**UNITED STATES****SECURITIES AND EXCHANGECOMMISSIONWashington, D.C. 20549**

 

**FORM 10-Q**

 

| **ý** |   | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|------------|--------|----------------------------------------------------------------------------------------------|

** **

**For the Quarterly Period Ended September 30, 2002**

 

**OR**

 

| **o** |   | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|--------|-----------------------------------------------------------------------------------------------|

 

**For the transition periodfrom              to**              

 

**CommissionFile No. 000-33275**

 

**WARREN RESOURCES, INC.**(Exact Name of Registrant as Specified in its Charter.)

 

| **Delaware**                                                     |   | **11-3024080**                           |
|------------------------------------------------------------------|--------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |   | (I.R.S. Employer  Identification Number) |
|                                                             |   |                                     |
| **489 Fifth Avenue, New York,  New York**                        |   | **10017**                                |
| (Address of Principal  Executive Offices)                        |   | (Zip Code)                               |
|                                                             |   |                                     |
| Registrant’s telephone  number, including area code:        |
| **(212) 697-9660**                                               |

 

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

 

Yes ýNo o

 

The aggregate number of Registrant’s outstanding shares on November 14,2002 was 17,546,215 shares of Common Stock, $0.0001 par value.

 

 

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**WARREN RESOURCES, INC.**

 

**INDEX**

 
| PART  I—  | FINANCIAL  INFORMATION                                                                               | 3      |
|----------------|------------------------------------------------------------------------------------------------------|--------|
|           |                                                                                                 |   |
|           | Item  1. Financial Statements                                                                        | 3      |
|           |                                                                                                 |   |
|           | Balance sheets as of  December 31, 2001 and September 30, 2002                                       | 3      |
|           |                                                                                                 |   |
|           | Statements of  operations for the three and nine months ended September 30, 2002 and 2001            | 4      |
|           |                                                                                                 |   |
|           | Statements of  cash flows for the nine months ended September 30, 2002 and 2001                      | 5      |
|           |                                                                                                 |   |
|           | Notes to  financial statements                                                                       | 6      |
|           |                                                                                                 |   |
|           | Item  2. Management’s discussion and analysis of results of operations and  financial condition | 11     |
|           |                                                                                                 |   |
|           | Item  3. Quantitative and Qualitative Disclosures About Market Risk                                  | 16     |
|           |                                                                                                 |   |
|           | Item  4. Evaluation of Disclosure Controls and Procedures                                            | 16     |
|           |                                                                                                 |   |
| PART  II— | OTHER  INFORMATION                                                                                   | 18     |
|           |                                                                                                 |   |
|           | Item 1. Legal Proceedings                                                                            | 18     |
|           |                                                                                                 |   |
|           | Item 2. Changes in Securities                                                                        | 19     |
|           |                                                                                                 |   |
|           | Item 3. Defaults upon Senior Securities                                                              | 19     |
|           |                                                                                                 |   |
|           | Item  4. Submission of Matters to a Vote of Security Holders                                         | 19     |
|           |                                                                                                 |   |
|           | Item  5. Other Information                                                                           | 20     |
|           |                                                                                                 |   |
|           | Item  6. Exhibits and Report on Form 8-K                                                             | 20     |
|           |                                                                                                 |   |
|           | Signatures                                                                                           | 20     |

 

2

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**PART I****—FINANCIALINFORMATION**

**ITEM I****—FINANCIALSTATEMENTS**

**WarrenResources, Inc. and SubsidiariesCONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                              |   | **September  30,  2002** |           | **December  31,  2001** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|----------------|-------------------------|--------|
|                                                                                                                                              |   | **(Unaudited)**          |           |                    |   |
| **ASSETS**                                                                                                                                        |   |                     |           |                    |   |
| CURRENT ASSETS                                                                                                                                    |   |                     |           |                    |   |
| Cash and cash  equivalents                                                                                                                        |   | $                        | 8,866,964      |                    | $      | 22,923,605 |   |
| Accounts  receivable                                                                                                                              |   | 3,845,649                |           | 5,543,326               |   |
| Accounts  receivable from affiliated partnerships                                                                                                 |   | 975,969                  |           | 801,661                 |   |
| Other  investments—trading securities                                                                                                        |   | —                   |           | 205,989                 |   |
| Restricted  investments in U.S. Treasury Bonds—available-for-sale, at fair value  (amortized cost of $673,403 and $1,142,637 respectively)   |   | 812,956                  |           | 1,187,123               |   |
| Other current  assets                                                                                                                             |   | 303,152                  |           | 1,294,986               |   |
| Assets held for  sale                                                                                                                             |   | —                   |           | 3,757,900               |   |
|                                                                                                                                              |   |                     |           |                    |   |
| Total current  assets                                                                                                                             |   | 14,804,690               |           | 35,714,590              |   |
|                                                                                                                                              |   |                     |           |                    |   |
| OTHER ASSETS                                                                                                                                      |   |                     |           |                    |   |
| Oil and gas  properties—at cost, based on successful efforts method of accounting, net of  accumulated depletion and amortization            |   | 40,695,399               |           | 39,974,798              |   |
| Property and  equipment—at cost, net                                                                                                         |   | 792,833                  |           | 891,304                 |   |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value  (amortized cost of $7,520,569 and $7,399,989 respectively) |   | 9,165,747                |           | 7,791,555               |   |
| Deferred bond  offering costs (net of accumulated amortization of $2,901,174 and $2,535,160  respectively)                                        |   | 3,539,894                |           | 3,905,908               |   |
| Goodwill                                                                                                                                          |   | 3,430,246                |           | 3,430,246               |   |
| Other assets                                                                                                                                      |   | 3,326,230                |           | 3,191,813               |   |
|                                                                                                                                              |   |                     |           |                    |   |
| Total other  assets                                                                                                                               |   | 60,950,349               |           | 59,185,624              |   |
|                                                                                                                                              |   |                     |           |                    |   |
|                                                                                                                                              |   | **$**                    | **75,755,039** |                    | **$**  | **94,900,214** | ** ** |
| **LIABILITIES AND SHAREHOLDERS’  DEFICIT**                                                                                                   |   |                     |           |                    |   |
|                                                                                                                                              |   |                     |           |                    |   |
| CURRENT  LIABILITIES                                                                                                                              |   |                     |           |                    |   |
| Current  maturities of debentures                                                                                                                 |   | $                        | 5,596,870      |                    | $      | 4,747,370 |   |
| Current  maturities of other long-term liabilities                                                                                                |   | —                   |           | 392,721                 |   |
| Accounts payable  and accrued expenses                                                                                                            |   | 2,662,754                |           | 6,511,137               |   |
| Deferred  income—turnkey drilling contracts with affiliated partnerships                                                                     |   | 24,533,079               |           | 32,943,586              |   |
|                                                                                                                                              |   |                     |           |                    |   |
| Total current  liabilities                                                                                                                        |   | 32,792,703               |           | 44,594,814              |   |
|                                                                                                                                              |   |                     |           |                    |   |
| LONG-TERM  LIABILITIES                                                                                                                            |   |                     |           |                    |   |
| Debentures, less  current portion                                                                                                                 |   | 50,371,830               |           | 53,391,330              |   |
| Other long-term  liabilities                                                                                                                      |   | 435,000                  |           | 29,191                  |   |
| Contingent  repurchase obligation                                                                                                                 |   | —                   |           | 3,318,993               |   |
|                                                                                                                                              |   |                     |           |                    |   |
|                                                                                                                                              |   | 50,806,830               |           | 56,739,514              |   |
| SHAREHOLDERS’  DEFICIT                                                                                                                       |   |                     |           |                    |   |
| Convertible  Preferred Stock Issuable, 71,248 shares in 2002                                                                                      |   | 855,030                  |           | —                  |   |
|                                                                                                                                              |   |                     |           |                    |   |
| Common Stock  (50,000,000 shares $.0001 par value authorized: 17,546,215 and 17,537,579  shares issued, respectively)                             |   | 1,755                    |           | 1,754                   |   |
|                                                                                                                                              |   |                     |           |                    |   |
| Additional  paid-in-capital                                                                                                                       |   | 52,243,452               |           | 52,213,453              |   |
| Accumulated  deficit                                                                                                                              |   | (62,114,038              | )              | (58,903,571             | )      |
| Accumulated  other comprehensive income, net of applicable income taxes of $714,000 and  $171,792 respectively                                    |   | 1,073,941                |           | 264,260                 |   |
|                                                                                                                                              |   | (7,939,860               | )              | (6,424,104              | )      |
| Less common  stock in Treasury—at cost; (5,191 and 4,563 shares respectively)                                                                |   | 12,634                   |           | 10,010                  |   |
| Total shareholders’  deficit                                                                                                                 |   | (7,952,494               | )              | (6,434,114              | )      |
|                                                                                                                                              |   |                     |           |                    |   |
|                                                                                                                                              |   | **$**                    | **75,755,039** |                    | **$**  | **94,900,214** | ** ** |

 

The accompanying notesare an integral part of these financial statements

 

3

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**Warren Resources, Inc. andSubsidiariesCONSOLIDATED STATEMENTS OFOPERATIONS**

 
|                                                                 |   | **Three  Months Ended  September 30** |           | **Nine  Months Ended  September 30** |   |
|----------------------------------------------------------------------|--------|---------------------------------------|----------------|--------------------------------------|--------|
|                                                                 |   | **2002**                              |           | **2001**                             |   | **2002** |   | **2001** |   |
| **REVENUES**                                                         |   |                                  |           |                                 |   |   |   |   |   |
| Turnkey  contracts with affiliated partnerships                      |   | $                                     | 2,468,774      |                                 | $      | 8,896,630 |   | $ | 8,842,756 |   | $ | 21,130,926 |   |
| Oil and gas  sales from marketing activities                         |   | 2,334,584                             |           | 3,812,866                            |   | 9,121,277 |   | 12,990,070 |   |
| Well services                                                        |   | 373,663                               |           | 2,002,238                            |   | 1,506,466 |   | 4,499,780 |   |
| Oil and gas  sales                                                   |   | 146,350                               |           | 176,951                              |   | 344,441 |   | 323,734 |   |
| Net gain (loss)  on investments                                      |   | 208,784                               |           | (13,981                              | )      | 471,963 |   | (35,803 | ) |
| Interest and  other income                                           |   | 262,089                               |           | 197,824                              |   | 1,152,813 |   | 1,547,630 |   |
|                                                                 |   |                                  |           |                                 |   |   |   |   |   |
|                                                                 |   | 5,794,244                             |           | 15,072,528                           |   | 21,439,716 |   | 40,456,337 |   |
|                                                                 |   |                                  |           |                                 |   |   |   |   |   |
| **EXPENSES**                                                         |   |                                  |           |                                 |   |   |   |   |   |
| Turnkey  contracts                                                   |   | 1,830,119                             |           | 8,023,850                            |   | 6,474,053 |   | 18,920,360 |   |
| Cost of marketed  oil and gas purchased from affiliated partnerships |   | 2,294,532                             |           | 3,800,416                            |   | 9,002,326 |   | 13,486,133 |   |
| Well services                                                        |   | 147,062                               |           | 1,057,870                            |   | 721,051 |   | 2,366,633 |   |
| Production &  exploration                                        |   | (815,478                              | )              | 52,639                               |   | 974,941 |   | 271,608 |   |
| Depreciation,  depletion and amortization                            |   | 377,586                               |           | 654,375                              |   | 2,094,203 |   | 1,792,167 |   |
| General and  administrative                                          |   | 2,017,970                             |           | 697,937                              |   | 4,451,307 |   | 1,846,961 |   |
| Interest                                                             |   | 1,484,395                             |           | 1,454,633                            |   | 4,427,963 |   | 4,349,735 |   |
| Contingent repurchase  obligation                                    |   | —                                |           | —                               |   | (3,064,661 | ) | — |   |
|                                                                 |   |                                  |           |                                 |   |   |   |   |   |
|                                                                 |   | 7,336,186                             |           | 15,741,720                           |   | 25,081,183 |   | 43,033,597 |   |
|                                                                 |   |                                  |           |                                 |   |   |   |   |   |
| Loss before  provision for income taxes                              |   | (1,541,942                            | )              | (669,192                             | )      | (3,641,467 | ) | (2,577,260 | ) |
|                                                                 |   |                                  |           |                                 |   |   |   |   |   |
| PROVISION FOR  INCOME TAXES                                          |   |                                  |           |                                 |   |   |   |   |   |
| Deferred income  tax benefit                                         |   | (453,000                              | )              | (172,000                             | )      | (539,000 | ) | (36,000 | ) |
|                                                                 |   |                                  |           |                                 |   |   |   |   |   |
|                                                                 |   | (453,000                              | )              | (172,000                             | )      | (539,000 | ) | (36,000 | ) |
|                                                                 |   |                                  |           |                                 |   |   |   |   |   |
| **NET LOSS**                                                         |   | **$**                                 | **(1,088,942** | **)**                                | **$**  | **(497,192** | **)** | **$** | **(3,102,467** | **)** | **$** | **(2,541,260** | **)** |
|                                                                 |   |                                  |           |                                 |   |   |   |   |   |
| LOSS PER SHARE                                                       |   |                                  |           |                                 |   |   |   |   |   |
| Basic &  Diluted                                                 |   | $                                     | (0.06          | )                                    | $      | (0.03 | ) | $ | (0.18 | ) | $ | (0.14 | ) |
| WEIGHTED AVERAGE  COMMON SHARES OUTSTANDING                          |   |                                  |           |                                 |   |   |   |   |   |
| Basic &  Diluted                                                 |   | 17,535,227                            |           | 17,534,961                           |   | 17,534,745 |   | 17,534,961 |   |

 

The accompanying notesare an integral part of these financial statements

 

4

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**Warren Resources, Inc. andSubsidiariesCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                         |   | **For the  nine months ended  September 30,** |       |
|------------------------------------------------------------------------------|--------|-----------------------------------------------|------------|
|                                                                         |   | **2002**                                      |       | **2001** |   |
|                                                                         |   | **(Unaudited)**                               |       |
| Cash flows from  operating activities:                                       |   |                                          |       |   |   |
| Net loss                                                                     |   | $                                             | (3,102,467 | ) | $ | (2,541,260 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |   |                                          |       |   |   |
| Accretion of  discount on available-for-sale debt securities                 |   | (390,227                                      | )          | (356,232 | ) |
| Amortization and  write-off of deferred bond offering costs                  |   | 366,014                                       |       | 332,427 |   |
| Gain on sale of  US treasury bonds—available for sale                   |   | (28,104                                       | )          | — |   |
| Depreciation,  depletion and amortization                                    |   | 2,094,203                                     |       | 1,792,167 |   |
| Deferred tax  benefit                                                        |   | (539,000                                      | )          | (36,000 | ) |
| Leases  contributed to partnerships                                          |   | 254,332                                       |       | — |   |
| Change in assets  and liabilities:                                           |   |                                          |       |   |   |
| Decrease in  trading securities                                              |   | 205,989                                       |       | 301,756 |   |
| Decrease in  accounts receivable—trade                                  |   | 2,147,677                                     |       | 1,929,901 |   |
| Increase in  accounts receivable from affiliated partnerships                |   | (174,308                                      | )          | (688,806 | ) |
| Decrease in  other assets                                                    |   | 857,417                                       |       | 241,465 |   |
| Decrease  (Increase) in accounts payable and accrued expenses                |   | (3,848,383                                    | )          | 262,164 |   |
| Decrease in  deferred income from affiliated partnerships                    |   | (8,410,507                                    | )          | (16,723,926 | ) |
| Decrease in contingent  repurchase obligation to affiliated partnerships     |   | (3,318,993                                    | )          | — |   |
| Increase in  other long term liabilities                                     |   | 435,000                                       |       | — |   |
|                                                                         |   |                                          |       |   |   |
| Net cash used in  operating activities                                       |   | (13,451,357                                   | )          | (15,486,344 | ) |
| Cash flows from  investing activities:                                       |   |                                          |       |   |   |
| Purchases of  U.S. Treasury Bonds—available-for-sale                    |   | (14,906                                       | )          | — |   |
| Purchases of oil  and gas properties                                         |   | (3,819,925                                    | )          | (14,238,151 | ) |
| Purchases of  property and equipment                                         |   | (1,780                                        | )          | (882,161 | ) |
| Cash received  from the sale of assets, net of selling fees                  |   | 4,175,552                                     |       | — |   |
| Proceeds from  U.S. Treasury Bonds—available-for-sale                   |   | 781,893                                       |       | 657,223 |   |
|                                                                         |   |                                          |       |   |   |
| Net cash  provided by (used in) investing activities                         |   | 1,120,834                                     |       | (14,463,089 | ) |
| Cash flows from  financing activities:                                       |   |                                          |       |   |   |
| Payments on  other long-term debt                                            |   | (2,538,924                                    | )          | (1,622,565 | ) |
| Deferred  offering costs                                                     |   | —                                        |       | (2,305,418 | ) |
| Issuance of  preferred stock, net                                            |   | 815,430                                       |       | 0 |   |
| Repurchase of  common stock                                                  |   | (2,624                                        | )          | — |   |
|                                                                         |   |                                          |       |   |   |
| Net cash used in  financing activities                                       |   | (1,726,118                                    | )          | (3,927,983 | ) |
|                                                                         |   |                                          |       |   |   |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                   |   | (14,056,641                                   | )          | (33,877,416 | ) |
| Cash and cash  equivalents at beginning of period                            |   | 22,923,605                                    |       | 58,969,552 |   |
|                                                                         |   |                                          |       |   |   |
| Cash and cash  equivalents at end of period                                  |   | $                                             | 8,866,964  |   | $ | 25,092,136 |   |
|                                                                         |   |                                          |       |   |   |
| Supplemental  disclosure of cash flow information                            |   |                                          |       |   |   |
| Cash paid for  interest, net of amount capitalized                           |   | $                                             | 4,027,364  |   | $ | 4,017,308 |   |
| Cash paid for  income taxes                                                  |   | —                                        |       | — |   |

 

The accompanying notesare an integral part of these financial statements

 

5

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**WARREN RESOURCES, INC. AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**SEPTEMBER 30, 2002**

** **

**NOTE1—ORGANIZATION**

Warren Resources, Inc. (the “Company”), was formed on June 12, 1990under the laws of the State of New York for the purpose of acquiring anddeveloping oil and gas properties. On September 5th, 2002, the Company changedits State of Incorporation to Delaware. As a result, all shares of the Company’s stock were converted intoshares of the Delaware Corporation.  TheCompany’s properties are primarily located in New Mexico, Texas, Wyoming, NorthDakota, Oklahoma, Michigan and California. In addition, the Company serves asthe managing general partner (the “MGP”) to affiliated partnerships and jointventures.

 

The accompanying unaudited financial statements and related notespresent the Company’s consolidated financial position as of September 30, 2002and December 31, 2001, the results of operations for the three and nine monthsended September 30, 2002 and 2001 and cash flows for the nine months endedSeptember 30, 2002 and 2001. The unaudited financial statements have beenprepared in accordance with generally accepted accounting principles forinterim financial information and with the instructions of Form 10-Q and Article10 of Regulation S-X. Accordingly, they do not include all of the informationand footnotes required by generally accepted accounting principles for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals) considered necessary for a fair presentation havebeen included. Operating results for the three and nine months ended September30, 2002 are not necessarily indicative of the results that may be expected forthe fiscal year ending December 31, 2002. Certain reclassifications have beenmade to the 2001 amounts to conform to the 2002 presentation. The accountingpolicies followed by the Company are set forth in Note A to the Company’sfinancial statements in Form 10-K for the year ended December 31, 2001. Theseinterim financial statements and notes thereto should be read in conjunctionwith our annual consolidated financial statements presented in our 2001 AnnualReport on Form 10-K.

 

**NOTE2—MANAGEMENT’S PLANS**

 

The Company had a net loss of $1.1 million for the quarter endedSeptember 30, 2002, as compared to a loss of $0.5 million for the correspondingquarter ending September 30, 2001. At September 30, 2002, current liabilitiesexceeded current assets by approximately $18.0 million and total liabilitiesexceeded total assets by approximately $7.8 million. During 2001, the Companyraised $18.1 million for its drilling programs compared to $46.5 million and$40.9 million in 2000 and 1999, respectively. As a result, the Company’sturnkey revenue and total gross profit in 2002 will be less than in 2001 and2000 and the number of the Company’s oil and gas properties developed throughpartnership arrangements will be reduced.

 

In order to improve operations and liquidity and meet its cash flow needs,the company has or intends to do the following:

 

• Sellinterests in some of our undeveloped oil and gas leases. The Company iscurrently in extended negotiations for several sales of a portion of its oiland gas interests which it is anticipated will be closed in the fourth quarterof 2002. Although there are no definitive agreements, the Company has receivedoffers to buy certain of its undeveloped oil and gas leases that havesignificantly appreciated when compared to their original cost.

 

• Raise additionalcapital through the sale of preferred stock in 2002 and common stock during2003.

 

• Obtain acredit facility based in part on the value of its proven reserves.

 

6

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• Continue privately placeddrilling programs, which based on prior experience management anticipatesraising approximately $10 million in 2002.

 

• Generate turnkey profit fromturnkey drilling contracts equal to approximately 25% of the total amount oftotal turnkey price.

 

• Reduce fixed overheadexpenses and primarily conduct developmental drilling operations in theCompany’s two main target areas, coalbed methane properties in Wyoming and oilformations in the Wilmington field in California.

 

As a result of these plans, management believes that it will generatesufficient cash flows to meet its current obligations in 2002.

 

**NOTE3—REPURCHASE OBLIGATION**

 

Certain Company sponsored oil and gas partnerships provide investorpartners a right to tender their interest to the Company for repurchase atspecified future dates. In the event the Company does repurchase the investorinterest, the Company will be entitled to receive any future cash flows fromthe underlying oil and gas properties. The determination of whether acontingent repurchase obligation exists is based upon the estimated discountedpresent value of future net revenues of proved developed and undevelopedreserves of each partnership, net of future capital costs and the Company’sworking interest, from reserve studies prepared by petroleum engineers comparedto the formula purchase price. A contingent repurchase obligation expense andliability of $3,318,993 was recognized at December 31, 2001 based on oil andgas pricing at March 15, 2002. During the first quarter of 2002, the Companyassigned additional proved undeveloped leases located in the Wilmington Unit tovarious partnerships to satisfy the contingent repurchase obligation. Thepartnerships’ proved undeveloped leases must be drilled by the Company usingfunds from an outside party or from the Company to provide future revenueswhich satisfy the contingent repurchase obligation. At March 31, 2002, theCompany had estimated that the proved undeveloped reserves will requireapproximately $30,500,000 of future development costs during 2002 through 2005for drilling and completing these wells compared to approximately $26,800,000at December 31, 2001. Based upon this calculation using prices at March 31,2002, the Company’s contingent repurchase obligation was extinguished. As a result,a gain of approximately $3,065,000 was recognized for the three-month periodending March 31, 2002. Using oil and gas prices at September 30, 2002, nocontingent repurchase obligation existed.

 

**NOTE4—PLUGGING AND ABANDONMENT LIABILITY**

 

Based upon updated information provided by the Company’s engineers inMay 2002, the Company determined that a plugging and abandonment liability of$1,371,000 existed at March 31, 2002, relating to certain shut-in propertieslocated in Texas, New Mexico and Wyoming. During the third quarter of 2002Warren disposed of some of these properties located in Texas and revisedestimated salvage proceeds on certain other wells and hence reduced theplugging and abandonment liability by $1,174,500. This amount is reflected in theincome statement as a reduction to production and exploration expense for thequarter. The Company expects to begin the remediation on the remaining wellsites in 2003.

 

**NOTE 5—Convertible Preferred StockIssuable**

 

At September 30, 2002, 71,248 shares of convertible preferred stock(“preferred stock”) were issuable without additional consideration.  The preferred stock pays an 8% cumulativedividend, payable quarterly. The holders of the preferred stock are not entitledto vote except as defined by the agreement or as provided by applicablelaw.  The preferred stock may bevoluntary converted at the election of the holder, commencing one year afterthe date of issuance.  Each outstandingredeemable convertible preferred share is convertible into common stock of theCompany based on the table below.  Theconversion rate is subject to adjustment from time to time as defined by theagreement.

 

| **Period**                          |   | **Common to  Preferred** |   |
|-------------------------------------|--------|--------------------------|--------|
| Until June 30, 2004                 |   | 1 to 1                   |   |
| July 1, 2004  through June 30, 2006 |   | .75 to 1                 |   |
| July 1, 2006  through redemption    |   | .50 to 1                 |   |

 

7

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

 

**NOTE6—EARNINGS PER SHARE**

 

Basic net earnings (loss) per share is computed by dividing netearnings (loss) by the weighted average number of shares of common stockoutstanding during the period. Diluted earnings (loss) per share is based onthe assumption that stock options are converted into common shares using thetreasury stock method and convertible bonds, debentures and preferred stock areconverted using the if-converted method. Conversion is not assumed if theresults are anti-dilutive.  Potentialcommon shares at September 30, 2002 and September 30, 2001, of 5,881,026 and6,247,439 respectively, relating to convertible bonds, debentures and preferredstock and 1,770,000 and 1,765,000 respectively relating to incentive stockoptions, were excluded from the computation of diluted earnings (loss) pershare because they are anti-dilutive. Incentive stock options have a weightedaverage exercise price of $4.51 and $4.62 at September 30, 2002 and September30, 2001, respectively. The Convertible Bonds and Debentures may be convertedfrom the date of issuance until maturity at 100% of principal amount intocommon stock of the company at prices ranging from $5.00 to $50.  The preferred stock may be converted at thediscretion of the holder (See note 5).

 

**NOTE7—LONG TERM DEBT**

 

The Convertible Bonds and Debentures may be converted from the date ofissuance until maturity at 100% of principal amount into common stock of thecompany at prices ranging from $4.50 to $50. Each year the holders of theConvertible Debentures may tender to the Company up to 10% of the aggregateDebenture issued. 

 
|                                                               |   | **September  30,  2002** |       | **December  31,  2001** |   |
|--------------------------------------------------------------------|--------|--------------------------|------------|-------------------------|--------|
| 12% Secured Convertible Debentures, due August 31, 2002            |   | $                        | —     |                    | $      | 470,000 |   |
| 12% Sinking Fund  Convertible Debentures, due August 31, 2002      |   | —                   |       | 55,000                  |   |
| 12% Sinking Fund  Debentures, due December 31, 2007                |   | 15,350,000               |       | 15,390,000              |   |
| 12% Secured  Convertible Debentures, due December 31, 2009         |   | 790,000                  |       | 840,000                 |   |
| 12% Secured  Convertible Bonds, due December 31, 2010              |   | 1,715,000                |       | 1,740,000               |   |
| 13.02% Sinking  Fund Convertible Debentures, due December 31, 2010 |   | 14,845,200               |       | 15,095,200              |   |
| 13.02% Sinking  Fund Convertible Debentures, due December 31, 2015 |   | 12,212,500               |       | 12,737,500              |   |
| 12% Secured  Convertible Bonds, due December 31, 2016              |   | 1,460,000                |       | 1,580,000               |   |
| 12% Sinking Fund  Convertible Debentures, due December 31, 2017    |   | 6,775,000                |       | 7,215,000               |   |
| 12% Secured  Convertible Bonds, due December 31, 2020              |   | 1,635,000                |       | 1,780,000               |   |
| 12% Secured  Convertible Bonds, due December 31, 2022              |   | 1,186,000                |       | 1,236,000               |   |
|                                                               |   |                     |       |                    |   |
|                                                               |   | 55,968,700               |       | 58,138,700              |   |
| Less: Current  Portion                                             |   | 5,596,870                |       | 4,747,370               |   |
|                                                               |   |                     |       |                    |   |
| Long Term  Portion                                                 |   | $                        | 50,371,830 |                    | $      | 53,391,330 |   |

 

**NOTE8—INCOME TAXES**

For the quarters ended September 30, 2002 and 2001, the Company’seffective income tax rate differed from the federal statutory rate due tochanges in the valuation allowance for deferred tax assets.

 

8

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**NOTE9—SALE OF ASSETS**

During the second quarter 2002, the Company initiateda plan to dispose of its Kirby Decker acreage, which was completed on August 2,2002. The Company sold all of its 24,133 gross (22,075 net) acres, which waslocated in Bighorn County, Montana. In connection with the disposal the Companydetermined that the carrying value of this property at June 30, 2002 exceededit’s fair value. Accordingly, an impairment expense of $1,121,481, was includedas part of depreciation, depletion and amortization expense for the threemonths ended June 30, 2002. The fair value was based on the selling price ofthe property.

 

On February 14th, 2002, the Company completed the sale ofsubstantially all of the assets of Pinnacle, which consists of theworkover/recompletion rig portion of the Company’s well service business, for apurchase price of $4.2 million to Basic Energy Services, Inc. (“Basic Energy”).Under the purchase agreement dated as of December 31, 2001, Basic Energy paidthe Company $3.7 million in cash at the closing and $500,000 in contractdrilling services credits issued by Basic Energy, which may be utilized by theCompany over a three year period with a maximum of $25,000 in any month. As ofSeptember 30, 2002, $99 thousand of these service credits have been utilized.Additionally, the Company entered into a noncompete agreement with BasicEnergy.

 

**NOTE10—LITIGATION**

The Company is party to various matters of litigation arising in thenormal course of business. Management believes that the ultimate outcome of thematters will not have a material effect on the Company’s financial condition orresults of operations.

 

**NOTE11—BUSINESS SEGMENT INFORMATION**

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

 
|                    |   | **Three  Months Ended**  |      | **Nine  months Ended**   |   |
|-------------------------|--------|--------------------------|-----------|--------------------------|--------|
|                    |   | **September  30,  2002** |      | **September  30,  2001** |   | **September  30,  2002** |   | **September  30,  2001** |   |
| **Revenue**             |   |                     |      |                     |   |   |   |   |   |
| Turnkey  Contracts      |   | $                        | 2,468,774 |                     | $      | 8,896,630 |   | $ | 8,842,756 |   | $ | 21,130,926 |   |
| Oil and Gas  Marketing  |   | 2,334,584                |      | 3,812,866                |   | 9,121,277 |   | 12,990,070 |   |
| Oil and Gas  Operations |   | 146,350                  |      | 176,951                  |   | 344,441 |   | 323,734 |   |
| Well Services           |   | 373,663                  |      | 2,002,238                |   | 1,506,466 |   | 4,499,780 |   |
| Other                   |   | 470,873                  |      | 183,843                  |   | 1,624,776 |   | 1,511,827 |   |
|                    |   |                     |      |                     |   |   |   |   |   |
|                    |   | $                        | 5,794,244 |                     | $      | 15,072,528 |   | $ | 21,439,716 |   | $ | 40,456,337 |   |

 
|                        |   | **September 30,  2002** |        | **September  30,  2001** |   | **September  30,  2002** |   | **September  30,  2001** |       |
|-----------------------------|--------|-------------------------|-------------|--------------------------|--------|--------------------------|--------|--------------------------|------------|
| **Operating Income (Loss)** |   |                    |        |                     |   |                     |   |                     |       |
| Turnkey  Contracts          |   | $                       | 611,842     |                     | $      | 810,947                  |   | $                        | 5,357,552  |   | $ | 2,112,788 |   |
| Oil and Gas  Marketing      |   | 40,052                  |        | 12,449                   |   | 118,951                  |   | (496,063                 | )          |
| Oil and Gas  Operations     |   | 621,008                 |        | (514,605                 | )      | (2,567,587               | )      | (1,341,260               | )          |
| Well Services               |   | 227,202                 |        | 958,273                  |   | 710,756                  |   | 1,805,376                |       |
| Other                       |   | (3,042,046              | )           | (1,936,256               | )      | (7,261,139               | )      | (4,658,101               | )          |
|                        |   |                    |        |                     |   |                     |   |                     |       |
|                        |   | $                       | (1,541,942) |                     | $      | (669,192                 | )      | $                        | (3,641,467 | ) | $ | (2,577,260 | ) |

 

9

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**NOTE12—New Accounting Pronouncements:**

 

In July 2001, the Financial Accounting Standards Board issuedStatements of Financial Accounting Standards (SFAS) No. 141, “BusinessCombinations” and No. 142, “Goodwill and Other Intangible Assets”. Thesestandards prohibit the application of the pooling of interests method ofaccounting for business combinations effective June 30, 2001 and requirecompanies to stop amortizing existing goodwill and intangible assets withindefinite lives. Under the new rules, companies would only adjust the carryingamount of goodwill or indefinite life intangible assets upon an impairment ofthe goodwill or indefinite life intangible assets. The Company adopted thesestandards effective January 1, 2002, and as such, has not recorded anyamortization of goodwill.

 

Initial adoption of these standards required that the first step of agoodwill impairment test be completed by June 30, 2002. The Company retained anindependent outside valuation expert to develop the fair value analysis toassist the Company in conducting the testing for impairment. The results of theanalysis indicted that no impairment of goodwill had occurred as of January 1,2002. The Company has set the beginning of the second quarter (April) as theannual period for goodwill impairment testing. The results will be reported nolater than June 30, of each year.

 

The following reconciles reported net loss and related per shareamounts to amounts that would have been presented exclusive of amortizationexpense recognized for goodwill that is no longer being amortized:

 
|                                       |   | **Three  months ended  September 30,** |       | **Nine  months ended  September 30,** |     |
|--------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|----------|
|                                       |   | **2002**                               |       | **2001**                              |     | **2002** |   | **2001** |   |
| Net loss                                   |   | $                                      | (1,088,942 | )                                     | $        | (497,192 | ) | $ | (3,102,467 | ) | $ | (2,541,260 | ) |
| Goodwill  amortization                     |   | —                                 |       | 67,392                                |     | — |   | 202,176 |   |
|                                       |   |                                   |       |                                  |     |   |   |   |   |
| Adjusted net  loss                         |   | (1,088,942                             | )          | $                                     | (429,800 | ) | $ | (3,102,467 | ) | $ | (2,339,084 | ) |
|                                       |   |                                   |       |                                  |     |   |   |   |   |
| Net loss per  share—basic and diluted |   |                                   |       |                                  |     |   |   |   |   |
| Reported net  loss                         |   | $                                      | (.06       | )                                     | $        | (.03 | ) | $ | (0.18 | ) | $ | (0.14 | ) |
| Goodwill  amortization                     |   | —                                 |       | .01                                   |     | — |   | .01 |   |
|                                       |   |                                   |       |                                  |     |   |   |   |   |
| Adjusted net  loss                         |   | $                                      | (.06       | )                                     | $        | (.02 | ) | $ | (0.18 | ) | $ | (0.13 | ) |

 

In June 2001, FASB issued SFAS No. 143, *Accounting for Asset RetirementObligations*, and in August 2001, issued SFAS No. 144, *Accountingfor the Impairment or Disposal of Long-Lived Assets*. SFAS No. 143requires entities to record the fair value of a liability for an assetretirement obligation in the period in which it is incurred and a correspondingincrease in the carrying amount of the related long-lived asset. Subsequently,the asset retirement cost should be allocated to expense using a systematic andrational method. SFAS No. 143 is effective for fiscal years beginning afterJune 15, 2002. SFAS No. 144 addresses financial accounting and reporting forthe impairment of long-lived assets and for long-lived assets to be disposedof. It supersedes, with exceptions, SFAS No. 121, *Accounting for the Impairment ofLong-Lived Assets and for Long-Lived Assets to Be Disposed Of*, andis effective for fiscal years beginning after December 15, 2001. The adoptionof SFAS No.144 had no impact on the Company’s consolidated financial positionor the results of operations. The Company is currently assessing the impact ofSFAS Nos. 143. However, at this time, the Company does not believe the impactof this statement will be material to its consolidated financial position orresults of operations.

 

In April 2002, FASB issued SFAS No. 145, Rescissions of FASB Statements4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections. Withthe rescission of SFAS 4, gains and losses on extinguishments of debt should beclassified as ordinary items unless they meet the criteria for extraordinaryitem classification in Opinion 30. The Company adopted this standard effectiveJanuary 1, 2002 and as such, has reported the extinguishments of the contingentrepurchase obligation as an ordinary item for the nine months ended September30, 2002. No contingent repurchase obligation existed at September 30, 2002.

 

10

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**NOTE13—Comprehensive Loss:**

 

Other comprehensive loss consist primarily of net unrealized investmentgains and losses, net of income tax effect. Total comprehensive losses for theperiods ending September 30 are as follow:

 
|                              |   | **2002** |             | **2001** |   |
|-----------------------------------|--------|----------|------------------|----------|--------|
| Three Months  ending September 30 |   | $        | (337,221    | )        | $      | (237,829 | ) |
| Nine Months  ending September 30  |   | $        | (2,292,786  | )        | $      | (2,548,723 | ) |

 

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

 

 

**FORWARD-LOOKING INFORMATION**

 

This Report on Form 10-Q and our other filings with the SEC containforward-looking statements within the meaning of Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934. When usedin this Report and our other filings with the SEC, the words “anticipated,”“believe,” “estimate,” “project,” “budget,” “will,” “should,” “hope,” “may”,“intend” and “expect” and similar expressions identify forward-looking statements.Although we believe that our plans, intentions and expectations reflected inthese forward-looking statements are reasonable, these plans, intentions andexpectations may not be achieved. Forward-looking statements in this Report andour filings with the SEC include, without limitation, statements regarding:

 

• financialposition; 

• businessstrategy; 

• budgets; 

• amount,nature and timing of capital expenditures; 

•  drilling of wells; 

•  natural gas and oil reserves; 

•  timing and amount of future production ofnatural gas and oil; 

•  operating costs and other expenditures; 

•  future net revenues from production andestimates of oil and gas reserves; 

•  cash flow and anticipated liquidity; and 

•  prospect development and property acquisitions.

 

These forward-looking statements are based on assumptions that theCompany believes are reasonable, but they are open to a wide range ofuncertainties and business risks, including the following:

 

• fluctuationsof the prices received or demand for oil and natural gas over time; 

• risksassociated with oil and gas exploration; 

• our abilityto find, acquire, market, develop and produce new properties; 

• availabilityand cost of material and equipment; 

• uncertaintyof reserve estimates and in the projection of future rates of production andtiming of development expenditures;

• operatinghazards;

•  climactic conditions; 

•  availability of capital and unexpectedsubstantial variances in capital requirements; 

•  the strength and financial resources of ourcompetitors; 

•  regulatory developments; 

•  environmental risks; and 

•  general economic conditions.

 

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Actual results, performance or achievements could differ materiallyfrom those contemplated, expressed or implied by the forward-looking statementscontained in this Report and our other filings with the SEC. Important factorsthat could cause actual results to differ materially from our forward-lookingstatements are set forth in this Report and our other filings with the SEC,including under the heading “Risk Factors” in our annual report on Form 10-K.These factors are not intended to represent a complete list of the general orspecific factors that may affect us. It should be recognized that otherfactors, including general economic factors and business strategies, may besignificant, presently or in the future, and the factors set forth in thisreport and our other filings with the SEC may affect us to a greater extentthan indicated. All forward-looking statements attributable to us or personsacting on our behalf are expressly qualified in their entirety by thecautionary statements set forth in this Report and our other filings with theSEC. Except as required by law, we undertake no obligation to update anyforward-looking statement, whether as a result of new information, futureevents or otherwise.

 

**LIQUIDITYAND CAPITAL RESOURCES:**

 

We have funded our activities primarily with the proceeds raisedthrough privately placed drilling programs and our private sale of our equityand debt securities. These private placements primarily were made through anetwork of independent broker dealers. Since 1992, we have raised approximately$217 million through the private placements of interests in 29 drillingprograms. Additionally, we have raised $58.7 million through the issuance ofour debt securities and $52.2 million through the issuance of our equitysecurities. In our drilling programs, we fund the costs associated with acreageacquisition and the tangible portion of drilling activities, while investors inthe drilling programs fund all intangible drilling costs.

 

Our cash and cash equivalents decreased $14.1 million for the ninemonths ended September 30, 2002. This resulted from a $13.5 million decrease incash provided from operating activities, a $1.1 million increase in cashprovided from investing activities and a $1.7 million decrease in cash providedfrom financing activities.

 

Cash provided from operating activities decreased due to drilling wellson behalf of the drilling programs and the related recognition of deferredrevenue during the first nine months. Additionally, the funds raised throughour drilling programs are primarily raised during the last quarter of ourcalendar year. As a result, during the first nine months of the calendar year,we incur turnkey expenses related to drilling programs and do not raiseadditional funds through drilling programs.

 

Cash provided from investing activities increased due to the sale ofcertain assets of our drilling rig subsidiary, CJS Pinnacle Petroleum Services,LLC (Pinnacle) and the sale of our Kirby Decker property in Montana.  This increase was partially offset bypurchases of oil and gas properties during the period. Lastly, cash providedfrom financing activities decreased due to the repayment of debt relating toPinnacle’s assets sold during the first quarter.

 

Our most material commitment of funds relates to the drilling programs.Our deferred revenue balance relating to our drilling commitments totaled $24.5million at September 30, 2002. This commitment varies pro rata with the amountof funds raised through our drilling funds.

 

The Company had a net loss of $1.1 million for the quarter endedSeptember 30, 2002, as compared to a loss of $0.5 million for the correspondingquarter ending September 30, 2001. At September 30, 2002, current liabilitiesexceeded current assets by approximately $18.0 million and total liabilitiesexceeded total assets by approximately $7.8 million.

 

During 2001, the Company raised $18.1 million for its drilling programscompared to $46.5 million and $40.9 million in 2000 and 1999, respectively. Asa result, the Company’s turnkey revenue and total gross profit in 2002 will beless than in 2001 and 2000 and the number of the Company’s oil and gasproperties developed through partnership arrangements will be reduced.

 

12

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In order to improve operations and liquidity and meet its cash flowneeds, the company has or intends to do the following:

 

• Sellinterests in some of our undeveloped oil and gas leases. The Company iscurrently in extended negotiations for several sales of a portion of its oiland gas interests which it is anticipated will be closed in the fourth quarterof 2002. Although there are no definitive agreements, the Company has receivedoffers to buy certain of its undeveloped oil and gas leases that havesignificantly appreciated when compared to their original cost.

 

• Raiseadditional capital through the sale of preferred stock in 2002 and common stockduring 2003.

 

• Obtain acredit facility based in part on the value of its proven reserves.

 

• Continueprivately placed drilling programs, which based on prior experience managementanticipates raising approximately $10 million in 2002.

 

•  Generate turnkey profit from turnkeydrilling contracts equal to approximately 25% of the total amount of totalturnkey price.

 

•  Reduce fixed overhead expenses and primarilyconduct developmental drilling operations in the Company’s two main targetareas, coalbed methane properties in Wyoming and oil formations in theWilmington field in California.

 

As a result of these plans, management believes that it will generatesufficient cash flows to meet its current obligations in 2002.

** **

**RESULTSOF OPERATIONS:**

Three months Ended September 30, 2002 Compared to Three Months EndedSeptember 30, 2001

 

*Turnkeycontract revenue and expenses.* Turnkey contract revenuedecreased $6.4 million in the third quarter to $2.5 million, a 72% decreasecompared to the corresponding quarter of the preceding year. Additionally,turnkey contract expense decreased $6.2 million during the third quarter to$1.8 million, a 77% decrease compared to the same period in 2001. Thesedecreases resulted from a lower level of drilling activity during the thirdquarter compared to the corresponding quarter of the preceding year. The levelof drilling activity is affected by the amount of funds raised from ourdrilling programs in the prior fiscal year. We raised $18.1 million from ourdrilling programs in 2001 compared to $46.5 million during 2000.

 

Gross profit from turnkey contract revenue and expenses was $0.6million or 26% for the third quarter. This compares to gross profit of $0.9million or 10% for the corresponding quarter in 2001. The increase in grossprofit percentage results from additional turnkey revenue recognized due tolower estimated costs to complete our drilling programs. During thecorresponding quarter of 2001, we increased the estimated costs to complete ourdrilling obligation relating to the 2000 and 1999 drilling programs by $1.7million and therefore reducing the related gross profit percentage for thatquarter.

 

*Oil andgas sales and costs from marketing activities.* Oil and gassales from marketing activities decreased $1.5 million in the third quarter to$2.3 million, a 39% decrease compared to the same period last year. Cost of oiland gas marketing activities decreased $1.5 million in the quarter to $2.3million, a 40% decrease compared to the same quarter in 2001. These decreasesresulted from lower production from our drilling programs for the period ascompared to the prior year. Oil and gas production from drilling programs forthe three months ended September 2002 and 2001 was 0.8 Bcfe and 1.4 Bcfe,respectively.

 

The gross profit from marketing activities for the third of 2002 was$40 thousand as compared to $12 thousand in the same period last year.

 

*Wellservices activities.* Well services revenue decreased $1.6million in the third quarter to $0.4 million, a 81% decrease compared to thecorresponding quarter of the preceding year. Well services expense decreased$0.9 million for the third quarter to $0.1 million, a 86% decrease compared tothe same period in 2001. These decreases in well services revenue and expenseresulted from the sale of certain assets of Pinnacle on February 14th,2002, for total consideration of $4.2 million. The operations of Pinnacleceased since the sale.

 

13

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Gross profit from well services activities was $0.2 million for thethird quarter. This compared to gross profit of $0.9 million for thecorresponding quarter last year. This decrease in gross profit resulted fromthe sale of Pinnacle’s operations in February 2002.

 

*Oil andgas sales.* Revenue for oil and gas sales for the thirdquarter decreased $31 thousand to $146 thousand, due to lower production in thequarter compared to the same quarter in the preceding year. Our share ofpre-payout production from drilling programs formed subsequent to 1998 isgenerally 25% of the production allocated to these drilling programs.

 

*Interestand other income.* Interest income increased $0.1 million inthe third quarter to $0.3 million, a 32% increase compared to the same quarterin 2001. Primarily, this increase is attributable to an additional $0.3 millionof USTB interest and is offset by $0.2 million relating to lower interestearned from lower average cash balances during this quarter as compared to thesame quarter in 2001.

 

*Netgain (loss) on investments.* Net gain on investments was $0.2million for the third quarter of 2002 as compared to a negligible loss in 2001.Primarily, investments represent zero coupon U.S. treasury bonds held in ourinventory. Fluctuations in net gain or loss on investments resulted fromchanges in long-term interest rates.

 

*Generaland administrative expenses.* General and administrativeexpenses increased $1.3 million in the third quarter of 2002 to $2.0 million, a189% increase compared to 2001. This increase resulted from allocating a lowerpercentage of salary expense and other administrative expenses to turnkeyexpense during the third quarter of 2002 compared to the similar period in2001, due to reduced drilling activities in turnkey operations as noted above.Also, in the third quarter the Company wrote off $0.8 million of deferredcharges relating to certain IPO expenses.

 

*Depreciation,Depletion and Amortization.* Depreciation, depletion andamortization expense decreased $0.3 million for the quarter to $0.4 million, a42% decrease compared to the corresponding quarter last year. This decreaseresulted from lower depreciation on oil and gas properties due to a lowercarrying value in 2002, as compared to 2001.

 

*Interestexpense.* Interest expense increased $30 thousand in the thirdquarter to $1.5 million, a 2% increase compared to the same quarter last year.Primarily, this increase reflects a reduction in the amount of interestcapitalized resulting from a portion of our properties becoming fullydeveloped.

 

*Production& exploration.* Production and exploration expensedecreased $0.9 million, resulting from the reversal of plugging and abandonmentliabilities of $1.2 million and is partially offset by increased costs relatingto the drilling of a monitor well in Wyoming.

 

Nine months Ended September 30, 2002 Compared to Nine Months EndedSeptember 30, 2001

 

*Turnkeycontract revenue and expenses.* Turnkey contract revenuedecreased $12.3 million to $8.8 million in the first nine months of 2002, a 58%decrease compared to the corresponding nine month period of the preceding year.Additionally, turnkey contract expense decreased $12.4 million during the firstnine months to $6.5 million, a 66% decrease. These decreases resulted from a lowerlevel of drilling activity during the first nine months of 2002 compared to thecorresponding period of the preceding year. The level of drilling activity isaffected by the amount of funds raised from our drilling programs in the priorfiscal year. We raised $18.1 million from our drilling programs in 2001compared to $46.5 million during 2000.

 

Gross profit from turnkey contract revenue and expenses was $2.4million or 27% for the nine months ended September 2002. This compares to grossprofit of $2.2 million or 10% for the corresponding period in 2001. Thisincrease in gross profit percentage results from additional turnkey revenuerecognized due to lower estimated costs to complete our drilling programs.During the corresponding nine months of 2001, we increased the estimated coststo complete our drilling obligation relating to the 2000 and 1999 drillingprograms by $4.2 million and therefore reducing the related gross profitpercentage for that quarter.

 

14

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*Oil andgas sales and costs from marketing activities.* Oil and gassales from marketing activities decreased $3.9 million in the first nine monthsof 2002 to $9.1 million, a 30% decrease compared to the same period last year.Cost of oil and gas marketing activities decreased $4.5 million in the firstnine months to $9.0 million, a 33% decrease compared to the same period in2001. These decreases resulted from a decrease in production from our drillingprograms for the nine months ended September 30, 2002, compared to the sameperiod in 2001 and a reduction in the average sales price per Mcf of gas. Oiland gas production from drilling programs for the nine months of 2002 and 2001was 2.7 Bcfe and 3.8 Bcfe, respectively. The average price of gas marketed andsold for the first nine  months of 2002was $1.91 compared to $3.28 for the same period in 2001.

 

The gross profit from marketing activities for the nine months endedSeptember 2002 was $119 thousand as compared to a $0.5 million loss for thecorresponding period in 2001. The 2001 loss resulted from a hedging transactionwhich expired on March 31, 2001.

 

*Wellservices activities.* Well services revenue decreased $3.0million for the first nine months of 2002 to $1.5 million, a 67% decreasecompared to the corresponding period of the preceding year. Well servicesexpense decreased $1.6 million for the first nine months to $0.7 million, a 70%decrease compared to the same period in 2001. This decrease in well servicesrevenue and expense resulted from the sale of certain assets of Pinnacle onFebruary 14th, 2002, for total consideration of $4.2 million. Theoperations of Pinnacle ceased since the sale. Gross profit from well servicesactivities was $0.8 million for the nine months ended September 2002. Thiscompared to gross profit of $2.1 million for the corresponding period lastyear. This decrease in gross profit results from the discontinuation ofPinnacle’s operations in 2002.

 

*Oil andgas sales.* We have interests in oil and gas productionattributable to our drilling programs. Through and prior to June 30, 2001,virtually all of our production was subordinated to our investors in thedrilling programs. Revenue for oil and gas sales for the first nine months of2002 increased $21 thousand to $344 thousand, resulting from Warren receivingits 25% interest in revenue from the 2000 drilling programs. Our share ofpre-payout production from drilling programs formed subsequent to 1998 isgenerally 25% of the production allocated to these drilling programs.

 

*Interestand other income.* Interest income decreased $0.4 million inthe first nine months of 2002 to $1.2 million, a 26% decrease compared to thesame period in 2001. Primarily, the decrease is attributable to a lower averagecash balance during the first nine months in 2002 compared to the same periodof 2001.

 

*Netgain (loss) on investments.* Net gain on investments was $0.5million for the first nine months of 2002 as compared to a negligible loss in2001. Primarily, investments represent zero coupon U.S. treasury bonds held inour inventory. Fluctuations in net gain or loss on investments resulted fromchanges in long-term interest rates.

 

*Generaland administrative expenses.* General and administrativeexpenses increased $2.6 million for the nine months ending September 2002 to $4.5 million, a 141% increase comparedto 2001. This increase resulted from allocating a lower percentage of salaryexpense and other administrative expenses to turnkey expense during the ninemonths ending September 30, 2002 compared to the corresponding period in 2001,due to reduced drilling activities in turnkey operations as noted above. Also,in the third quarter the Company wrote off $0.8 million of deferred chargesrelating to certain IPO expenses.

 

*Depreciation,Depletion and Amortization.* Depreciation, depletion andamortization expense increased $0.3 million in the first nine months of 2002 to$2.1 million, a 17% increase compared to the corresponding period last year.This increase resulted from a $1.1 million impairment expense on our KirbyDecker property, offset partially by lower depreciation on oil and gasproperties due to a lower carrying value in 2002, as compared to 2001.

 

*Interestexpense.* Interest expense increased $77 thousand in the firstnine months of 2002 to $4.4 million, a 2% increase compared to the same periodlast year. Primarily, this increase reflects a reduction in the amount ofinterest capitalized resulting from a portion of our properties becoming fullydeveloped.

 

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*RepurchaseObligation.* Certain Company sponsored oil and gaspartnerships provide investor partners a right to tender their interest to theCompany for repurchase at specified future dates. In the event the Company doesrepurchase the investor interest, the Company will be entitled to receive anyfuture cash flows from the underlying oil and gas properties. A repurchaseobligation expense and a related liability of $3.3 million was recorded atDecember 31, 2001 based on oil and gas pricing at March 15, 2002. Thedetermination of whether a repurchase liability exists is based upon estimatesof future net cash flows from reserve studies prepared by petroleum engineerscompared to the potential repurchase of drilling program units. During thethree months ended March 31, 2002, the Company assigned additional provedundeveloped leases located in the Wilmington Unit to various partnerships. As aresult the liability was extinguished and a gain was recognized in the firstthree months ended March 31, 2002 of $3.1 million. Based on oil and gas pricesat September 30, 2002, no repurchase obligation existed.

 

*Production& exploration.* Production and exploration expenseincreased $0.7 million in the first nine months of 2002, resulting from the recordingof a dismantlement, restoration and abandonment liability and the relatedexpense of $0.3 million, monitor well expenses of $0.2 million and increasedexpenses relating to our oil and gas sales.

** **

**Item 3****. *Quantitativeand qualitative disclosure about market risk***

 

*CommodityRisk.* Our major market risk exposure is the commodity pricingapplicable to our natural gas and oil production. Realized commodity pricesreceived for our production are primarily driven by the prevailing worldwideprice for crude oil and spot prices applicable to natural gas. The effects ofprice volatility is expected to continue. Below is a description of thefinancial instruments we have used to reduce our exposure to commodity pricerisk. Since March 31, 2001, we have not employed any commodity hedges,derivatives or embedded derivatives, although we may do so in the future.

 

In May 2000, we entered into participating collars to hedge natural gasproduction through March 31, 2001. The participating collars were designated ashedges, and realized losses were recognized in marketing revenues when theassociated production occurred. We hedged approximately 180,000 Mcf per monthfor eleven months with a floor price of $2.50 per Mcf and a ceiling price of$3.55 per Mcf. As a result of this collar for the period ending March 31, 2001,we recorded a hedging loss of $0.5 million.

 

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

 

**Quarterlyevaluation of the company’s Disclosure Controls and Internal Controls.**Withinthe 90 days prior to the filing of this Quarterly Report on Form 10-Q, thecompany evaluated the effectiveness of the design and operation of its“disclosure controls and procedures” (Disclosure Controls), and its “internalcontrols and procedures for financial reporting” (Internal Controls). Thisevaluation (the Controls Evaluation) was done under the supervision and withthe participation of management, including our Chief Executive Officer (CEO)and Chief Financial Officer (CFO). Rules adopted by the SEC require that inthis section of the Quarterly Report we present the conclusions of the CEO andthe CFO about the effectiveness of our Disclosure Controls and InternalControls based on and as of the date of the Controls Evaluation.

 

**CEO andCFO Certifications.**Appearing immediately following theSignatures section of this Quarterly Report there are two separate forms of“Certifications” of the CEO and the CFO. The first form of Certification isrequired in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (theSection 302 Certification). This section of the Quarterly Report which you arecurrently reading is the information concerning the Controls Evaluationreferred to in the Section 302 Certifications and this information should beread in conjunction with the Section 302 Certifications for a more completeunderstanding of the topics presented.

 

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**DisclosureControls and Internal Controls.**Disclosure Controls areprocedures that are designed with the objective of ensuring that informationrequired to be disclosed in our reports filed under the Securities Exchange Actof 1934 (Exchange Act), such as this Quarterly Report, is recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s (SEC) rules and forms. Disclosure Controls are alsodesigned with the objective of ensuring that such information is accumulatedand communicated to our management, including the CEO and CFO, as appropriateto allow timely decisions regarding required disclosure.  Internal Controls are procedures which aredesigned with the objective of providing reasonable assurance that (1)

our transactions are properly authorized; (2) our assets aresafeguarded against unauthorized or improper use; and (3) our transactions areproperly recorded and reported, all to permit the preparation of our financialstatements in conformity with generally accepted accounting principles.

 

**Limitationson the Effectiveness of Controls.**The company’s management,including the CEO and CFO, does not expect that our Disclosure Controls or ourInternal Controls will prevent all error and all fraud. A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, assurance that the objectives of the control system are met. Further,the design of a control system must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Because of the inherent limitations in all control systems, noevaluation of controls can provide absolute assurance that all control issuesand instances of fraud, if any, within the company have been detected. Theseinherent limitations include the realities that judgments in decision-makingcan be faulty, and that breakdowns can occur because of simple error ormistake. Additionally, controls can be circumvented by the individual acts ofsome persons, by collusion of two or more people, or by management override ofthe control. The design of any system of controls also is based in part uponcertain assumptions about the likelihood of future events, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions; over time, control may become inadequate becauseof changes in conditions, or the degree of compliance with the policies orprocedures may deteriorate. Because of the inherent limitations in acost-effective control system, misstatements due to error or fraud may occurand not be detected.

 

**Scope ofthe Controls Evaluation.**The CEO/CFO evaluation of ourDisclosure Controls and our Internal Controls included a review of thecontrols’ objectives and design, the controls’ implementation by the companyand the effect of the controls on the information generated for use in thisQuarterly Report. In the course of the Controls Evaluation, we sought toidentify data errors, controls problems or acts of fraud and to confirm thatappropriate corrective action, including process improvements, were beingundertaken. This type of evaluation will be done on a quarterly basis so thatthe conclusions concerning controls effectiveness can be reported in ourQuarterly Reports on Form 10-Q and Annual****Report on Form 10-K. Our Internal Controlsare also evaluated on an ongoing basis by other personnel in our Accounting andFinance organization and by our independent auditors in connection with theiraudit and review activities. The overall goals of these various evaluationactivities are to monitor our Disclosure Controls and our Internal Controls andto make modifications as necessary; our intent in this regard is that theDisclosure Controls and the Internal Controls will be maintained as dynamicsystems that change (including with improvements and corrections) as conditionswarrant.

 

Among other matters, we sought in our evaluation to determine whetherthere were any “significant deficiencies” or “material weaknesses” in thecompany’s Internal Controls, or whether the company had identified any acts offraud involving personnel who have a significant role in the company’s InternalControls. This information was important both for the Controls Evaluationgenerally and because items 5 and 6 in the Section 302 Certifications of theCEO and CFO require that the CEO and CFO disclose that information to ourBoard’s Audit Committee and to our independent auditors and to report onrelated matters in this section of the Quarterly Report. In the professionalauditing literature, “significant deficiencies” are referred to as “reportableconditions”; these are control issues that could have a significant adverseeffect on the ability to record, process, summarize and report financial datain the financial statements. A “material weakness” is defined in the auditingliterature as a particularly serious reportable condition where the internalcontrol does not reduce to a relatively low level the risk that misstatementscaused by error or fraud may occur in amounts that would be material inrelation to the financial statements and not be detected within a timely periodby employees in the normal course of performing their assigned functions. Wealso sought to deal with other controls matters in the Controls Evaluation, andin each case if a problem was identified, we considered what revision,improvement and/or correction to make in accord with our on-going procedures.

 

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In accord with SEC requirements, the CEO and CFO note that, since thedate of the Controls Evaluation to the date of this Quarterly Report, therehave been no significant changes in Internal Controls or in other factors thatcould significantly affect Internal Controls, including any corrective actionswith regard to significant deficiencies and material weaknesses.

 

**Conclusions.**Based upon the Controls Evaluation, our CEO and CFO haveconcluded that, subject to the limitations noted above, our Disclosure Controlsare effective to ensure that material information relating to Warren and its consolidatedsubsidiaries is made known to management, including the CEO and CFO,particularly during the period when our periodic reports are being prepared,and that our Internal Controls are effective to provide reasonable assurancethat our financial statements are fairly presented in conformity with generallyaccepted accounting principles.

** **

**PART II****—OTHERINFORMATION**

** **

**Item 1. *Legal Proceedings***

 

Except as provided below, we are not engaged in any material legalproceedings to which we or our subsidiaries are a party or to which any of ourproperty is subject.

 

On September 28, 1999, Magness Petroleum Company, our joint venturepartner in the Wilmington Field, filed a complaint against Warren, Pedco, andcertain Warren subsidiaries in the Superior Court of Los Angeles County,alleging that we had breached our joint venture agreement with Magness and analleged oral agreement regarding advance payment of expenses for drilling andcompletion operations. Magness sought dissolution of the joint venture, an accountingand a declaratory judgment as to the rights of the parties under the jointventure agreement. We were successful in enforcing the arbitration provision inthe joint venture agreement and entered into an agreement with Magness tosubmit the matter for arbitration by the Judicial Arbitration MediationServices, or “JAMS,” before the Honorable Keith J. Wisot, a retired Los AngelesSuperior Court Judge. Judge Wisot, as the arbitrator, ruled that the jointventure agreement is a valid enforceable agreement; declined to dissolve thejoint venture; denied Magness’ claims for breach of contract; held that therewas a material breach of the contract by Magness; declared Pedco and Warren areresponsible for supervision and control of drilling and completion operationsand Magness is responsible for production operations; held in favor of Warrenon accounting disputes; and held that he and JAMS would retain jurisdiction toenforce the award. On August 8, 2001, Magness filed a demand with the AmericanArbitration Association, or “AAA,” reasserting its claims for dissolution ofthe joint venture and breach of contract. On August 20, 2001, Warren filed arequest to resume arbitration before Judge Wisot and Magness filed an objectionto such jurisdiction. On September 19, 2001, Warren petitioned the SuperiorCourt of California for Los Angeles County to compel Magness to enter bindingarbitration with Warren before Judge Wisot and JAMS. On October 5, 2001,Magness cross-petitioned to compel Warren to enter binding arbitration withMagness before AAA. On January 3, 2002, the Los Angeles Superior Court grantedWarren’s petition, denied Magness’ petition and ordered Magness to discontinueits efforts to remove the controversy from the jurisdiction of JAMS and toproceed forthwith to arbitration before Judge Wisot of JAMS. Magness appealedthis ruling by the Superior Court and on February 6, 2002, the Court of Appealof the State of California stayed the January 3, 2002 order compellingarbitration before JAMS, pending a hearing on the lower court’s ruling. Thehearing was held before the Court of Appeal on September 27, 2002, but nodecision has yet been issued. Accordingly, pending the ruling by the Court ofappeal and final resolution, further development of the Wilmington Field willbe curtailed.

 

In 1998, Pedco was sued in the 81st Judicial District Courtof Frio County, Texas by Stricker Drilling Company, Inc. and Manning SafetySystems to recover the value of lost equipment based on a well blow out. Warrenwas later joined in the suit as a defendant. As a result of the lawsuit, GothamInsurance Company, Pedco’s well blow-out insurer, intervened. The suit wassettled in 1999 with all parties except Gotham. Gotham paid over $1.7 millionunder the insurance policy and now seeks a refund of approximately $1.5 millionof monies paid, denying coverage, and alleging fraud and misrepresentation anda failure of Pedco to act with due diligence and pursuant to safetyregulations. Pedco countersued for the remaining proceeds under the policycoverage. In the summer and fall of 2000, summary judgments were entered forPedco on essentially all claims except its bad faith claims against Gotham.Gotham’s claims against Pedco and Warren were rejected. Final judgment wasrendered on May 14, 2001 in Pedco’s favor for the remaining 

 

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policy proceeds, interest and attorney fees. Gotham has appealed thefinal judgment. Pedco is defending the judgment on appeal although seeking toreverse the ruling denying its bad faith claim against Gotham. The case onappeal was heard on March 28, 2002 and we are awaiting the appeal court’sdecision on the appeal.

 

We are also a party to legal actions arising in the ordinary course ofour business. In the opinion of our management, based in part on consultationwith legal counsel, the liability, if any, under these claims is eitheradequately covered by insurance or would not have a material adverse effect onus.

 

**Item 2. *Changes in Securities***

 

a. Not applicable

 

b.  Notapplicable

 

c.  Notapplicable

 

**Item 3. *Defaults upon**SeniorSecurities***

 

Not applicable.

 

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

 

On September 5, 2002, we held a special meeting of stockholders. At themeeting, the following matters were considered and approved:

 

1.               A proposal tochange our state of incorporation from New York to Delaware was approved by theholders of greater than 66-2/3% of the outstanding shares of Common Stock ofWarren Resources, Inc., a  New York.Corporation (“Warren New York”), with 12,771,136 shares of Common Stock votedfor this proposal, 394,140 shares of Common Stock voted against this proposal,and 5,136 shares of Common Stock abstaining from the vote.  The reincorporation into Delaware was accomplishedthrough the merger of Warren Resources New York with and into its wholly-ownedsubsidiary, Warren Resources, Inc., a Delaware corporation (“Warren ResourcesDelaware” or the “Company”). As of the effective date of the merger, WarrenResources New York ceased to exist. The reincorporation effects a change in thelegal domicile of the Company and did not result in any change in the Company’sbusiness, management, employees, fiscal year, assets or liabilities, locationof any of the facilities (including corporate headquarters). Pursuant to theAgreement and Plan of Merger between Warren Resources Delaware and WarrenResources New York, each share of Warren Resources New York’s Common Stock,$0.001 par value, was automatically converted into one share of WarrenResources Delaware’s Common Stock, par value $0.0001 per share and eachpreviously issued share of Warren Resources New York Common Stock, $0.001 parvalue per share, was deemed cancelled on the effective date of the merger.

 

1.               A proposal  to adopt the Company’s 2001 Stock IncentivePlan (the “2001 Plan”) was approved by the holders of greater than a majorityof all the shares of Common Stock outstanding with 10,536,400 shares of CommonStock voted for this proposal, 2,462,788 shares of Common Stock voted againstthis proposal, and 171,224 shares of Common Stock abstaining from the vote;

 

2.               A proposal  to adopt the Company’s 2001 Key EmployeeStock Incentive Plan (the “Key Employee Plan”) was approved by the holders ofgreater than a majority of all the shares of Common Stock outstanding with10,455,953 shares of Common Stock voted for this proposal, 2,530,980 shares ofCommon Stock voted against this proposal, and 183,479 shares of Common Stockabstaining from the vote; and

 

3.               A proposal  to adopt the Company’s 2000 Equity IncentivePlan for Employees of Petroleum Development Corporation (the “2000 Plan”) wasapproved by the holders of greater than a majority of all the shares of CommonStock outstanding with 11,277,973 shares of Common Stock voted for thisproposal, 1,706,020 shares of Common Stock voted against this proposal, and186,419 shares of Common Stock abstaining from the vote.

 

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**Item 5****. *OtherInformation***

 

In accord with Section 10A(i)(2) of the Securities Exchange Act of1934, as added by Section 202 of the Sarbanes-Oxley Act of 2002, the company isresponsible for listing the non-audit services approved in the Second Quarterby the company’s Audit Committee to be performed by Grant Thornton LLP, thecompany’s external auditor. Non-audit services are defined in the law asservices other than those provided in connection with an audit or a review ofthe financial statements of the company. The non-audit services approved by theAudit Committee in the Third Quarter are each considered by the company to beaudit-related services which are closely related to the financial auditprocess. Each of the services has been approved in accord with a pre-approvalfrom the Committee’s Chairman pursuant to delegated authority by the Committee.

 

During the quarterly period covered by this filing, the Audit Committeeapproved additional engagements of Grant Thornton LLP for the followingnon-audit services: (1) tax matter consultations and income tax returnpreparations.

 

**Item 6****. *Exhibits andReports on Form 8-K***

 

1. A Current Report on Form 8-K was filed on September11, 2002, under Item 5 setting forth the Registrant’s change of corporatedomicile from the State of New York to the State of Delaware.

 

 

**Signatures,and Certifications of the Chief Executive Officer and the Chief FinancialOfficer of the Company.**

 

The following pages include the Signatures page for this Form 10-Q, andtwo separate Certifications of the Chief Executive Officer (CEO) and the ChiefFinancial Officer (CFO) of the company.

 

The first form of Certification is required by Rule 13a-14 under theSecurities Exchange Act of 1934 (the Exchange Act) in accord with Section 302of the Sarbanes-Oxley Act of 2002 (the Section 302 Certification). The Section302 Certification includes references to an evaluation of the effectiveness ofthe design and operation of the company’s “disclosure controls and procedures”and its “internal controls and procedures for financial reporting”. Item 4 ofPart I of this Quarterly Report presents the conclusions of the CEO and the CFOabout the effectiveness of such controls based on and as of the date of suchevaluation (relating to Item 4 of the Section 302 Certification), and containsadditional information concerning disclosures to the company’s Audit Committeeand independent auditors with regard to deficiencies in internal controls andfraud (Item 5 of the Section 302 Certification) and related matters (Item 6 ofthe Section 302 Certification).

 

The second form of Certification is required by section 1350 of chapter63 of title 18 of the United States Code.

 

 

**SIGNATURES**

 

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

 
|                    | WARREN RESOURCES, INC.  (Registrant) |
|-------------------------|--------------------------------------|
|                    |                                 |   |   |
|                    |                                 |   |   |
| Date: November 14, 2002 | By:                                  |   | /s/ Timothy A. Larkin |   |
|                    |                                 |   | Timothy A. Larkin |
|                    |                                 |   | *Senior  Vice President,* |
|                    |                                 |   | *Chief  Financial Officer and  Principal Accounting Officer* |

 

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**CERTIFICATIONOF CHIEF EXECUTIVE OFFICER**

 

I, Norman F. Swanton, certifythat:

 

1. I have reviewed thisquarterly report on Form 10-Q of Warren Resources, Inc.

 

2. Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3. Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4. The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

 

(a) designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly report is being prepared;

 

(b) evaluated the effectivenessof the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this quarterly report (the “Evaluation Date”);and

 

(c) presented in this quarterlyreport our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent functions):

 

(a) all significant deficienciesin the design or operation of internal controls which could adversely affectthe registrant’s ability to record, process, summarize and report financialdata and have identified for the registrant’s auditors any material weaknessesin internal controls; and

 

(b) any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6. The registrant’s othercertifying officers and I have indicated in this quarterly report whether therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 
| Date: November 14, 2002 |   |
|-------------------------|--------|
|                    |   |   |   |
|                    |   |   |   |
|                    |   |   | /s/ Norman F. Swanton |   |
|                    |   |   | Norman F. Swanton |
|                    |   |   | *Chairman and Chief Executive  Officer* |

 

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**CERTIFICATIONOF CHIEF FINANCIAL OFFICER**

 

I, Timothy A. Larkin, certifythat:

 

1. I have reviewed thisquarterly report on Form 10-Q of Warren Resources, Inc.

 

2. Based on my knowledge, thisquarterly report does not contain any untrue statement of a material fact oromit to state a material fact necessary to make the statements made, in lightof the circumstances under which such statements were made, not misleading withrespect to the period covered by this quarterly report;

 

3. Based on my knowledge, thefinancial statements, and other financial information included in thisquarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, the periods presented in this quarterly report;

 

4. The registrant’s othercertifying officers and I are responsible for establishing and maintainingdisclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and15d-14) for the registrant and have:

 

(a) designed such disclosurecontrols and procedures to ensure that material information relating to theregistrant, including its consolidated subsidiaries, is made known to us byothers within those entities, particularly during the period in which thisquarterly report is being prepared;

 

(b) evaluated the effectivenessof the registrant’s disclosure controls and procedures as of a date within 90days prior to the filing date of this quarterly report (the “Evaluation Date”);and

 

(c) presented in this quarterlyreport our conclusions about the effectiveness of the disclosure controls andprocedures based on our evaluation as of the Evaluation Date;

 

5. The registrant’s othercertifying officers and I have disclosed, based on our most recent evaluation,to the registrant’s auditors and the audit committee of registrant’s board ofdirectors (or persons performing the equivalent functions):

 

(a) all significant deficienciesin the design or operation of internal controls which could adversely affectthe registrant’s ability to record, process, summarize and report financialdata and have identified for the registrant’s auditors any material weaknessesin internal controls; and

 

(b) any fraud, whether or notmaterial, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6. The registrant’s othercertifying officers and I have indicated in this quarterly report whether therewere significant changes in internal controls or in other factors that couldsignificantly affect internal controls subsequent to the date of our mostrecent evaluation, including any corrective actions with regard to significantdeficiencies and material weaknesses.

 

 
| Date: November 14, 2002 |   |
|-------------------------|--------|
|                    |   |   |   |
|                    |   |   |   |
|                    |   |   | /s/ Timothy A. Larkin |   |
|                    |   |   | Timothy A. Larkin |
|                    |   |   | *Senior Vice President,  Chief Financial Officer and  Principal Accounting Office* |

 

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