Table of Contents

 

 

 

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****Washington,D.C. 20549**

 

**FORM 10-Q**
| **x**                                                  | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES**

**EXCHANGE  ACT OF 1934**  |
|--------------------------------------------------------|---------------------------------------------------------------------------------------------------------------|
|                                                   |                                                                                                          |
| **For the  Quarterly Period Ended June 30, 2009** |
|                                                   |
| **OR**                                                 |
| ** **                                             |
| o                                                      | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES**

**EXCHANGE  ACT OF 1934** |

 

**For thetransition period from              to             **

# ** **

# **Commission File No. 000-33275**

 

**WARRENRESOURCES, INC.**(Exact Name ofRegistrant as Specified in its Charter.)

 

| **Maryland**  (State or other jurisdiction of  incorporation or organization)                 | ** ** | **11-3024080**  (I.R.S. Employer  Identification Number) |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|
| ** **                                                                                    | ** ** | ** **                                               |
| **1114  Avenue of the Americas,**

**New  York, NY**(Address of  Principal Executive Offices) |       | **10036**  (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 by Section 13and 15 (d) of the Securities Exchange Act of 1934 during the preceding 12months and (2) has been subject to such filing requirements for the past90 days. Yes x No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o  No o

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2of the Exchange Act).

 

| Large accelerated filer  x |   | Accelerated filer o          |
|----------------------------|--------|------------------------------|
|                       |   |                         |
| Non-accelerated filer o    |   | Smaller  reporting company o |

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

Theaggregate number of Registrant’s outstanding shares on August 4, 2009 was58,876,160 shares of Common Stock, $0.0001 par value.

 

 

 

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Table of Contents

 

**WARRENRESOURCES, INC.**

**TABLE OF CONTENTS**

 
| PART I—        | FINANCIAL INFORMATION                                                                                 |   |
|--------------------------|-------------------------------------------------------------------------------------------------------|--------|
|                     |                                                                                                  |   |
|                     | Item 1. Financial Statements  (Unaudited)                                                             |   |
|                     |                                                                                                  |   |
|                     | Consolidated Balance Sheets as of  June 30, 2009 and December 31, 2008                      |   |
|                     |                                                                                                  |   |
|                     | Consolidated Statements of  Operations for the three and six months ended June 30, 2009 and 2008 |   |
|                     |                                                                                                  |   |
|                     | Consolidated  Statements of Cash Flows for six months ended June 30, 2009 and 2008               |   |
|                     |                                                                                                  |   |
|                     | Notes to the  Consolidated Financial Statements                                                       |   |
|                     |                                                                                                  |   |
|                     | Item 2.  Management’s Discussion and Analysis of Financial Conditions and Results of  Operations |   |
|                     |                                                                                                  |   |
|                     | Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                   |   |
|                     |                                                                                                  |   |
|                     | Item 4. Controls and  Procedures                                                                      |   |
|                     |                                                                                                  |   |
|  PART II— | OTHER INFORMATION                                                                                     |   |
|                     |                                                                                                  |   |
|                     | Item 1. Legal Proceedings                                                                             |   |
|                     |                                                                                                  |   |
|                     | Item 1A. Risk Factors                                                                                 |   |
|                     |                                                                                                  |   |
|                     | Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                  |   |
|                     |                                                                                                  |   |
|                     | Item 3.  Defaults upon Senior Securities                                                              |   |
|                     |                                                                                                  |   |
|                     | Item 4.  Submission of Matters to a Vote of Security Holders                                          |   |
|                     |                                                                                                  |   |
|                     | Item 5. Other Information                                                                             |   |
|                     |                                                                                                  |   |
|                     | Item 6. Exhibits                                                                                      |   |
|                     |                                                                                                  |   |
|                     | Signatures                                                                                            |   |

 

2

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Table of Contents

 

**PART I—FINANCIAL INFORMATION**

 

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

 

**Warren Resources, Inc. and SubsidiariesCONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                                                     | ** ** | **June 30,  2009   (Unaudited)**                | ** **  | **December 31,  2008** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                     | ** ** | **(in thousands, except share  and per share data)** | ** **  |
| **ASSETS**                                                                                                                                                                                                                                                                     | ** ** | ** **                                           | ** **  | ** **                  | ** ** |
| Current  Assets                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Cash  and cash equivalents                                                                                                                                                                                                                                                     |       | $                                                    | 9,416       |                        | $          | 29,688 |   |
| Accounts  receivable – trade                                                                                                                                                                                                                                              |       | 8,862                                                |        | 9,680                       |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                                                          |       | 97                                                   |        | 109                         |       |
| Inventory                                                                                                                                                                                                                                                                      |       | 2,875                                                |        | —                      |       |
| Other  current assets                                                                                                                                                                                                                                                          |       | 884                                                  |        | 734                         |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Total  current assets                                                                                                                                                                                                                                                          |       | 22,134                                               |        | 40,211                      |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Other  Assets                                                                                                                                                                                                                                                                  |       |                                                 |        |                        |       |
| Oil and gas properties—at cost, based on full cost  method of accounting, net ofaccumulated depreciation, depletion and  amortization (includes unprovedproperties excluded from amortization of  $26,042 and $27,116 as ofJune 30, 2009 and December 31, 2008) |       | 228,954                                              |        | 239,438                     |       |
| Property  and equipment—at cost, net                                                                                                                                                                                                                                      |       | 1,671                                                |        | 2,011                       |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                                                          |       | 877                                                  |        | 985                         |       |
| Other  assets                                                                                                                                                                                                                                                                  |       | 4,195                                                |        | 3,988                       |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Total  other assets                                                                                                                                                                                                                                                            |       | 235,697                                              |        | 246,422                     |       |
| ** **                                                                                                                                                                                                                                                                     | ** ** | **$**                                                | **257,831** | ** **                  | **$**      | **286,633** | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                  |       |                                                 |        |                        |       |
| Current  Liabilities                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Current  maturities of debentures and other long-term liabilities                                                                                                                                                                                                              |       | $                                                    | 321         |                        | $          | 315 |   |
| Accounts  payable and accruals                                                                                                                                                                                                                                                 |       | 22,942                                               |        | 49,616                      |       |
| Derivative  financial instruments                                                                                                                                                                                                                                              |       | 3,139                                                |        | —                      |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Total  current liabilities                                                                                                                                                                                                                                                     |       | 26,402                                               |        | 49,931                      |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Long-Term  Liabilities                                                                                                                                                                                                                                                         |       |                                                 |        |                        |       |
| Debentures,  less current portion                                                                                                                                                                                                                                              |       | 1,508                                                |        | 1,508                       |       |
| Other  long-term liabilities, less current portion                                                                                                                                                                                                                             |       | 10,444                                               |        | 10,769                      |       |
| Derivative  financial instruments                                                                                                                                                                                                                                              |       | 7,313                                                |        | —                      |       |
| Line  of credit                                                                                                                                                                                                                                                                |       | 115,000                                              |        | 112,400                     |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
|                                                                                                                                                                                                                                                                           |       | 134,265                                              |        | 124,677                     |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Commitments  and Contingencies                                                                                                                                                                                                                                                 |       |                                                 |        |                        |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Stockholders’  Equity                                                                                                                                                                                                                                                     |       |                                                 |        |                        |       |
| 8% convertible preferred stock, par value $.0001;  authorized 10,000,000 shares,  issued and  outstanding, 98,112 shares in 2009 and 2008, respectively  (aggregate liquidation preference $1,178 in 2009  and $1,177 in 2008)                                                 |       | 1,179                                                |        | 1,177                       |       |
| Common  stock - $.0001 par value; authorized, 100,000,000 shares; issued 58,876,160  shares in 2009 and 58,825,881 shares in 2008                                                                                                                                              |       | 6                                                    |        | 6                           |       |
| Additional  paid-in-capital                                                                                                                                                                                                                                                    |       | 431,191                                              |        | 430,243                     |       |
| Accumulated  deficit                                                                                                                                                                                                                                                           |       | (334,606                                             | )           | (318,881                    | )          |
| Accumulated  other comprehensive income, net of applicable income taxes of $80 in 2009 and  $137 in 2008                                                                                                                                                                       |       | 122                                                  |        | 208                         |       |
|                                                                                                                                                                                                                                                                           |       | 97,892                                               |        | 112,753                     |       |
|                                                                                                                                                                                                                                                                           |       |                                                 |        |                        |       |
| Less  common stock in Treasury—at cost; 632,250 shares in 2009 and 2008                                                                                                                                                                                                   |       | 728                                                  |        | 728                         |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                               |       | 97,164                                               |        | 112,025                     |       |
| ** **                                                                                                                                                                                                                                                                     | ** ** | **$**                                                | **257,831** | ** **                  | **$**      | **286,633** | ** ** |

 

The accompanyingnotes are an integral part of these financial statements.

** **

**3**

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**Table ofContents**

** **

**Warren Resources, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                 | ** ** | **Three Months Ended**          | ** **   | **Six Months Ended**            | ** ** |
|------------------------------------------------------------|------------|---------------------------------|--------------|---------------------------------|------------|
| ** **                                                 | ** ** | **June 30, (Unaudited)**   | ** **   | **June 30, (Unaudited)**   | ** ** |
| ** **                                                 | ** ** | **(in thousands, except share** | ** **   | **(in thousands, except share** | ** ** |
| ** **                                                 | ** ** | **and per share data)**         | ** **   | **and per share data)**         | ** ** |
|                                                       | ** ** | **2009**                        | ** **   | **2008**                        | ** ** | **2009** |   | **2008** |   |
| Operating revenues                                         |       |                            |         |                            |       |   |   |   |   |
| Oil and gas sales                                          |       | $                               | 15,219       |                            | $          | 34,236 |   | $ | 26,766 |   | $ | 57,720 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Operating expenses                                         |       |                            |         |                            |       |   |   |   |   |
| Lease operating expense and taxes                          |       | 5,405                           |         | 6,519                           |       | 14,204 |   | 12,383 |   |
| Depreciation,  depletion and amortization                  |       | 5,192                           |         | 4,512                           |       | 10,507 |   | 8,426 |   |
| General  and administrative                                |       | 2,825                           |         | 4,486                           |       | 6,080 |   | 7,798 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Total  operating expenses                                  |       | 13,422                          |         | 15,517                          |       | 30,791 |   | 28,607 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Income  (loss) from operations                             |       | 1,797                           |         | 18,719                          |       | (4,025 | ) | 29,113 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Other  income (expense)                                    |       |                            |         |                            |       |   |   |   |   |
| Interest  and other income                                 |       | 24                              |         | 224                             |       | 120 |   | 569 |   |
| Interest  expense                                          |       | (1,488                          | )            | (1,231                          | )          | (3,032 | ) | (2,573 | ) |
| Loss  on derivative financial instruments                  |       | (9,464                          | )            | —                          |       | (8,730 | ) | — |   |
| Net  gain on investments                                   |       | —                          |         | —                          |       | — |   | 93 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Total  other income (expense)                              |       | (10,928                         | )            | (1,007                          | )          | (11,642 | ) | (1,911 | ) |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Income  (loss) before taxes                                |       | (9,131                          | )            | 17,712                          |       | (15,667 | ) | 27,202 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Deferred  income tax expense                               |       | 39                              |         | 9                               |       | 57 |   | 36 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Net  income (loss)                                         |       | (9,170                          | )            | 17,703                          |       | (15,724 | ) | 27,166 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Less  dividends and accretion on preferred shares          |       | 24                              |         | 21                              |       | 48 |   | 54 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Net  income (loss) applicable to common stockholders       |       | $                               |  (9,194 | )                               | $          |  17,682 |   | $ |  (15,772 | ) | $ |  27,112 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Earnings  (loss) per share – Basic                    |       | $                               | (0.16        | )                               | $          | 0.30 |   | $ | (0.27 | ) | $ | 0.47 |   |
| Earnings  (loss) per share – Diluted                  |       | (0.16                           | )            | 0.30                            |       | (0.27 | ) | 0.46 |   |
|                                                       |       |                            |         |                            |       |   |   |   |   |
| Weighted  average common shares outstanding – Basic   |       | 58,193,631                      |         | 58,027,083                      |       | 58,200,020 |   | 57,804,809 |   |
| Weighted  average common shares outstanding – Diluted |       | 58,193,631                      |         | 59,011,546                      |       | 58,200,020 |   | 58,678,293 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

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**Table ofContents**

** **

**Warren Resources, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **For the six months ended********June 30, (Unaudited)** | ** **    |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|---------------|
| ** **                                                                         | ** ** | **(in thousands)**                                            | ** **    |
| ** **                                                                         | ** ** | **2009**                                                      | ** **    | **2008** | ** ** |
| ** **                                                                         | ** ** | ** **                                                    | ** **    | ** ** | ** ** |
| Cash  flows from operating activities:                                             |       |                                                          |          |   |   |
| Net  income (loss)                                                                 |       | $                                                             |  (15,724 | ) | $ |  27,166 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities: |       |                                                          |          |   |   |
| Accretion  of discount on available-for-sale debt securities                       |       | (24                                                           | )             | (28 | ) |
| Amortization  and write-off of deferred bond offering costs                        |       | 95                                                            |          | 85 |   |
| Gain  on sale of US treasury bonds – available for sale                       |       | —                                                        |          | (93 | ) |
| Depreciation,  depletion and amortization and impairment                           |       | 10,507                                                        |          | 8,425 |   |
| Loss  on derivative financial instruments                                          |       | 10,452                                                        |          | — |   |
| Stock  option expense                                                              |       | 996                                                           |          | 1,086 |   |
| Deferred  tax expense                                                              |       | 57                                                            |          | 36 |   |
| Change  in assets and liabilities:                                                 |       |                                                          |          |   |   |
| Decrease  (Increase) in accounts receivable—trade                             |       | 818                                                           |          | (8,065 | ) |
| Decrease  (Increase) in other assets                                               |       | (150                                                          | )             | 841 |   |
| Decrease  in accounts payable and accruals                                         |       | 1,715                                                         |          | 869 |   |
|                                                                               |       |                                                          |          |   |   |
| Net  cash provided by operating activities                                         |       | 8,742                                                         |          | 30,322 |   |
| Cash  flows from investing activities:                                             |       |                                                          |          |   |   |
| Purchase,  exploration and development of oil and gas properties                   |       | (31,257                                                       | )             | (59,045 | ) |
| Purchase  of property and equipment                                                |       | —                                                        |          | (93 | ) |
| Proceeds  from U.S. Treasury Bonds—available-for-sale                         |       | —                                                        |          | 426 |   |
|                                                                               |       |                                                          |          |   |   |
| Net  cash used in investing activities                                             |       | (31,257                                                       | )             | (58,712 | ) |
|                                                                               |       |                                                          |          |   |   |
| Cash  flows from financing activities:                                             |       |                                                          |          |   |   |
| Proceeds  from line of credit                                                      |       | 7,050                                                         |          | 36,247 |   |
| Payments  on debt and debentures                                                   |       | (4,807                                                        | )             | (826 | ) |
| Issuance  of common stock, net                                                     |       | —                                                        |          | 2,758 |   |
| Repurchase  of preferred stock, net                                                |       | —                                                        |          | (1,958 | ) |
|                                                                               |       |                                                          |          |   |   |
| Net  cash provided by financing activities                                         |       | 2,243                                                         |          | 36,221 |   |
|                                                                               |       |                                                          |          |   |   |
| Net  increase (decrease) in cash and cash equivalents                              |       | (20,272                                                       | )             | 7,831 |   |
|                                                                               |       |                                                          |          |   |   |
| Cash  and cash equivalents at beginning of period                                  |       | 29,688                                                        |          | 12,815 |   |
|                                                                               |       |                                                          |          |   |   |
| Cash  and cash equivalents at end of period                                        |       | $                                                             |  9,416   |   | $ |  20,646 |   |
|                                                                               |       |                                                          |          |   |   |
| Supplemental  disclosure of cash flow information                                  |       |                                                          |          |   |   |
| Cash  paid for interest                                                            |       | $                                                             |  2,546   |   | $ |  1,995 |   |
| Noncash investing and financing activities                                         |       |                                                          |          |   |   |
| Accrued preferred stock dividend                                                   |       | 47                                                            |          | 51 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

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**WARRENRESOURCES, INC. AND SUBSIDIARIES**

** **

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**

** **

**NOTE A—ORGANIZATION**

 

Warren Resources, Inc.(the “Company” or “Warren”), was originally formed on June 12, 1990 forthe purpose 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 and New Mexico.

 

The accompanyingunaudited financial statements and related notes present the Company’sconsolidated financial position as of June 30, 2009 and December 31,2008, the consolidated results of operations for the three and six months endedJune 30, 2009 and 2008 and consolidated cash flows for the six monthsended June 30, 2009 and 2008. 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, they do not include all of the information and footnotes requiredby accounting principles generally accepted in the United States of America forcomplete financial statements. In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for a fairpresentation have been included. Operating results for the six months ended June 30,2009, are not necessarily indicative of the results that may be expected forthe fiscal year ending December 31, 2009. The accounting policies followedby the Company are set forth in Note A to the Company’s financial statementsincluded in Form 10-K for the year ended December 31, 2008. Theseinterim financial statements and notes thereto should be read in conjunctionwith the consolidated financial statements presented in the Company’s 2008Annual Report on Form 10-K.

 

**NOTE B – LIQUIDITY AND MANAGEMENT’SPLANS**

 

At June 30, 2009, the Company had cash and cashequivalents of $9.4 million, a working capital deficit of $4.6 million(including a current liability of $3.5 million related to the derivativefinancial instruments) and incurred a loss of $9.2 million (including aunrealized loss of $9.8 million related to the mark-to-market of derivativefinancial instruments) for the three months ended June 30, 2009.  The Company depends on its Credit Facility,as described in Note F, for a portion of its operating and capital needs.  As of June 30, 2009, the Company had$115 million outstanding under the Credit Facility which matures in November 2012and currently has a borrowing base of $120 million. The borrowing base will bere-determined during the fourth quarter of 2009 unless the syndicate banks orthe Company request an early, one-time redetermination.  If the borrowing base is reduced to a levelbelow the current outstanding balance, the Company would be obligated to reducethe deficiency by 25% within 90 days and has an additional 90 days to cure the remainingdeficiency.

 

Management has takenseveral actions to ensure that the Company will have sufficient liquidity tomeet its obligations through December 31, 2009, including a reduction inits 2009 capital expenditure budget to $9 million, entered into price swapagreements for a portion of its 2009 production to reduce price volatility,temporarily shut-in three pilot areas in the Atlantic Rim that are uneconomicat current prices to reduce lease operating expenses, employee reductions andreductions in discretionary expenditures, including elimination of year-endbonuses and implementation of a salary freeze in 2009. The Company is alsoevaluating other measures to further improve its liquidity, including debt orequity sales, volumetric production payments, additional commodity pricehedging and other monetization of assets strategies. Management believes thatthese actions will enable the Company to meet its liquidity requirementsthrough the next twelve months.

 

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##### **Table ofContents**

 

##### **NOTE C**—STOCK BASEDCOMPENSATION

 

*Stock Options*

 

Compensation expense related to stock options andrestricted stock awards recognized in operating results (general andadministrative expenses) under Statement of Financial Accounting Standards (“SFAS”)No. 123R was approximately $0.5 and $0.6 million for the three monthsended June 30, 2009 and June 30, 2008, respectively, and $1.0 millionand $1.1 million for the six months ended June 30, 2009 and June 30,2008, respectively.

 

Thefollowing assumptions were used to value stock options calculated using theBlack-Scholes options pricing model:

 
| ** **               | ** ** | **Six months ended June 30,** | ** ** |
|--------------------------|------------|------------------------------------|------------|
| ** **               | ** ** | **2009**                           | ** ** | **2008** | ** ** |
| Dividend  yield          |       | 0                                  | %          | 0 | % |
| Expected  volatility     |       | 69.59                              | %          | 48.1 | % |
| Risk-free  interest rate |       | 1.54                               | %          | 2.02 | % |
| Fair  value of options   |       | $                                  | 0.28       |   | $ | 4.20 |   |
| Expected  life           |       | 3.5 years                          |       | 3.5 years |   |
|                          |            |                                    |            |  |  |  |  |

 
| ** **                             | ** ** | ** **     | ** ** | **Weighted** | ** **  | **Weighted**        | ** ** | ** **          | ** ** |
|----------------------------------------|------------|----------------|------------|--------------|-------------|---------------------|------------|---------------------|------------|
| ** **                             | ** ** | ** **     | ** ** | **Average**  | ** **  | **Average**         | ** ** | **Aggregate**       | ** ** |
| ** **                             | ** ** | **Number**     | ** ** | **Exercise** | ** **  | **Remaining**       | ** ** | **Intrinsic Value** | ** ** |
| ** **                             | ** ** | **of Options** | ** ** | **Price**    | ** **  | **Term (in years)** | ** ** | **(in thousands)**  | ** ** |
| Outstanding  at December 31, 2008 |       | 2,477,715      |       | $            |  10.15 |                |       |                |       |   |
| Granted                                |       | 1,619,874      |       | 0.56         |        |                |       |                |       |
| Exercised                              |       | —         |       | —       |        |                |       |                |       |
| Forfeited  or expired                  |       | (674,799       | )          | 8.04         |        |                |       |                |       |
| Outstanding  at June 30, 2009     |       | 3,422,790      |       | $            |  6.02  |                | 3.27       |                | $          |  3,063 |   |
|                                   |       |           |       |         |        |                |       |                |       |
| Exercisable  at June 30, 2009     |       | 1,411,913      |       | $            |  10.86 |                | 1.63       |                | $          |  — |   |

 

Thetotal intrinsic value of options exercised during the six months ended June 30,2008 was $5.1 million. There were no options exercised in the six months ended June 30,2009.

 

As of June 30,2009, total unrecognized stock-based compensation expense related to non-vestedstock options was $1.9 million, which we expect to recognize over a weightedaverage period of 1.6 years.

 

*RestrictedShares*

 

Restricted share activityas of June 30, 2009 was as follows:

 
| ** **                             | ** ** | **Shares** | ** ** | **Weighted  Average  Fair Value** | ** ** |
|----------------------------------------|------------|------------|------------|----------------------------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | ** **                             | ** ** |
| Outstanding  at December 31, 2008 |       | 131,392    |       | $                                      | 10.96      |   |
| Granted                                |       | —     |       | —                                 |       |
| Vested                                 |       | (50,279    | )          | 10.90                                  |       |
| Forfeited                              |       | —     |       | —                                 |       |
| Outstanding  at June 30, 2009     |       | 81,113     |       | $                                      | 11.00      |   |

 

Restricted stock awardsfor executive officers and employees vest ratably over three years. Fair valueof our restricted shares is based on our closing stock price on the date ofgrant.  As of June 30, 2009, total unrecognized stock-based 

 

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compensation expenserelated to non-vested restricted shares was $0.9 million, which is expected tobe recognized over a weighted average period of approximately 1.5 years.

#### ** **

#### **NOTE D**—CHANGES IN STOCKHOLDERS’ EQUITY

 

The preferred stock paysan 8% cumulative dividend which is treated as a deduction of additional paid incapital. The holders of the preferred stock are not entitled to vote except asdefined by the agreement or as provided by applicable law.  The preferred stock may be voluntarilyconverted, at the election of the holder, into common stock of the Companybased on a conversion rate of one share of preferred stock for 0.50 shares ofcommon stock.

 

Additionally, on October 1,2009, holders of the preferred stock may elect to require the Company to redeemtheir preferred stock 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 theamount equal to the Redemption Price or (2) issue to the holder shares ofcommon stock in an amount equal to 125% of the redemption price and any accruedand unpaid dividends, based on the weighted average closing “bid” price of theCompany’s common stock for the thirty trading days immediately preceding thedate of the written redemption election by the holder up to a maximum of 1.5shares of common stock for each one share of preferred stock redeemed. TheCompany is accreting the carrying value of its preferred stock to itsredemption price using the effective interest method with changes recorded toadditional paid in capital. The accretion of preferred stock results in areduction of earnings per share applicable to common stockholders.

 

Notwithstanding theforgoing, if the closing “bid” price of the Company’s publicly traded commonstock as reported by the NASDAQ stock market, or any exchange on which theshares of common stock are traded, exceeds 133% of the conversion price then ineffect for the convertible preferred shares for at least 10 days during any30-day trading period, the Company has the right to redeem in whole or in partthe convertible preferred stock at a redemption price of $12 per share (plusany accrued unpaid dividends) or convert the convertible preferred shares (plusany accrued unpaid dividends) into common stock at the then applicableconversion rate.

 

**NOTE E—EARNINGS (LOSS) PER SHARE**

 

Basic earnings (loss) pershare is computed by dividing net earnings (loss) applicable to commonstockholders by the weighted average number of shares of common stock outstandingduring the period. Diluted earnings (loss) per share is based on the assumptionthat stock options and warrants are converted into common shares using thetreasury stock method and convertible bonds and preferred stock are convertedusing the if-converted method. Conversion is not assumed if the results areanti-dilutive.  Potential common sharesfor the six months ended June 30, 2009 and June 30, 2008 of 96,941and 48,743 respectively, relating to convertible bonds and preferred stock,were excluded from the computation of diluted earnings (loss) per share becausethey are anti-dilutive. Potential common shares of  3,980,941 and 1,110,492 respectively,relating to stock options, warrants and restricted stock were excluded from thecomputation of diluted earnings (loss) per share for the six months ended June 30,2009 and 2008, respectively, because they are anti-dilutive. Stock options havea weighted average exercise price of $6.02 and $10.21 at June 30, 2009 andJune 30, 2008, respectively. At June 30, 2009, the convertible bondsmay be converted from the date of issuance until maturity at 100% of principalamount into common stock of the Company at a price of $35 to $50.  The preferred stock may be converted at thediscretion of the holder or upon meeting certain conditions at the discretionof the Company (see Note D).

 

Basic and diluted netearnings (loss) per share are computed based on the following information:

 

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| ** **                                            | ** ** | **Three Months  Ended********June 30, 2009** | ** **   | **Three Months  Ended********June 30, 2008** | ** ** | **Six Months  Ended********June 30, 2009** | ** ** | **Six Months  Ended********June 30, 2008** | ** **    |
|-------------------------------------------------------|------------|---------------------------------------------------|--------------|---------------------------------------------------|------------|-------------------------------------------------|------------|-------------------------------------------------|---------------|
| ** **                                            | ** ** | **(in thousands, except for per  share data)**    | ** **   | **(in thousands, except for per   share data)**   | ** ** |
| Net  earnings (loss) available to common shareholders |       | $                                                 |  (9,194 | )                                                 | $          |  17,682                                    |       | $                                               |  (15,772 | ) | $ |  27,112 |   |
|                                                  |       |                                              |         |                                              |       |                                            |       |                                            |          |
| Weighted  average shares outstanding - basic          |       | 58,193,631                                        |         | 58,027,083                                        |       | 58,200,020                                      |       | 57,804,809                                      |          |
| Effect  of dilutive securities – stock options   |       | —                                            |         | 473,360                                           |       | —                                          |       | 436,706                                         |          |
| Effect  of dilutive securities – preferred stock |       | —                                            |         | 53,528                                            |       | —                                          |       | 53,528                                          |          |
| Effect  of dilutive securities – warrants        |       | —                                            |         | 457,575                                           |       | —                                          |       | 383,250                                         |          |
|                                                  |       |                                              |         |                                              |       |                                            |       |                                            |          |
| Weighted  average shares outstanding - diluted        |       | 58,193,631                                        |         | 59,011,546                                        |       | 58,200,020                                      |       | 58,678,293                                      |          |
|                                                  |       |                                              |         |                                              |       |                                            |       |                                            |          |
| Basic  net earnings (loss) per share                  |       | $                                                 |  (0.16  | )                                                 | $          |  0.30                                      |       | $                                               |  (0.27   | ) | $ |  0.47 |   |
| Diluted  net earnings (loss) per share                |       | $                                                 |  (0.16  | )                                                 | $          |  0.30                                      |       | $                                               |  (0.27   | ) | $ |  0.46 |   |

 

**NOTE F—LONG-TERM LIABILITIES**

 

Long-termliabilities, excluding derivative financial instruments (see Note J), consistedof the following for the balance sheets dated:

 
| ** **                             | ** ** | **June 30,**   | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|---------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2009**            | ** ** | **2008**              | ** ** |
| ** **                             | ** ** | **(in  thousands)** | ** ** |
| Line  of Credit                        |       | $                   | 115,000    |                  | $          | 112,400 |   |
| Convertible  debentures                |       | 1,676               |       | 1,676                 |       |
| Debt  collateralized by treasury stock |       | 433                 |       | 489                   |       |
| Asset  retirement obligations          |       | 8,341               |       | 8,604                 |       |
| Litigation  allowance                  |       | 1,823               |       | 1,823                 |       |
|                                   |       | 127,273             |       | 124,992               |       |
| Less  current portion                  |       | 321                 |       | 315                   |       |
| Long-term  portion                     |       | $                   | 126,952    |                  | $          | 124,677 |   |

#### ** **

On November 19,2007, the Company entered into a five year, $250 million credit agreement withMerrill Lynch Capital (now owned by GE Capital Corporation). The CreditFacility provides for a revolving credit line up to the lesser of (i) theborrowing base, (ii) $250 million or (iii) the draw limit requestedby the Company. The Credit Facility matures on November 19, 2012. It issecured by substantially all of our assets. The borrowing base will bedetermined by the lenders at least semi-annually on each April 1 and October 1and is based in part on the proved reserves of the Company. The currentborrowing base is $120 million. Interest payments are made quarterly inarrears. During the first quarter of 2009 the Company drew down approximately$7.35 million under this facility. During April 2009, the Company repaid$4.75 million of the borrowings, leaving $5 million of currently availablecredit. Credit line interest of approximately $0.5 million was accrued for asof June 30, 2009.

 

The Company is subject tocertain covenants under the terms of the Credit Facility which include, but arenot limited to the maintenance of the following financial ratios (1) minimumcurrent ratio of current assets (including unused borrowing base in currentassets) to current liabilities of 1.0 to 1.0 and (2) a minimum annualizedconsolidated EBITDAX (as defined by the Credit Facility) to net interestexpense to of 2.5 to 1.0.  As of June 30,2009, the Company has borrowed $115 million under the Credit Facility and wasin compliance with all covenants.

 

Depending on the currentlevel of borrowing base usage, the annual interest rate on each base rateborrowing under the Credit Facility will be at our option either: (a) thehigher of (i) the Agent’s prime rate of interest announced from time totime, or (ii) the Federal Funds rate most recently determined by theAgent, plus 0.5% per annum, plus an applicable margin that ranges from 0.25% to1.0%, or (b) Eurodollar Loan rate plus an applicable margin that rangesfrom 1.25% to 2.0%.

 

Theconvertible bonds may be converted from the date of issuance until maturity at100% of principal amount into common stock of the Company at prices rangingfrom $35 to $50. Each year the holders of the convertible bonds may tender tothe Company up to 10% of the aggregate bonds issued and outstanding. During thesix months ended June 30, 2009, there were no Bond Redemptions

 

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#### **NOTE G—CONTINGENCIES**

 

In January 2008, theLos Angeles city attorney filed a complaint against Warren E&P, Inc.,a subsidiary of the Company (“Warren E&P”), and six of its individualemployees and independent contractors in the Superior Court of California,County of Los Angeles (State ofCalifornia v. Warren E&P, Inc., et al.).* * The complaint alleged eightmisdemeanor violations concerning four alleged events in Wilmington, Californiaduring 2007. The complaint asserts one count of failing to report the dischargeor threatened discharge of oil into marine waters for an event occurring on orabout March 7, 2007; one count of failing to prepare and implement an oilspill contingency plan; four counts of violating the California Fish and GameCode by placing petroleum or its by-products in or at a place where they canpass into waters of the state; and two similar violations of the CaliforniaClean Water Act. The complaint alleges all eight counts against Warren E&P, Inc.and one to four counts against each of the individuals. Warren E&P has beendiscussing and negotiating a resolution of this case with the City Attorney’soffice, and has reached a tentative, oral agreement with the City Attorney’soffice to settle this case. The oral agreement must be documented in writing,but generally provides that the criminal case will be dismissed against alldefendants, and Warren will be required to enter into a Consent Decree andCivil Compromise Agreement, which will require it to pay certain costs andcivil penalties and fines in the approximate amount of $100,000. Warren E&Pand its counsel are currently working with the City Attorney’s office on thespecific terms of the Consent Decree and Civil Compromise Agreement, and bothanticipate this case will be resolved and ultimately settled in the thirdquarter of 2009.

 

In 2005, Warren recordeda provision for $1.8 million relating to a contingent liability that theCompany may face as a result of a lawsuit originally filed in 1998 by GothamInsurance Company in the 81st Judicial District Court of Frio County,Texas (Gotham Insurance Company v. Pedeco, Inc., et al.,) seeking arefund of approximately $1.8 million paid by Gotham and other insurersunder an insurance policy issued for a well blow-out that occurred in 1997.After several appeals to the Texas Court of Appeals and the Texas SupremeCourt, the case has been remanded to the trial court for further proceedings.Both parties have filed Motions for Summary Judgment before the trial courtthat are expected to be heard in the third quarter of 2009.

 

Except for the foregoing,the Company is not a party to any material pending legal or governmentalproceedings, other than ordinary routine litigation incidental to our business.While the ultimate outcome and impact of any proceeding cannot be predictedwith certainty, our management believes that the resolution of any proceedingwill not have a material adverse effect on our financial condition or resultsof operations.

 

**NOTE H—COMPREHENSIVE INCOME**

 

Other comprehensiveincome consists primarily of net unrealized investment gains and losses, net ofincome tax effect. Total comprehensive income for the periods is as follow:

 
| ** **                             | ** ** | **2008**           | ** **       | **2009** | ** ** |
|----------------------------------------|------------|--------------------|------------------|----------|------------|
| ** **                             | ** ** | **(in thousands)** | ** **       |
| Six  Months ending June 30,       |       | $                  |  (15,811    | )        | $          |  27,110 |   |
|                                   |       |               |             |     |       |
| **Three  Months ending June 30,** | ** ** | **$**              | ** (9,231** | **)**    | **$**      | ** 17,687** | ** ** |

#### ** **

#### **NOTE I - FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The estimated fairvalues of financial instruments recognized in the Consolidated Balance Sheetsor disclosed within these Notes to Consolidated Financial Statements have beendetermined using available market information, information from unrelated thirdparty financial institutions and appropriate valuation methodologies, primarilydiscounted projected cash flows. However, considerable judgment is requiredwhen interpreting market information and other data to develop estimates offair value.

 

*Short-term Assets and Liabilities.*****The fair values of cash and cash equivalents, accountsreceivable, accounts payable and accrued expenses and other current liabilitiesapproximate their carrying values because of their short-term nature.

 

*U.STreasury Bonds - Trading and Available-For-Sale Securities.* The fair values are based upon quoted market prices for those or similarinvestments and are reported on the Consolidated Balance Sheets at fair value.

 

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*CollateralSecurity Agreement Account (included in other non-current assets).*The balance sheet carrying amountapproximates fair value, as it earns a market rate.

 

*ConvertibleDebentures*:****Fair values of fixed rate convertibledebentures were calculated using interest rates in effect as of year end forsimilar instruments with the other terms unchanged.

 

*Other Long-Term Liabilities*. The carrying amount approximates fair value due the current ratesoffered to the Company for long-term liabilities of the same remainingmaturities.

 

*Line of Credit.*The carrying amount approximates fairvalue due the current rates offered to the Company for lines of credit.

 
| ** **                   | ** ** | **2009**           | ** ** | **2008**     | ** ** |
|------------------------------|------------|--------------------|------------|--------------|------------|
| ** **                   | ** ** | **Fair**           | ** ** | **Carrying** | ** ** | **Fair** | ** ** | **Carrying** | ** ** |
| ** **                   | ** ** | **value**          | ** ** | **amount**   | ** ** | **value** | ** ** | **amount** | ** ** |
| ** **                   | ** ** | **(in thousands)** | ** ** |
|                         |       |               |       |         |       |   |   |   |   |
| Financial  assets            |       |               |       |         |       |   |   |   |   |
| Collateral  Security account |       | $                  | 3,156      |         | $          | 3,156 |   | $ | 3,154 |   | $ | 3,154 |   |
| Financial  liabilities       |       |               |       |         |       |   |   |   |   |
| Fixed  rate debentures       |       | $                  | 1,797      |         | $          | 1,676 |   | $ | 2,543 |   | $ | 1,676 |   |
| Other  long-term liabilities |       | 433                |       | 433          |       | 489 |   | 489 |   |
| Line  of credit              |       | 115,000            |       | 115,000      |       | 112,400 |   | 112,400 |   |

 

**FAIRVALUE MEASUREMENTS:**

 

On September 15,2006, the FASB issued SFAS No. 157, “Fair Value Measurement”. Weadopted SFAS No. 157 effective January 1, 2008. SFAS No. 157defines fair value as the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participantsat the measurement date and establishes a three level hierarchy for measuringfair value. The statement requires fair value measurements be classified anddisclosed in one of the following categories:

 

*Level 1**:*   Quoted prices (unadjusted) in activemarkets for identical assets and liabilities that we have the ability to accessat the measurement date.

 

*Level 2**:*  Inputs other than quoted prices includedwithin Level 1 that are either directly or indirectly observable for the assetor liability, including quoted prices for similar assets or liabilities in activemarkets, quoted prices for identical or similar assets or liabilities ininactive markets, inputs other than quoted prices that are observable for theasset or liability, and inputs that are derived from observable market data bycorrelation or other means. Instruments categorized in Level 2 includenon-exchange traded derivatives such as over-the-counter forwards and swaps.

 

*Level 3**:*  Unobservable inputs for the asset orliability, including situations where there is little, if any, market activity forthe asset or liability.

 

Thevaluation assumptions utilized to measure the fair value of the Company’scommodity derivatives were observable inputs based on market data obtained fromindependent sources and are considered Level 2 inputs (quoted prices forsimilar assets, liabilities (adjusted) and market-corroborated inputs).

 

Thefollowing tables present for each hierarchy level our assets and liabilities,including both current and non-current portions, measured at fair value on arecurring basis.

 

 
| **June 30, 2009**                       | ** ** | **Level 1**        | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|--------------------|------------|-------------|------------|-------------|------------|-----------|------------|
| ** **                                   | ** ** | **(in thousands)** | ** ** |
| **Assets**                                   |       |               |       |        |       |        |       |      |       |
| Restricted  investments in US Treasury Bonds |       |               |       |        |       |        |       |      |       |
| –  available for sale, at fair value    |       | $                  | 974        |        | $          | —      |       | $         | —     |   | $ | 974 |   |
|                                              |            |                    |            |             |            |             |            |           |            |  |  |  |  |

 

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| ** **                      | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|---------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-----------|------------|
|                            |       |        |       |        |       |        |       |      |       |
| **Liabilities**                 |       |        |       |        |       |        |       |      |       |
| Commodity  derivative liability |       | $           | 330        |        | $          | 10,122      |       | $         | —     |   | $ | 10,452 |   |
|                                 |            |             |            |             |            |             |            |           |            |  |  |  |  |

 
| **December 31, 2008**                   | ** ** | **Level 1**         | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** |   |
|----------------------------------------------|------------|---------------------|------------|-------------|------------|-------------|------------|-----------|--------|
| ** **                                   | ** ** | **(in  thousands)** |       |
| **Assets**                                   |       |                |       |        |       |        |       |      |   |
| Restricted  investments in US Treasury Bonds |       |                |       |        |       |        |       |      |   |
| –  available for sale, at fair value    |       | $                   | 1,094      |        | $          | —      |       | $         | — |   | $ | 1,094 |   |
|                                              |            |                     |            |             |            |             |            |           |        |  |  |  |  |

 

**NOTE J —DERIVATIVE FINANCIAL INSTRUMENTS**

 

To minimize the effect ofa downturn in oil and gas prices and protect our profitability and theeconomics of our development plans, we enter into crude oil and natural gashedge contracts. The terms of contracts depend on various factors, includingmanagement’s view of future crude oil and natural gas prices. This pricehedging program is designed to moderate the effects of a crude oil and naturalgas price downturn while allowing us to participate in some commodity priceincreases. Management regularly monitors the crude oil and natural gas marketsand our financial commitments to determine if, when, and at what level someform of crude oil and/or natural gas hedging and/or basis adjustments or otherprice protection is appropriate. Currently, our derivatives are in the form ofswaps.  However, we may use a variety of derivative instruments inthe future to hedge. The Company has not designated these derivatives as hedgesunder SFAS No. 133.

 

The following tablesummarizes the open financial derivative positions as of June 30, 2009 relatedto oil and gas production. The Company will receive prices as noted in thetable below and will pay a counterparty market price based on the NYMEX (fornatural gas production) or WTI (for oil production) index price, settledmonthly.

 
| ** **  | ** ** | ** ** | ** ** | ** **          | ** ** | ** **  | ** ** | **Price per**  | ** ** |
|-------------|------------|------------|------------|---------------------|------------|-------------|------------|----------------|------------|
| **Product** | ** ** | **Type**   | ** ** | **Contract Period** | ** ** | **Volume**  | ** ** | **Mcf or Bbl** | ** ** |
| Gas         |       | Swap       |       | 02/01/09-12/31/10   |       | 3,000 Mcf/d |       | $              | 6.88       |   |
| Gas         |       | Swap       |       | 03/01/09-02/28/11   |       | 3,000 Mcf/d |       | $              | 6.02       |   |
| Oil         |       | Swap       |       | 04/01/09-12/31/09   |       | 1,325 Bbld  |       | $              | 49.70      |   |
| Oil         |       | Swap       |       | 01/01/11-12/31/11   |       | 1,225 Bbld  |       | $              | 61.80      |   |

 

The tables belowsummarize the amount of gain (loss) recognized in income from derivativeinstruments.

 
| ** **                                                                  | ** ** | **Amount of Gain (Loss)  Recognized in Income for  Derivatives not designated as  Hedging Instruments under  Statement 133** | ** ** | **Amount of Gain (Loss)  Recognized in Income for  Derivatives not designated as  Hedging Instruments under  Statement 133** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------|------------|
| **Derivatives not designated as  Hedging  Instruments under Statement 133** | ** ** | **Three  months ended June  30, 2009 (in thousands)**                                                                        | ** ** | **Six  months ended June  30, 2009 (in thousands)**                                                                          | ** ** |
| Realized  cash settlements on hedges                                        |       | $                                                                                                                            | 376        |                                                                                                                         | $          | 1,392 |   |
| Unrealized  gain (loss) on hedges                                           |       | (9,840                                                                                                                       | )          | (10,122                                                                                                                      | )          |
| Total                                                                       |       | $                                                                                                                            | (9,464     | )                                                                                                                            | $          | (8,730 | ) |

 

We present our derivativeassets and liabilities in our Condensed Balance Sheets on a net basis. All derivativesare held with one counter party and gains and losses are offset in the BalanceSheet presentation. The table below reflects the line item in our CondensedBalance Sheet where the fair value of our net derivatives, are included.

 

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| ** **                                                                   | ** ** | **Derivative Liabilities** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------|------------|
| **(in thousands)**                                                           | ** ** | **Balance Sheet Location** | ** ** | **Fair Value** | ** ** |
| Commodity  – Natural Gas                                                |       | current                    |       | $ | 3,062 |   |
| Commodity  – Natural Gas                                                |       | Non-current                |       | (138 | ) |
| Commodity  – Oil                                                        |       | current                    |       | (6,201 | ) |
| Commodity  – Oil                                                        |       | Non-current                |       | (7,175 | ) |
|                                                                         |       |                       |       |   |   |
| Total  derivatives not designated as hedging instruments under Statement 133 |       |                       |       | $ | (10,452 | ) |

 

**NOTE K —RECENTLY ISSUED ACCOUNTING STANDARDS**

 

In April 2009, theFASB issued FASB Staff Position on FAS 107-1 and APB 28-1, “Interim Disclosuresabout Fair Value of Financial Instruments” (FSP FAS 107-1 and APB28-1).  This FSP requires that the fair value disclosures required bySFAS 107 “Disclosures about Fair Value of Financial Instruments” be includedfor interim reporting periods.  We adopted this new accountingstandard effective April 1, 2009.  The adoption of FSP FAS 107-1and APB 28-1 did not have a material impact on our financial statements.

 

In April 2009, theFASB issued SFAS No. 165, *SubsequentEvents*. SFAS No. 165 establishes general standards ofaccounting for and disclosure of events that occur after the balance sheet datebut before financial statements are issued or available to be issued. Weadopted SFAS No. 165 for the quarter ending June 30, 2009. TheCompany has evaluated subsequent events through August 5, 2009, which isthe date these financial statements were issued.

 

In April 2009, theFASB issued SFAS No. 167, *Amendments toFASB Interpretation No. 46(R)*. SFAS No. 167 requires aqualitative approach to identifying a controlling financial interest in avariable interest entity (VIE), and requires ongoing assessment of whether anentity is a VIE and whether an interest in a VIE makes the holder the primarybeneficiary of the VIE. SFAS No. 167 is effective for annual reportingperiods beginning after November 15, 2009. We do not expect adoption tohave a material impact on our consolidated financial statements.

 

In June 2009, theFASB issued SFAS No. 168, *The FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles*, SFAS No. 168 identifies the FASBAccounting Standards Codification as the authoritative source of generallyaccepted accounting principles in the United States. Rules andinterpretive releases of the Securities and Exchange Commission (SEC) underfederal securities laws are also sources of authoritative GAAP for SECregistrants. SFAS No. 168 is effective for financial statements issued forinterim and annual periods ending after September 15, 2009. We do notexpect adoption to have a material impact on our consolidated financialstatements.

 

The FASB revised SFAS No. 141(Revised 2007) “Business Combinations” (SFAS 141R) in 2007. The revisionbroadens the application of SFAS 141 to cover all transactions and events inwhich an entity obtains control over one or more other businesses. ThisStatement applies prospectively to business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. We may experience afinancial statement impact depending on the nature and extent of any newbusiness combinations entered into after the effective date of SFAS No. 141(R).

 

In December 2007,the FASB issued SFAS No. 160 “Noncontrolling Interest in ConsolidatedFinancial Statements — an Amendment of ARB 51” (SFAS 160). SFAS 160 clarifiesthat a noncontrolling interest in a subsidiary is an ownership interest in theconsolidated entity that should be reported as equity in the consolidatedfinancial statements. It also requires consolidated net income to be reportedat amounts that include the amounts attributable to both the parent and thenoncontrolling interest, and requires disclosure, on the face of theconsolidated statement of income, of the amounts of consolidated net incomeattributable to the parent and to the noncontrolling interest. SFAS 160 iseffective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008. The adoption of SFAS 160 did nothave a material effect on our consolidated financial statements.

 

In March 2008,the FASB issued SFAS No. 161 “Disclosures about Derivative Instruments andHedging Activities — An Amendment of FASB Statement No. 133” (SFAS 161),that requires new and expanded disclosures regarding hedging activities. Thesedisclosures include, but are not limited to, a proscribed tabular presentationof derivative data; financial statement presentation of fair values on a grossbasis, including those that currently qualify for netting under FASBInterpretation No. 39; and specific footnote narrative regarding how andwhy derivatives are used. The disclosures are 

 

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required in allinterim and annual reports. SFAS 161 is effective for fiscal and interimperiods beginning after November 15, 2008. The adoption of SFAS 161 didnot have a material effect on our consolidated financial statements.

 

On December 31,2008, the SEC published a final rule to revise its oil and gas reservesestimation and disclosure requirements. The primary objectives of the revisionsare to increase the transparency and information value of reserve disclosuresand improve comparability among oil and gas companies. The rule iseffective for annual reports on Form 10-K for fiscal years ending on orafter December 31, 2009. The Company anticipates that the implementationof the new rule will provide a more meaningful and comprehensiveunderstanding of oil and gas reserves. The new disclosure requirements include:consideration of new technologies in evaluating oil and natural gas reserves;disclosure of probable and possible oil and natural gas reserves; use of an average pricebased on the prior twelve month period rather than year-end prices, andrevisions of the oil and natural gas disclosure requirements for operations.The Company anticipates that the implementation of the new rule willprovide a more meaningful and comprehensive understanding of oil and gasreserves. The Company is currently evaluating the effect that the new reportingrequirements will have on the financial statements.

 

**Item 2. *Management’s Discussion and Analysis of Financial Conditions andResults of Operations***

 

**CAUTIONARY NOTE REGARDINGFORWARD-LOOKING STATEMENTS**

 

*TheCompany has made in this report, and may from time to time otherwise make in otherpublic filings, press releases and discussions with Company management,forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934 concerning the Company’s operations, economic performance and financialcondition. These forward-looking statements include information concerningfuture production and reserves, schedules, plans, timing of development,contributions from oil and gas properties, and those statements preceded by,followed by or that otherwise include the words “believes,” “expects,” “anticipates,”“intends,” “estimates,” “projects,” “target,” “goal,” “plans,” “objective,” “should”or similar expressions or variations on such expressions. For such statements,the Company claims the protection of the safe harbor for forward-lookingstatements contained in the Private Securities Litigation Reform Act of 1995.Although the Company believes that the expectations reflected in suchforward-looking statements are reasonable, it can give no assurance that suchexpectations will prove to have been correct. Important factors that couldcause actual results to differ materially from the Company’s expectationsinclude, but are not limited to, the Company’s assumptions about energymarkets, production levels, reserve levels, operating results, competitiveconditions, technology, the availability of capital resources, capitalexpenditures and other contractual obligations, the supply and demand for andthe price of oil, natural gas and other products or services, the weather,inflation, the availability of goods and services, drilling risks, futureprocessing volumes and pipeline throughput, general economic conditions, eitherinternationally or nationally or in the jurisdictions in which the Company orits subsidiaries are doing business, legislative or regulatory changes,including changes in environmental regulation, environmental risks andliability under federal, state and local environmental laws and regulations,potential environmental obligations, the securities or capital markets, ourability to repay debt and other factors discussed in “Risk Factors” and in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in the Company’s 2008 Annual Report on Form 10-K, this Form 10-Qand in the Company’s other public filings, press releases and discussions withCompany management. Warren undertakes no obligation to publicly update orrevise any forward-looking statement,**whether as a result of new information, subsequentevents or otherwise, unless otherwise required by law.*

 

**Overview**

 

We are an independentenergy company engaged in the exploration and development of domestic onshoreoil and natural gas reserves. We focus our efforts primarily on our waterfloodoil recovery programs and horizontal drilling in the Wilmington field withinthe Los Angeles Basin of California and on the exploration and development ofcoalbed methane (“CBM”) properties located in the Rocky Mountain region. As of June 30,2009, we owned natural gas and oil leasehold interests in approximately 163,053gross, 86,716 net acres, approximately 80% of which are undeveloped.Substantially all our undeveloped acreage is located in the Rocky Mountains.

 

**Liquidity and CapitalResources**

 

Our cashand cash equivalents decreased $20.3 million during the six months of 2009 to$9.4 million at June 30, 2009. This resulted from cash used in investingactivities of $31.3 million.  This waspartially offset by cash provided by operating activities of $8.7 million andcash provided by financing activities of $2.2 million.

 

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Cash used in investingactivities was primarily spent on oil and gas properties and equipment.  Cash provided by operating activities wasprimarily generated by oil and gas operations. Cash provided by financing activities primarily represents proceedsreceived under our Credit Facility as discussed in more detail below.

 

The Company recorded animpairment expense of $272.3 million at December 31, 2008 relating to itsceiling test on the carrying costs of its oil and gas properties and goodwillimpairments.  This resulted primarilyfrom realized oil prices decreasing 62% from $86.21 at December 31, 2007to $32.92 at December 31, 2008.  Asa result, many of our proved undeveloped reserves became uneconomic at this oilprice.  Additionally, the Company wroteoff approximately $3.4 million of goodwill at December 31, 2008.  The Company had no impairment charges duringthe six months ended June 30, 2009.

 

On November 19,2007, Warren entered into a five year, $250 million credit agreement withMerrill Lynch Capital on behalf of itself and a syndicate of five participatingbanks (the “Credit Facility”).   TheCredit Facility provides for a revolving loan up to the lesser of (i) theborrowing base (ii) $250 million or (iii) the draw limit requested bythe Company.  The Credit Facility matureson November 19, 2012.  It is securedby substantially all of our assets.  Theborrowing base will be determined by the lenders at least semi-annually on April 1and October 1 of each year, and is based in part on the proved reserves ofthe Company. The current borrowing base is $120 million, representing animmediate availability of $5 million. The Company is subject to certain covenants required by the CreditFacility which include, but are not limited to the maintenance of the followingfinancial ratios (1) a minimum current ratio (including the unusedborrowing base and excluding unrealized gains and losses on derivativefinancial instruments) of not less than 1.0 to 1.0 and (2) a minimumannualized consolidated EBITDAX (as defined by the Credit Facility) to netinterest expense of not less than to of 2.5 to 1.0.  As of June 30, 2009, the Company hadborrowed $115 million under the Credit Facility and was in compliance with allcovenants.   If oil and gas commodityprices are at lower levels, the Company could be in violation of CreditFacility covenants during 2009.  If theCompany fails to satisfy its Credit Facility covenants, it would be an event ofdefault.  Under such event of default andupon notice, all borrowings would become immediately due and payable to thelending banks.

 

On May 12,2009, Warren and its lenders amended the Credit Facility (the “First Amendment”)to (i) increase the margins on LIBOR based borrowings from a range of1.25% to 2.0% to a range of 2.75% to 3.50% (depending on the then-currentborrowing base usage), (ii) increase the margins on Base Rate borrowingsfrom a range of 0% to 0.75% to a range of 1.50% to 2.25% (depending on thethen-current borrowing base usage), (iii) add a floor to the margin rateof all LIBOR based loans to 3.50% for the next six months, and (iv) increasethe unused commitment fee rate from a range of 0.20% to 0.50% to a flat rate of0.50%. The First Amendment also gives Warren the right for the next six months,if it so chooses, to obtain up to a $30 million financing secured by a secondmortgage lien on its assets on terms acceptable to each of the Credit Facilitylenders.

 

Duringthe second quarter of 2009, the Company incurred $1.4 million of interestexpense under the Credit Facility of which approximately $0.5 million wasaccrued for as of June 30, 2009. The weighted average interest rate as of June 30,2009, was 4.85%.

 

Ouroperations are affected by local, national and worldwide economic conditions.We have relied on the capital markets, particularly for equity securities, aswell as the banking and debt markets, to meet financial commitments andliquidity needs if internally generated cash flow from operations is notadequate to fund our capital requirements. Capital markets in the United Statesand elsewhere have been experiencing extreme adverse volatility and disruption,due in part to the financial stresses affecting the liquidity of the bankingsystem, the real estate mortgage industry and the financial markets generally.In recent months, this volatility and disruption has reached unprecedentedlevels. As a result, our access to capital has become limited.

 

If oil and gas commodityprices remain at recent low levels or go lower, the Company may not generatesufficient cash flows to cover capital expenditures. In such case, theavailability of funds under our Credit Facility is critical to ourCompany.  The borrowing base will bere-determined during the fourth quarter of 2009 unless the syndicate banks orthe Company request an earlier, one-time re-determination.  If the Credit Facility’s borrowing base isreduced to a level below current borrowings, the Company would be obligated tobegin reducing the deficiency by 25% within 90 days after the deficiency occursand the remaining 75% within 180 days after the deficiency occurs.

 

The continuing crisis inthe U.S. and world financial and securities markets could have a materialadverse effect on our business and operations. Additionally, low commodity prices may restrict our ability to meet ourcurrent obligations.  As a 

 

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result, Management hastaken several actions to ensure that the Company will have sufficient liquidityto meet its obligations through December 31, 2009, including a reductionin its 2009 capital expenditure budget to $9 million, entered into price swapagreements for a portion of its 2009 production to reduce price volatility, temporarilyshut-in three pilot areas in the Atlantic Rim that are uneconomic at currentprices to reduce lease operating expenses, headcount reductions and reductionsin discretionary expenditures, including elimination of year-end bonuses. TheCompany is also evaluating other measures to further improve its liquidity,including, additional borrowings from 2nd Lien Lenders, the sale of equity or debtsecurities, the sale of certain assets, entering into joint ventures with thirdparties, volumetric production payments, additional commodity price hedging andother monetization of assets strategies. Management believes that these actionswill enable the Company to meet its liquidity requirements through December 31,2009. The Company has hired outside consultants to assist us in theseendeavors.  There is no assurance thatthe Company will be successful in these capital raising efforts that may benecessary to fund operations during 2009.

 

In addition to exploringways to raise capital, as mentioned above, the Company has reduced and willcontinue to reduce its general and administrative expenses by reducingemployees and consultants, where necessary. In addition, the Company has waived the March 2009 annual bonusesand currently has a salary freeze in effect.

 

During the first sixmonths of 2009, operating results declined significantly compared to 2008.  Primarily, this resulted from the significantdecline in oil and gas commodity prices. Additionally during the first six months of 2009, the Company incurred anet loss of $9.2 million (including $9.8 million in unrealized losses relatingto the mark-to-market of derivative financial instruments) as compared to netincome of $17.7 million for the comparable period of 2008.  At June 30, 2009, current assets were approximately$4.6 million less than current liabilities (including $3.5 million in currentliabilities relating to derivative financial instruments).   As mentioned previously, the unusedavailability under the Credit Facility is added to current assets whencalculating the current ratio covenant. Additionally, current assets and current liabilities relating tounrealized gains and losses from derivative financial instruments are excludedfrom the calculation.

 

In the future, if naturalgas inventories rise to levels such that no natural gas storage capacityexists, certain U.S. natural gas production will need to be reduced or shutin.  Additionally, if commodity pricesdecline to levels that make it uneconomic to produce oil and natural gas, theCompany or its partners may elect to shut in or reduce production.  As a result, some or all of the Company’s oiland natural gas production may be shut in or curtailed during the next 12months, which would have a material adverse effect on operations.

 

The Company’s provedreserves declined significantly compared to prior years and may decline infuture years.  Due to current commodityprices, compared to the cost of developing our undeveloped oil reserves and ourestimated lease operating expenses, a significant portion of our futureprojects are or may be uneconomic at this time. As a result, a significant portion of our proved undeveloped reservesare no longer in the proved category. The Company’s projects have material lease operating expenses.  Our oil operations include a secondaryrecovery waterflood with significant fixed costs.  During the second quarter of 2009, our oillease operating expenses were $13.36 per barrel of oil produced. Our naturalgas operations include reinjecting the produced water into deep formations andcompressing and transporting the gas with significant fixed costs. During thesecond quarter of 2009, our natural gas lease operating expenses were $2.41 permcf of gas produced. The Company’s proved reserves are based on assumptions thatmay prove to be inaccurate.

 

At June 30, 2009, wehad approximately 1.4 million vested outstanding stock options issued under ourstock based equity compensation plans. Of the total 1.4 million outstandingvested options, all had exercise prices above the closing market price $2.45 ofour common stock on June 30, 2009.

 

*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 bonds are secured at maturity by zero couponU.S. treasury bonds deposited into an escrow account equaling the parvalue of the bonds maturing on or before the maturity of the bonds. Such U.S.treasury bonds had a fair market value of $0.9 million at June 30,2009.  The table below does not reflectthe release of escrowed U.S. treasury bonds to us upon redemption.

 

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|                         | ** ** | **Payments  due by period *** |       |
|------------------------------|------------|-------------------------------|------------|
| **Contractual Obligations**  | ** ** |                          |       | **Less  Than** |   | **1-3** |   | **3-5** |   | **More  Than** |   |
| **As of June 30, 2009** |       | **Total**                     |       | **1 Year** |   | **Years** |   | **Years** |   | **5 Years** |   |
| ** **                   | ** ** | **(in  thousands)**           | ** ** |
| Line  of credit              |       | $                             | 115,000    |   | $ | — |   | $ | — |   | $ | 115,000 |   | $ | — |   |
| Bonds                        |       | 1,676                         |       | 167 |   | 287 |   | 232 |   | 990 |   |
| Leases                       |       | 2,781                         |       | 324 |   | 1,277 |   | 902 |   | 278 |   |
| Total                        |       | $                             | 119,457    |   | $ | 491 |   | $ | 1,564 |   | $ | 116,134 |   | $ | 1,268 |   |

 

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*                      Does not include estimated interest of$5,852,000 less than one year, $11,720,000 1-3 years, $2,601,000 3-5 yearsand $1,500,000 thereafter.

 

**RESULTS OF OPERATIONS:**

 

**Three months Ended June 30, 2009 Compared toThree Months Ended June 30, 2008**

 

*Oil and gas sales.* Revenue from oil and gas sales decreased$19.0 million in the second quarter of 2009 to $15.2 million, a 56% decreasecompared to the same quarter in 2008. This decrease resulted from a decrease in realized energy prices.  The average realized price per barrel of oilfor the three months ended June 30, 2009 and 2008 was $53.81 and $112.25,respectively.  Additionally, the averagerealized price per Mcf of gas for the three months ended June 30, 2009 and2008 was $2.67 and $9.05, respectively. Net oil production for the three months ended June 30, 2009 and 2008was 237 Mbbls and 252 Mbbls, respectively. Net gas production for the three months ended June 30, 2009 and2008 was 930 Mmcf and 657 Mmcf, respectively.

 

*Lease operating expense.* Lease operating expense for the secondquarter of 2009 decreased 17% to $5.4 million ($2.30 per Mcfe) compared to $6.5million ($3.01 per Mcfe) in the comparable period of 2008. Primarily, thisdecrease reduced lease operating expenses in our Atlantic Rim Project resultedfrom shutting in uneconomic wells and reduced workovers on wells.  Additionally, this decrease resulted fromreduced field expenses in our California oil properties.

 

*Depreciation, depletion andamortization .*Depreciation,depletion and amortization expense increased $0.7 million for the secondquarter of 2009 to $5.2 million, a 15% increase compared to the correspondingquarter last year. This increase reflects an increase in production and anincrease in the depletion rate resulting from a decrease in proved reservescompared to the same quarter in 2008. Production increased 8% during thisperiod.

 

*General and administrativeexpenses.* Generaland administrative expenses decreased $1.7 million in the second quarter of2009 to $2.8 million, a 37% decrease compared to the corresponding quarter lastyear.  This reflects a decrease inpersonnel as a result of cost cutting activities.

 

*Interest expense.* Interest expense increased $0.3 millionin the second quarter of 2009 to $1.5 million compared to the same quarter lastyear.  The increase results from interestexpense relating to the drawdown under our Credit Facility.

 

*Interest and other income.* Interest and other income decreased $0.2million in the second quarter of 2009 to $24 thousand, an 89% decrease comparedto the same quarter in 2008. This represents a decrease in interest earned dueto lower cash and cash equivalents balances and lower interest rates ascompared to the corresponding quarter last year.

* *

*Loss onderivative financial instruments.*Derivative losses of $9.5 million were recorded in thesecond quarter of 2009. This amount reflects $9.8 million of unrealized losses,resulting from mark to market accounting of our oil and gas swaps and ispartially offset by $0.3 million of realized gains in the quarter from ournatural gas swap positions.

 

**Six months Ended June 30, 2009 Compared to SixMonths Ended June 30, 2008**

 

*Oil and gas sales.* Revenue from oil and gas sales decreased$30.1 million during the first six months of 2009 to $26.8 million, a 54%decrease compared to the same period in 2008. This decrease resulted from a decrease in realized energy prices.  The average realized price per barrel of oilfor the six months ended June 30, 2009 and 2008 was $44.17 and $98.95,respectively.  Additionally, the averagerealized price per Mcf of gas for the six months ended June 30, 2009 and 

 

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2008 was $2.78 and $8.19,respectively.  Net oil production for thesix months ended June 30, 2009 and 2008 was 490 Mbbls and 495 Mbbls,respectively.  Net gas production for thesix months ended June 30, 2009 and 2008 was 1.9 Bcf and 1.1 Bcf,respectively.

 

*Lease operating expense.* Lease operating expense for the firstsix months of 2009 increased 15% to $14.2 million ($2.96 per Mcfe) compared to$12.4 million ($3.07 per Mcfe) in the comparable period of 2008. Primarily,this increase resulted from an increase in production.  Total production increased to 4.8 Bcfe forthe first six months of 2009 compared to 4.0 Bcfe for the first six months of2008, an increase of 19%.

 

*Depreciation, depletion andamortization .*Depreciation,depletion and amortization expense increased $2.1 million for the first sixmonths of 2009 to $10.5 million, a 25% increase compared to the correspondingperiod last year. This increase reflects an increase in production and anincrease in the depletion rate resulting from a decrease in proved reservescompared to the same period in 2008. Production increased 19% during thisperiod.

 

*General and administrativeexpenses.* Generaland administrative expenses decreased $1.7 million in the first six months of2009 to $6.1 million, a 22% decrease compared to the corresponding period lastyear.  This reflects a decrease inpersonnel as a result of cost cutting activities.

 

*Interest expense.* Interest expense increased $0.5 millionin the first six months of 2009 to $3.0 million compared to the same periodlast year.  The increase results frominterest expense relating to the drawdown under our Credit Facility.

 

*Interest and other income.* Interest and other income decreased $0.4million in the first six months of 2009 to $0.1 million, a 79% decreasecompared to the same period in 2008. This represents a decrease in interestearned due to lower cash and cash equivalents balances and lower interest ratesas compared to the corresponding period last year.

* *

*Loss onderivative financial instruments.*Derivative losses of $8.7 million were recorded in thefirst six months of 2009. This amount reflects $10.1 million of unrealizedlosses, resulting from mark to market accounting of our oil and gas swaps andis partially offset by $1.4 million of realized gains in the quarter from ournatural gas swap positions.

 

**CRITICAL ACCOUNTING POLICIES**

 

Our discussion andanalysis of our financial condition and results of operations are based onconsolidated financial statements that have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses. Webelieve that certain accounting policies affect our more significant judgmentsand estimates used in the preparation of our consolidated financial statements.Our 2008 Form 10-K includes a discussion of our critical accountingpolicies.

 

**Item 3. ****Quantitative andQualitative Disclosures About Market Risk**

 

***Energy PriceRisk***

 

The Company’s most significantmarket risk is the pricing for natural gas and crude oil. Management expectsenergy prices to remain volatile and unpredictable. If energy prices declinesignificantly, revenues and cash flow would significantly decline. Below is asensitivity analysis of the Company’s commodity price related derivativeinstruments.

 

***CommodityRisk***

 

Our primary market riskexposure is in the price we receive for our natural gas and oil production.Realized pricing is primarily driven by the prevailing worldwide price forcrude oil and spot regional market prices applicable to our U.S. natural gasproduction. Pricing for natural gas and oil production has been volatile andunpredictable for several years, and we expect this volatility to continue inthe future. The prices we receive for production depend on many factors outsideof our control, including volatility in the differences between product pricesat sales points and the applicable index price.

 

In 2009 we entered intoseveral financial derivative swap contracts to hedge our exposure to commodityprice risk associated with anticipated future oil and gas production. Through aprice swap, we have fixed the price we will receive on 

 

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a portion of our naturalgas and oil production. In a swap transaction, the counterparty is required tomake a payment to us for the difference between the fixed price and thesettlement price if the settlement price is below the fixed price. We arerequired to make a payment to the counterparty for the difference between thefixed price and the settlement price if the fixed price is below the settlementprice. We believe we will have more predictability of our crude oil and gasrevenues as a result of these financial derivative contracts.

 

The following tablesummarizes our open financial derivative positions as of August 1, 2009related to oil and gas production. The Company will receive prices asnoted in the table below and will pay a counterparty market price based on theNYMEX (for natural gas production) or WTI (for oil production) index price,settled monthly.

 
| ** **  | ** ** | ** ** | ** ** | ** **          | ** ** | ** **  | ** ** | **Price per**  | ** ** |
|-------------|------------|------------|------------|---------------------|------------|-------------|------------|----------------|------------|
| **Product** | ** ** | **Type**   | ** ** | **Contract Period** | ** ** | **Volume**  | ** ** | **Mcf or Bbl** | ** ** |
| Gas         |       | Swap       |       | 02/01/09-12/31/10   |       | 3,000 Mcf/d |       | $              | 6.88       |   |
| Gas         |       | Swap       |       | 03/01/09-02/28/11   |       | 3,000 Mcf/d |       | $              | 6.02       |   |
| Oil         |       | Swap       |       | 04/01/09-12/31/09   |       | 1,325 Bbld  |       | $              | 49.70      |   |
| Oil         |       | Swap       |       | 01/01/11-12/31/11   |       | 1,225 Bbld  |       | $              | 61.80      |   |

 

***InterestRate Risk***

 

We hold investments inU.S. treasury bonds available for sale, which represents securities heldin escrow accounts on behalf of certain debentures. Additionally, we holdU.S. treasury bonds trading securities, which predominantly representU.S. treasury bonds released from escrow accounts. The fair market valueof these securities will generally increase if the federal discount ratedecreases and decrease if the federal discount rate increases. All of ourconvertible debt has fixed interest rates, so consequently we are not exposedto cash flow or fair value risk from market interest rate changes on this debt.

 

At June 30,2009, we had debt outstanding under our Credit Facility of $115 million.  On May 12, 2009, Warren and its lendersamended the Credit Facility (the “First Amendment”) to (i) increase themargins on LIBOR based borrowings from a range of 1.25% to 2.0% to a range of2.75% to 3.50% (depending on the then-current borrowing base usage), (ii) increasethe margins on Base Rate borrowings from a range of 0% to 0.75% to a range of1.50% to 2.25% (depending on the then-current borrowing base usage), (iii) adda floor to the margin rate of all LIBOR based loans to 3.50% for the next sixmonths, and (iv) increase the unused commitment fee rate from a range of0.20% to 0.50% to a flat rate of 0.50%.

 

***Financial Instruments***

 

Our financial instrumentsconsist of cash and cash equivalents, U.S. treasury bonds and other long-termliabilities. The carrying amounts of cash and cash equivalents, U.S. treasurybonds and other long-term liabilities, approximate fair market value due to thehighly liquid nature of these short-term instruments or they are reported atfair value.

*** ***

***Inflation and Changes in Prices***

 

The general level ofinflation affects our costs. Salaries and other general and administrativeexpenses are impacted by inflationary trends and the supply and demand ofqualified professionals and professional services. Inflation and pricefluctuations affect the costs associated with exploring for and producingnatural gas and oil, which have a material impact on our financial performance.

 

***Forward-LookingStatements and Risk***

 

Certain statements inthis report, including statements of the future plans, objectives, and expectedperformance of the company, are forward-looking statements that are dependentupon certain events, risks and uncertainties that may be outside the company’scontrol, and which could cause actual results to differ materially from thoseanticipated. Some of these include, but are not limited to, the market pricesof oil and gas, economic and competitive conditions, exploration risks such asdrilling unsuccessful wells, higher-than-expected costs, potential liabilityfor remedial actions under existing or future environmental regulations andlitigation, potential liability resulting from pending or futurelitigation,  

 

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environmental andregulatory uncertainties that could delay or prevent drilling, and notsuccessfully completing, or any material delay of, any development of new orexisting fields, expansion, or capital expenditure, legislative and regulatorychanges, financial market conditions, political and economic uncertainties offoreign governments, future business decisions, and other uncertainties, all ofwhich are difficult to predict. Forward-looking statements are generallyaccompanied by words such as “estimate”, “project”, “predict”, “will”, “anticipate”,“plan”, “intend”, “believe”, “expect” or similar expressions that convey theuncertainty of future events or outcomes. You should not place undue relianceon these forward-looking statements, which speak only as of the date of thisreport. Unless legally required, Warren does not undertake any obligation toupdate any forward-looking statements, as a result of new information, futureevents or otherwise. Certain risks that may affect Warren’s results ofoperations and financial position appear in Part 1, Item 1A “Risk Factors”of Warren’s 2008 Annual Report on Form 10-K.

 

There are numerousuncertainties inherent in estimating quantities of proved oil and gas reservesand in projecting future rates of production and the timing of developmentexpenditures. The total amount or timing of actual future production may varysignificantly from reserves and production estimates. The drilling ofexploratory wells can involve significant risks, including those related totiming, success rates and cost overruns. Lease and rig availability, complexgeology and other factors can affect these risks. Fluctuations in oil andnatural gas prices or a prolonged continuation of low prices may adverselyaffect the company’s financial position, results of operations and cash flows.

 

#### **Item 4. **Controls andProcedures

 

***Evaluation ofDisclosure Controls and Procedures***

 

Our management,under the supervision and with the participation of our Chief Executive Officer(“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness ofour disclosure controls and procedures as defined in Securities and ExchangeCommission (“SEC”) Rule 13a-15(e) and 15d-15(e) as of the end ofthe period covered by this report.  Basedupon that evaluation, management  hasconcluded that our  disclosure  controls and  procedures  are effective to ensure  thatinformation  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 requireddisclosure and is  recorded,  processed, summarized  and  reported within the time periods specified in the SEC’s rules and forms.

 

***Changes inInternal Control over Financial Reporting***

 

There have been nochanges in our internal controls over financial reporting or in other factorsduring the quarter ended June 30, 2009, that have materially affected, orare reasonably likely to materially affect, the Company’s internal control overfinancial reporting.

 

## **PART II—OTHERINFORMATION**

 

**Item 1. *Legal Proceedings***

 

See Note G —Contingencies of the Notes to Financial Statements (Part I, Item 1)for information regarding the legal proceedings in which we are involved.

 

**Item 1A. *Risk Factors***

 

Our business has manyrisks. In addition to the other information set forth in this report and ourpress releases and other reports and materials that we file with the Securitiesand Exchange Commission, you should carefully consider the factors discussed inPart I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K forthe year ended December 31, 2008, which could materially affect ourbusiness, financial condition, operating results or liquidity and the tradingprice of our common stock.  Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition and/or operatingresults.

 

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

 

a.    Not applicable

 

b.    Notapplicable

 

c.    Notapplicable

 

**Item 3. *Defaults upon Senior Securities***

 

Notapplicable.

 

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

 

At the Annual Meeting ofthe Company held on May 20, 2009 in New York, NY there were represented byperson or by proxy 52,036,389 shares of common stock out of 58,872,593 sharesentitled to vote as of the record date, constituting a quorum. At the meeting,the following two matters were considered and approved:

 

·                  Proposal that Len DeCecchis and Thomas Noonan beelected as directors for a term expiring at the 2012 annual meeting, or untiltheir successors are duly elected:

 
| Len DeCecchis |   | 30,694,690 |   | FOR    |   | 21,341,698 |   | WITHHOLD |
|---------------|--------|------------|--------|--------|--------|------------|--------|----------|
|          |   |       |   |   |   |       |   |     |
| Thomas Noonan |   | 30,995,886 |   | FOR    |   | 21,040,502 |   | WITHHOLD |

 

·                  Proposal to ratify the appointment of Grant ThorntonLLP as the Company’s auditors for 2009:

 
| 51,467,753 |   | FOR |   | 340,866 |   | AGAINST |   | 227,769 |   | ABSTAIN |
|------------|--------|-----|--------|---------|--------|---------|--------|---------|--------|---------|

 

**Item 5. *Other Information***

 

Not applicable.

** **

**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**                                                                                                                                      |
|        |       |                                                                                                                                                 |
| 10.1*       |       | Form of Change of  Control Agreement                                                                                                            |
| 31.1*       |       | Certification of Chief  Executive Officer pursuant to Rule 13a-15(e)/15d-15(e)                                                                  |
| 31.2*       |       | Certification of Chief  Financial Officer pursuant to Rule 13a-15(e)/15d-15(e)                                                                  |
| 32.1*       |       | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted by  Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2*       |       | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted by  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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

 

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**SIGNATURES**

 

Pursuant to 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) |
|----------------------------|--------------------------------------|
|                       |                                 |   |
| Date: August 5,  2009 | By:                                  | /s/ Timothy A. Larkin |
|                       |                                 | Timothy A. Larkin |
|                       |                                 | *Executive Vice President,  Chief Financial Officer and  Principal Accounting Officer* |

 

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