyenabling the Company to obtain more capital to drill more oil and gas wells. Tothe extent that an investor tenders a drilling program interest for sale and thedrilling program and other investors elect not to repurchase the withdrawingpartner’s interest, we will be required to repurchase the interest from theinvestor. The price of our repurchase is fixed by the drilling programagreement to be the lower of the PV-10 value of the assets of the program and aformula based on the amount of the investor’s cash investment reduced by theamount of any cash distributions received. As of September 30, 2005, based onthe December 31, 2004 reserve reports of the respective drilling programs, theaggregate PV-10 value of the assets in these programs is $19.0 million.Because this PV-10 value is less than the formula price of $91.2 million at September30, 2005, the maximum repurchase price obligation at September 30, 2005 was$19.0 million based on the December 31, 2004 reserve report. This PV-10 valuewould be higher if current prices for crude oil and natural gas were toincrease when we drill the remaining 5 net wells or place the remaining 39 netwells on production on behalf of these seven drilling programs. In the event ofrepurchase, we receive the investor’s interest in the program, which includesthe investor’s beneficial share of the program’s reserves and related futurenet cash flows. There are no known events that would result in termination ofthe material benefits of our off-balance sheet arrangements except for adecrease in oil and gas pricing that occurs after an acquisition. The onlymaterial off-balance sheet benefit of this arrangement is the acquisition ofproved reserves. To the extent that we acquire interests for their PV-10 valuebased on this arrangement, and declining oil and natural gas prices, or otherfactors, render those interests less valuable, a material reduction in thebenefits of this arrangement to the Company would occur.

 

The table below presents the projected timing of ourmaximum potential repurchase commitment associated with these programs as of September30, 2005:

 
| ** **                                   | ** ** | **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) |       | $                                              | 19,042     |   | $ | 3,357 |   | $ | 12,774 |   | $ | 2,568 |   | $ | 343 |   |
|                                              |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                 Based on thepartnership reserves taken from the Williamson partnership reserve report as ofDecember 31, 2004 and using pricing at that date. This report does not includereserves for 5 net wells that are scheduled to be drilled for these programs orfor the 39 net wells drilled and waiting to be placed on production.

 

Commencing January 1, 2006, we may be obligated tocommence purchasing drilling program interests at their PV-10 value.  As a result, the following factors may affectthe liquidity and capital resources of the Company:

 

•                            Anincrease in the price of oil and natural gas, or an increase in the amount ofproved reserves (from drilling the remaining 5 net wells that are scheduled tobe drilled for these drilling programs during 2005, from the 39 net wellsdrilled and waiting to be placed on production, or from other factors) mayincrease the PV-10 value of the drilling programs and, as a result, increasethe price of our repurchase.  After theacquisition of the drilling program interests, oil and natural gas prices maydecline resulting in a decline in the expected future net cash flow or fairmarket value of the assets acquired in the repurchase and a possible recordingof impairment expense.

 

•                            If ourexisting working capital is inadequate to fund the repurchase of drillingprogram interests, we may be unable to obtain financing, or obtain financing onterms acceptable to us, to purchase the drilling program interests at theirPV-10 value.

 

17

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***Additional Repurchase Commitments***

 

Under the terms of 13 of our drilling programs formedbefore 1998, the minority interest investors have the right to require us torepurchase their interests in each program for a formula price, to the extentthat the drilling programs and other program investors elect not to purchase awithdrawing partner’s interest. The tender rights were included to make suchprograms more attractive to potential investor partners, thereby enabling theCompany to obtain more capital to drill more oil and gas wells. This right iseffective either seven years from the date of a partnership’s formation, orbetween the 15th and 25th anniversary of its formation. The formula price iscomputed as the original capital contribution of the investor reduced by thegreater of cash distributions we made to the investor, or 10% for every $1.00which the oil price at the repurchase date is below $13.00 per barreladjusted by the CPI changes since the program’s formation. If we purchaseinterests in drilling programs, we receive the investor’s interest in the program,which includes the investor’s beneficial share of the reserves and relatedfuture net cash flows. The table below presents the repurchase commitmentassociated with the pre-1998 drilling programs, giving no effect to any reservevalue that is acquired in repurchase.

 
| ** **                                      | ** ** | **Amount of repurchase commitment per period** | ** ** |
|-------------------------------------------------|------------|------------------------------------------------|------------|
| **Other Commitments  As of September 30, 2005** | ** ** | **Total**                                      | ** ** | **Less Than 1  Year** | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                                      | ** ** | ** **                                     | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Partnership  repurchase commitments:            |       |                                           |       |   |   |   |   |   |   |   |   |
| Pre-1998  Partnerships                          |       | $                                              | 413        |   | — |   | — |   | $ | 16 |   | $ | 397 |   |
|                                                 |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |

 

**CRITICAL ACCOUNTING POLICIES**

 

*Oil and Gas Producing Activities*

 

**We usethe successful efforts method of accounting for oil and gas properties.  Under this methodology, costs incurred toacquire mineral interests in oil and gas properties, to drill and equipexploratory wells that find proved reserves and to drill and equip developmentwells are capitalized. Costs to drill exploratory wells that do not find provedreserves, geological and geophysical costs and costs of carrying and retainingunproved properties are expensed.**

** **

**Unprovedoil and gas properties that are individually significant are periodicallyassessed for impairment of value and a loss is recognized at the time ofimpairment by providing an impairment allowance.  Other unproved properties are amortized basedon our experience of successful drilling, terms of leases and historical leaseexpirations.**

** **

**Capitalizedcosts of producing oil and gas properties are depleted by the units-of-productionmethod on a field-by-field basis.  Leasecosts are depleted using total proved reserves while lease equipment andintangible development costs are depleted using proved developed reserves.  Our proved properties are evaluated on afield-by-field basis for impairment.  Animpairment loss is indicated whenever net capitalized costs exceed expectedfuture net cash flow based on engineering estimates.  In this circumstance, we recognize animpairment loss for the amount by which the carrying value of the propertiesexceeds the estimated fair value based on discounted cash flow.**

** **

**On thesale or retirement of a complete unit of a proved property, the cost andrelated accumulated depletion and amortization are eliminated from the propertyaccounts, and the resulting gain or loss is recognized.  On the retirement or sale of a partial unitof proved property, the cost is charged to accumulated depletion andamortization with a resulting gain or loss recognized in earnings.**

** **

**On thesale of an entire interest in an unproved property, a gain or loss on the saleis recognized, taking into consideration the amount of any recorded impairmentif the property had been assessed individually. If a partial interest in an unproved property is sold, the amountreceived is treated as a reduction of the cost of the interest retained.**

 

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**Ourestimate of proved reserves is based on the quantities of oil and gas thatengineering and geological analysis demonstrates, with reasonable certainty, tobe recoverable from established reservoirs in the future under currentoperating and economic parameters. Reserves and their relation to estimated future net cash flows impactour depletion and impairment calculations. As a result, adjustments to depletion and impairment are madeconcurrently with changes to reserve estimates. Our reserve estimates and the projected cash flows derived from thesereserve estimates are prepared, in accordance with SEC guidelines by anindependent engineering firm based in part on data provided by us.  The accuracy of our reserve estimates dependsin part on the quality and quantity of available data, the interpretation ofthat data, the accuracy of various mandated economic assumptions, and thejudgments of the individuals preparing the estimates.**

 

*Revenue Recognition*

 

**Affiliatedpartnerships enter into agreements with us to drill wells to completion for afixed price.  We, in turn, enter intodrilling contracts primarily with unrelated parties to drill wells on a daywork basis.  Therefore, if problems areencountered on a well, the cost of that well will increase and gross profitwill decrease and could result in a loss on the well.  We recognize revenue from the turnkeydrilling agreements on a proportional performance method as services areperformed. This involves management making judgments and estimates as to thevarious stage of completion of each well based on the review of drilling logs,status reports from engineers and historical experience in completing similarwells. When estimates of future revenues and expenses on a specific contract indicatethat a loss will be incurred, the total estimated loss is accrued.**

** **

**Oiland gas sales result from undivided interests held by us in various oil and gasproperties.  Sales of natural gas and oilproduced are recognized when delivered to or picked up by the purchaser.  Oil and gas sales from marketing activitiesresult from sales by us of oil and gas produced by affiliated joint venturesand partnerships and are recognized when delivered to purchasers.**

 

*Capitalized Interest*

 

**TheCompany capitalizes interest relating to its California and Wyoming propertiesin accordance with FAS 34.  Assetsqualifying for interest capitalization represent lease costs associated withundeveloped acreage on which exploration activities are in progress.  Interest capitalization commences whenactivities necessary to ready the asset for its intended use have been incurredand continues as long as activities necessary to get the lease ready for itsintended use are in progress.  If theCompany suspends these activities, interest capitalization shall cease untilactivities are resumed.  However, briefinterruptions and interruptions that are externally imposed do not result incessation. Capitalized interest is calculated by multiplying ourweighted-average interest rate on debt by the amount of qualifying costs.  Capitalized interest cannot exceed grossinterest expense.**

 

*Asset Retirement Obligations*

 

The Company adoptedStatement of Financial Accounting Standards No. 143, “Accounting for AssetRetirement Obligations” (“SFAS No. 143”), which requires the Company to recorda liability equal to the fair value of the estimated cost to retire an asset.The asset retirement liability is recorded in the period in which theobligation meets the definition of a liability, which is generally when theasset is placed into service. When the liability is initially recorded, theCompany will increase the carrying amount of the related long-lived asset by anamount equal to the original liability. The liability is accreted to itspresent value each period, and the capitalized cost is depreciated over theuseful life of the related long-lived asset. Upon settlement of the liabilityor the sale of the well, the liability is reversed. The asset retirementobligation is based on a number of assumptions requiring professional judgment.The Company cannot predict the type of revisions to these assumptions that willbe required in future periods due to the availability of additionalinformation, including prices for oil field services, technological changes,governmental requirements and other factors.

 

19

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## **New Accounting Pronouncements**

** **

In December 2004,the FASB issued SFAS No. 123(R), “Share-Based Payment”. This Statementrevises SFAS No. 123, “Accounting for Stock-Based Compensation” andsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”SFAS No. 123(R) focuses primarily on the accounting for transactions inwhich an entity obtains employee services in share-based payment transactions.SFAS No. 123(R) requires companies to recognize in the statement ofoperations the cost of employee services received in exchange for awards of equityinstruments based on the grant-date fair value of those awards. SFAS123(R) was initially required to be implemented by July 1, 2005, butits effectiveness has been delayed until January 1, 2006 by the Securitiesand Exchange Commission. Accordingly, we will adopt SFAS 123(R) onJanuary 1, 2006 and we are in the process of evaluating the impact of theadoption of SFAS 123(R).

** **

**Item 3. *Quantitativeand 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 programs 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.**

** **

** **

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

#### ** **

#### **The general level of inflationaffects our costs.  Salaries and othergeneral and administrative expenses are impacted by inflationary trends and thesupply and demand of qualified 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.**

#### ** **

#### **Item4. *Evaluation of Disclosure Controls and Procedures***

 

Our management, under thesupervision and with the participation of our Chief Executive Officer (“CEO”)and Chief Financial Officer (“CFO”), has evaluated the effectiveness of ourdisclosure 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 concluded that our disclosure controls andprocedures are effective to ensure that information we are required to disclosein reports that we file or submit under the Securities Exchange Act iscommunicated to management, including the CEO and CFO, as appropriate to allowtimely decisions regarding required disclosure and is recorded, processed,summarized and reported within the time periods specified in the SEC’s rulesand forms.

 

In addition, there havebeen no changes in our internal controls over financial reporting or in otherfactors that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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## **PART II—OTHERINFORMATION**

 

**Item 1. *Legal Proceedings***

 

*GothamInsurance Company v. Warren.* In 1998, we and oursubsidiary, Warren E&P, Inc., were sued in the 81st Judicial DistrictCourt of 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 underwriters. Gotham paid approximately$1.8 million under the insurance policy and has sought a refund ofapproximately $1.8 million, is denying coverage, and alleging fraud andmisrepresentation and a failure of Warren E&P to act with due diligence andpursuant to safety regulations. Warren E&P countersued for the remainingproceeds under the policy coverage. 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 and remandedthe case to the trial court for further proceedings consistent with theSan Antonio Court of Appeals’ decision. A hearing was held onDecember 17, 2004 to consider the parties’ motions to determine both theamount of actual loss incurred by Gotham, the amount of judgment liability tobe paid by Warren and Warren E&P and Warren’s other claims against Gothamthat were pending but unheard by the District Court as a result of the DistrictCourt’s granting a summary judgment in Warren E&P’s favor in May 2001. OnJanuary 4, 2005, we received an order of the trial court that Warren andWarren E&P were obligated to repay Gotham $1.8 million, along withattorneys’ fees and statutory interest estimated at $966,000. At December 31,2004, Warren recorded a provision for $1,800,000 relating to this settlement. OnApril 11, 2005, we filed to appeal the order of the trial court to the TexasCourt of Appeals. In connection with the appeal, on April 14, 2005 we posted asupersedeas bond with the Court of Appeals in the amount of $2.9 million tocover the trial court judgment plus potential legal fees, court costs andstatutory interest for the next two years. The supersedeas bond was secured bya collateral pledge of U.S. Treasury securities owned by us in the amount of$2.9 million. On September 7, 2005, Warren submitted its Brief to the Court ofAppeals. We are waiting for the responsive brief from Gotham. No date has beenset for oral arguments of the appeal. Although we believe that we havemeritorious grounds for the appeal, if our appeal is unsuccessful, we will beobligated to pay the restitution to Gotham as ordered by the trial court.

 

We are also a party tolegal actions arising in the ordinary course of our business.  In the opinion of our management, based in parton consultation with legal counsel, the liability, if any, under these claimsis either adequately covered by insurance or would not have a material adverseeffect on us.

** **

**Item2. *Unregistered Sales of Equity Securities and Use ofProceeds***

 

a.     During thequarter ended September 30, 2005:

 

1.               Weissued 54,902 shares of our common stock to the individual investor and entityholders of our outstanding convertible bonds who elected to convert $145,000 ofour 2010 13.02% bonds into our common stock at the rate of $5.00 per share;$24,993 of our 2010 12% bonds at $9.00 per share; and $185,000 of our 2015bonds at $8.00 per share. We believe the issuance of the shares was exempt fromthe registration requirements of the Act underSection 3(a)(9) thereunder.

 

2.               Weissued 528,336 shares of our common stock to the individual investor and entityholders who converted 528,336 shares of our 8% convertible preferred stock intocommon stock on a one share of common for one share of preferred basis. Webelieve the issuance of the shares was exempt from the registrationrequirements of the Act underSection 3(a)(9) thereunder.

 

3.               Weissued 187,500 shares of our common stock to four accredited individual andentity investor that sold us certain oil and gas properties based on their PV-10value of $1,500,000. We believe the issuance of the shares was exempt from theregistration requirements of the Act under Section 4(2) thereunder.

 

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. *Other Information***

 

Not applicable.

 

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**Item 6. *Exhibits***

 
| **a)**     | ** ** | **Exhibits**                                                                                                                                                                                                     |
|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                                                                                                                                       |
|       |       | Exhibits not  incorporated by reference to a prior filing are designated by an (*) and are  filed herewith; all exhibits not so designated 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. |
|---|--------|-----------------|

 

**SIGNATURES**

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                   | WARREN RESOURCES, INC. |
|------------------------|------------------------|
|                   | (Registrant)           |
|                   |                   |   |
|                   |                   |   |
|                   |                   | /s/ Timothy A. Larkin |   |
| Date: November 8, 2005 | By:                    | Timothy A. Larkin |
|                   |                   | *Executive Vice President,* |
|                   |                   | *Chief Financial Officer and* |
|                   |                   | *Principal Accounting Officer* |

 

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