Table ofContents

 

 

 

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

 

**FORM 10-Q**

 

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

**For the Quarterly Period Ended September 30, 2010**

 

**OR**

** **

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

**For the transition period from              to**

 

**Commission File No. 000-33275**

 

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

 

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

**New York, NY**              | ** ** | **10036**                                |
| (Address of Principal Executive Offices)                        |       | (Zip Code)                               |

 

Registrant’s telephone number, including area code: **(212) 697-9660**

 

Indicateby check mark whether the Registrant (1) has filed all reports required tobe filed by Section 13 and 15 (d) of the Securities Exchange Act of1934 during the preceding 12 months and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes x No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).    Yes  o    No  o

 

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

 

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

 

 

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

 

Yes  o    No  x

 

Theaggregate number of Registrant’s outstanding shares on November 3, 2010was 71,185,417 shares of Common Stock, $0.0001 par value.

 

 

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Table ofContents

 

**WARREN RESOURCES, INC.**

 

**TABLE OF CONTENTS**

 
| PART I—  | FINANCIAL INFORMATION                                                                                        |   |   |
|--------------------|--------------------------------------------------------------------------------------------------------------|--------|--------|
|               |                                                                                                         |   |   |
|               | Item 1.  Financial Statements (Unaudited)                                                                    |   |   |
|               |                                                                                                         |   |   |
|               | Consolidated  Balance Sheets as of September 30, 2010 and December 31, 2009                        |   |   |
|               |                                                                                                         |   |   |
|               | Consolidated  Statements of Operations for the three and nine months ended  September 30, 2010 and 2009 |   |   |
|               |                                                                                                         |   |   |
|               | Consolidated  Statements of Cash Flows for the nine months ended  September 30, 2010 and 2009           |   |   |
|               |                                                                                                         |   |   |
|               | Notes to the Consolidated Financial Statements                                                               |   |   |
|               |                                                                                                         |   |   |
|               | Item 2. Management’s Discussion and Analysis of  Financial Conditions and Results of Operations         |   |   |
|               |                                                                                                         |   |   |
|               | Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                          |   |   |
|               |                                                                                                         |   |   |
|               | Item 4. Controls and Procedures                                                                              |   |   |
|               |                                                                                                         |   |   |
| PART II— | OTHER INFORMATION                                                                                            |   |   |
|               |                                                                                                         |   |   |
|               | Item  1. Legal Proceedings                                                                                   |   |   |
|               |                                                                                                         |   |   |
|               | Item  1A. Risk Factors                                                                                       |   |   |
|               |                                                                                                         |   |   |
|               | Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                         |   |   |
|               |                                                                                                         |   |   |
|               | Item 3. Defaults upon Senior Securities                                                                      |   |   |
|               |                                                                                                         |   |   |
|               | Item  4. Removed and Reserved                                                                                |   |   |
|               |                                                                                                         |   |   |
|               | Item  5. Other Information                                                                                   |   |   |
|               |                                                                                                         |   |   |
|               | Item 6.  Exhibits                                                                                            |   |   |
|               |                                                                                                         |   |   |
|               | Signatures                                                                                                   |   |   |

 

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**PART I—FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**Warren Resources, Inc. andSubsidiaries**

**CONSOLIDATED BALANCE SHEETS**

** **
| ** **                                                                                                                                                                                                                                                                             | ** ** | **September 30,  2010  (Unaudited)**                                          | ** **  | **December 31,  2009** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                             | ** ** | **(in thousands, except share  and per share data)** | ** **  |
| **ASSETS**                                                                                                                                                                                                                                                                             |       |                                                                               |        |                        |       |
| Current Assets                                                                                                                                                                                                                                                                         |       |                                                                               |        |                        |       |
| Cash and cash equivalents                                                                                                                                                                                                                                                              |       | $                                                                                  | 16,376      |                        | $          | 17,238 |   |
| Accounts receivable — trade                                                                                                                                                                                                                                                       |       | 12,533                                                                             |        | 11,104                      |       |
| Restricted investments in U.S. Treasury  Bonds—available for sale, at fair value                                                                                                                                                                                                  |       | 118                                                                                |        | 97                          |       |
| Derivative financial instruments                                                                                                                                                                                                                                                       |       | —                                                                             |        | 421                         |       |
| Other current assets                                                                                                                                                                                                                                                                   |       | 608                                                                                |        | 600                         |       |
|                                                                                                                                                                                                                                                                                   |       |                                                                               |        |                        |       |
| Total current assets                                                                                                                                                                                                                                                                   |       | 29,635                                                                             |        | 29,460                      |       |
|                                                                                                                                                                                                                                                                                   |       |                                                                               |        |                        |       |
| Other Assets                                                                                                                                                                                                                                                                           |       |                                                                               |        |                        |       |
| Oil and gas properties—at cost, based on full cost  method of accounting, net of accumulated depreciation, depletion and  amortization (includes unproved properties excluded from amortization of  $25,925 and $27,976 as of September 30, 2010 and December 31, 2009) |       | 229,183                                                                            |        | 224,552                     |       |
| Property and equipment—at cost, net                                                                                                                                                                                                                                               |       | 8,429                                                                              |        | 1,435                       |       |
| Restricted investments in U.S. Treasury  Bonds—available for sale, at fair value                                                                                                                                                                                                  |       | 1,063                                                                              |        | 875                         |       |
| Other assets                                                                                                                                                                                                                                                                           |       | 3,951                                                                              |        | 4,097                       |       |
|                                                                                                                                                                                                                                                                                   |       |                                                                               |        |                        |       |
| Total other assets                                                                                                                                                                                                                                                                     |       | 242,626                                                                            |        | 230,959                     |       |
| ** **                                                                                                                                                                                                                                                                             | ** ** | **$**                                                                              | **272,261** | ** **                  | **$**      | **260,419** | ** ** |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                                                                                         |       |                                                                               |        |                        |       |
| Current Liabilities                                                                                                                                                                                                                                                                    |       |                                                                               |        |                        |       |
| Current maturities of debentures and other  long-term liabilities                                                                                                                                                                                                                      |       | $                                                                                  | 3,400       |                        | $          | 1,051 |   |
| Accounts payable and accruals                                                                                                                                                                                                                                                          |       | 18,315                                                                             |        | 17,149                      |       |
| Derivative financial instruments                                                                                                                                                                                                                                                       |       | 3,157                                                                              |        | —                      |       |
|                                                                                                                                                                                                                                                                                   |       |                                                                               |        |                        |       |
| Total current liabilities                                                                                                                                                                                                                                                              |       | 24,872                                                                             |        | 18,200                      |       |
|                                                                                                                                                                                                                                                                                   |       |                                                                               |        |                        |       |
| Long-Term Liabilities                                                                                                                                                                                                                                                                  |       |                                                                               |        |                        |       |
| Debentures, less current portion                                                                                                                                                                                                                                                       |       | 1,486                                                                              |        | 1,486                       |       |
| Other long-term liabilities, less current portion                                                                                                                                                                                                                                      |       | 12,254                                                                             |        | 11,277                      |       |
| Derivative financial instruments                                                                                                                                                                                                                                                       |       | 1,263                                                                              |        | 10,798                      |       |
| Line of credit                                                                                                                                                                                                                                                                         |       | 82,500                                                                             |        | 89,900                      |       |
|                                                                                                                                                                                                                                                                                   |       |                                                                               |        |                        |       |
|                                                                                                                                                                                                                                                                                   |       | 97,503                                                                             |        | 113,461                     |       |
|                                                                                                                                                                                                                                                                                   |       |                                                                               |        |                        |       |
| Commitments and Contingencies                                                                                                                                                                                                                                                          |       |                                                                               |        |                        |       |
|                                                                                                                                                                                                                                                                                   |       |                                                                               |        |                        |       |
| Stockholders’ Equity                                                                                                                                                                                                                                                              |       |                                                                               |        |                        |       |
| 8% convertible preferred  stock, par value $.0001; authorized 10,000,000 shares,  issued and outstanding, 10,703 shares and  98,112 in 2010 and 2009, respectively  (aggregate liquidation preference $128 in 2010 and $1,177 in 2009)                                                 |       | 128                                                                                |        | 1,179                       |       |
| Common stock — $.0001 par value; authorized,  100,000,000 shares; issued 71,180,083 shares in 2010 and 70,651,160 shares in  2009                                                                                                                                                 |       | 7                                                                                  |        | 7                           |       |
| Additional paid-in-capital                                                                                                                                                                                                                                                             |       | 462,794                                                                            |        | 460,787                     |       |
| Accumulated deficit                                                                                                                                                                                                                                                                    |       | (312,531                                                                           | )           | (332,600                    | )          |
| Accumulated other comprehensive income, net of  applicable income taxes of $142 in 2010 and $74 in 2009                                                                                                                                                                                |       | 216                                                                                |        | 113                         |       |
|                                                                                                                                                                                                                                                                                   |       | 150,614                                                                            |        | 129,486                     |       |
| Less common stock in Treasury—at cost; 632,250  shares in 2010 and 2009                                                                                                                                                                                                           |       | 728                                                                                |        | 728                         |       |
| Total stockholders’ equity                                                                                                                                                                                                                                                        |       | 149,886                                                                            |        | 128,758                     |       |
| ** **                                                                                                                                                                                                                                                                             | ** ** | **$**                                                                              | **272,261** | ** **                  | **$**      | **260,419** | ** ** |

 

The accompanying notes are an integral part of these financialstatements.

 

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**Warren Resources, Inc. andSubsidiaries**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                 | ** ** | **Three Months Ended  September 30, (Unaudited)**              | ** **  | **Nine Months Ended  September 30, (Unaudited)**               | ** ** |
|------------------------------------------------------------|------------|------------------------------------------------------------------------------------|-------------|------------------------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **(in thousands, except share  and per share data)** | ** **  | **(in thousands, except share  and per share data)** | ** ** |
| ** **                                                 | ** ** | **2010**                                                                           | ** **  | **2009**                                                                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Operating revenues                                         |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Oil and gas sales                                          |       | $                                                                                  | 23,117      |                                                                               | $          | 16,439 |   | $ | 65,688 |   | $ | 43,204 |   |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Operating expenses                                         |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Lease operating expense and taxes                          |       | 7,666                                                                              |        | 5,771                                                                              |       | 21,632 |   | 19,975 |   |
| Depreciation, depletion and amortization                   |       | 5,608                                                                              |        | 5,253                                                                              |       | 15,531 |   | 15,760 |   |
| General and administrative                                 |       | 4,003                                                                              |        | 2,502                                                                              |       | 11,617 |   | 8,582 |   |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Total operating expenses                                   |       | 17,277                                                                             |        | 13,526                                                                             |       | 48,780 |   | 44,317 |   |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Income (loss) from operations                              |       | 5,840                                                                              |        | 2,913                                                                              |       | 16,908 |   | (1,113 | ) |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Other income (expense)                                     |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Interest and other income                                  |       | 97                                                                                 |        | 22                                                                                 |       | 225 |   | 143 |   |
| Interest expense                                           |       | (896                                                                               | )           | (1,658                                                                             | )          | (2,649 | ) | (4,690 | ) |
| Gain (loss) on derivative financial instruments            |       | (746                                                                               | )           | 898                                                                                |       | 5,517 |   | (7,832 | ) |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Total other income (expense)                               |       | (1,545                                                                             | )           | (738                                                                               | )          | 3,093 |   | (12,379 | ) |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Income (loss) before taxes                                 |       | 4,295                                                                              |        | 2,175                                                                              |       | 20,001 |   | (13,492 | ) |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Deferred income tax expense (benefit)                      |       | (25                                                                                | )           | (18                                                                                | )          | (68 | ) | 39 |   |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Net income (loss)                                          |       | 4,320                                                                              |        | 2,193                                                                              |       | 20,069 |   | (13,531 | ) |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Less dividends and accretion on preferred shares           |       | 3                                                                                  |        | 24                                                                                 |       | 16 |   | 72 |   |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Net income (loss) applicable to common  stockholders       |       | $                                                                                  |  4,317 |                                                                               | $          |  2,169 |   | $ |  20,053 |   | $ |  (13,603 | ) |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Earnings (loss) per share — Basic                     |       | $                                                                                  | 0.06        |                                                                               | $          | 0.04 |   | $ | 0.29 |   | $ | (0.23 | ) |
| Earnings (loss) per share — Diluted                   |       | 0.06                                                                               |        | 0.04                                                                               |       | 0.28 |   | (0.23 | ) |
|                                                       |       |                                                                               |        |                                                                               |       |   |   |   |   |
| Weighted average common shares outstanding — Basic    |       | 70,463,901                                                                         |        | 58,243,910                                                                         |       | 70,305,292 |   | 58,231,570 |   |
| Weighted average common shares outstanding —  Diluted |       | 71,548,470                                                                         |        | 59,372,684                                                                         |       | 71,355,853 |   | 58,231,570 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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**Warren Resources, Inc. andSubsidiaries**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **For the nine months ended  September 30, (Unaudited)** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **(in thousands)**                                                                | ** ** |
| ** **                                                                         | ** ** | **2010**                                                                               | ** ** | **2009** | ** ** |
| ** **                                                                         | ** ** | ** **                                                                             | ** ** | ** ** | ** ** |
| Cash flows from operating activities:                                              |       |                                                                                   |       |   |   |
| Net income (loss)                                                                  |       | $                                                                                      | 20,069     |   | $ | (13,531 | ) |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                                                                   |       |   |   |
| Accretion of discount on available-for-sale debt  securities                       |       | (38                                                                                    | )          | (36 | ) |
| Amortization of deferred offering costs                                            |       | 147                                                                                    |       | 153 |   |
| Depreciation, depletion and amortization                                           |       | 15,531                                                                                 |       | 15,760 |   |
| Change in fair value of derivative financial  instruments                          |       | (5,957                                                                                 | )          | 8,965 |   |
| Stock option expense                                                               |       | 1,925                                                                                  |       | 1,455 |   |
| Deferred tax expense (benefit)                                                     |       | (68                                                                                    | )          | 39 |   |
| Change in assets and liabilities:                                                  |       |                                                                                   |       |   |   |
| Increase in accounts receivable—trade                                         |       | (406                                                                                   | )          | (64 | ) |
| Increase in other assets                                                           |       | (9                                                                                     | )          | (5 | ) |
| Increase in accounts payable and accruals                                          |       | 3,167                                                                                  |       | 1,803 |   |
| Decrease in other long-term liabilities                                            |       | (565                                                                                   | )          | — |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash provided by operating activities                                          |       | 33,796                                                                                 |       | 14,539 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Cash flows from investing activities:                                              |       |                                                                                   |       |   |   |
| Purchase, exploration and development of oil and  gas properties                   |       | (22,420                                                                                | )          | (37,705 | ) |
| Purchase of property and equipment                                                 |       | (3,556                                                                                 | )          | — |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash used in investing activities                                              |       | (25,976                                                                                | )          | (37,705 | ) |
|                                                                               |       |                                                                                   |       |   |   |
| Cash flows from financing activities:                                              |       |                                                                                   |       |   |   |
| Proceeds from line of credit                                                       |       | —                                                                                 |       | 7,050 |   |
| Payments on long-term debt                                                         |       | (7,728                                                                                 | )          | (4,836 | ) |
| Issuance of common stock, net                                                      |       | 97                                                                                     |       | — |   |
| Repurchase of preferred stock, net                                                 |       | (1,051                                                                                 | )          | — |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash provided by (used in) financing  activities                               |       | (8,682                                                                                 | )          | 2,214 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net decrease in cash and cash equivalents                                          |       | (862                                                                                   | )          | (20,952 | ) |
|                                                                               |       |                                                                                   |       |   |   |
| Cash and cash equivalents at beginning of period                                   |       | 17,238                                                                                 |       | 29,688 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Cash and cash equivalents at end of period                                         |       | $                                                                                      | 16,376     |   | $ | 8,736 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Supplemental disclosure of cash flow information                                   |       |                                                                                   |       |   |   |
| Cash paid for interest                                                             |       | $                                                                                      | 2,454      |   | $ | 4,697 |   |
| Noncash investing and financing activities                                         |       |                                                                                   |       |   |   |
| Note payable on purchase of property and equipment                                 |       | 3,500                                                                                  |       | — |   |
| Accrued preferred stock dividend                                                   |       | 16                                                                                     |       | 71 |   |

 

The accompanying notes are an integral part of these financialstatements.

 

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** **

**WARREN RESOURCES, INC. ANDSUBSIDIARIES**

** **

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

 

**NOTEA—ORGANIZATION**

 

WarrenResources, Inc. (the “Company” or “Warren”), was originally formed on June 12,1990 for the purpose of acquiring and developing oil and gas properties. TheCompany is incorporated under the laws of the state of Maryland. The Company’sproperties are primarily located in Wyoming, California and New Mexico.

 

Theaccompanying unaudited financial statements and related notes present theCompany’s consolidated financial position as of September 30, 2010 and December 31,2009, the consolidated results of operations for the three and nine months endedSeptember 30, 2010 and 2009 and consolidated cash flows for the ninemonths ended September 30, 2010 and 2009. The unaudited financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialinformation and with the instructions of Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements. In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included. Operatingresults for the nine months ended September 30, 2010 are not necessarilyindicative of the results that may be expected for the fiscal year ending December 31,2010. The accounting policies followed by the Company are set forth in Note Ato the Company’s financial statements included in Form 10-K for the yearended December 31, 2009. These interim financial statements and notesthereto should be read in conjunction with the consolidated financialstatements presented in the Company’s 2009 Annual Report on Form 10-K.

 

**NOTE B**—**STOCK BASED COMPENSATION**

 

*StockOptions*

 

Compensationexpense related to stock options and restricted stock awards recognized inoperating results (general and administrative expenses) was approximately $0.4and $0.5 million for the three months ended September 30, 2010 and September 30,2009, respectively, and approximately $1.9 million and $1.5 million for thenine months ending September 30, 2010 and September 30, 2009respectively.

 

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

 
| ** **              | ** ** | **Nine months ended September 30,** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------|------------|---------------------------------------------------------|------------|------------|------------|------------|------------|------------|
| ** **              | ** ** | **2010**                                                | ** ** | **2009**   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Dividend yield          |       | 0                                                       | %          | 0          | %          |       |       |       |   |   |
| Expected volatility     |       | 77.80                                                   | %          | 69.59      | %          |       |       |       |   |   |
| Risk-free interest rate |       | 1.60                                                    | %          | 1.54       | %          |       |       |       |   |   |
| Expected life           |       | 3.5 years                                               |       | 3.5 years  |       |       |       |       |   |   |

 
| ** **                             | ** ** | **Number  of Options** | ** ** | **Weighted  Average  Exercise   Price** | ** ** | **Weighted  Average  Remaining   Term (in years)** | ** ** | **Aggregate  Intrinsic Value  (in thousands)** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|----------------------------------------------|------------|-------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding at December 31, 2009  |       | 3,419,040                   |       | $                                            | 6.02       |                                                              |       |                                                     |       |   |
| Granted                                |       | 1,098,500                   |       | 2.44                                         |       |                                                              |       |                                                     |       |
| Exercised                              |       | (190,200                    | )          | 0.51                                         |       |                                                              |       |                                                     |       |
| Forfeited or expired                   |       | (690,000                    | )          | 8.37                                         |       |                                                              |       |                                                     |       |
| Outstanding at September 30, 2010 |       | 3,637,340                   |       | $                                            | 4.78       |                                                              | 3.10       |                                                     | $          | 6,376 |   |
|                                   |       |                        |       |                                         |       |                                                              |       |                                                     |       |
| Exercisable at September 30, 2010 |       | 1,401,341                   |       | $                                            | 9.13       |                                                              | 2.14       |                                                     | $          | 1,182 |   |

 

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Thetotal intrinsic value of options exercised during the nine months ended September 30,2010 was approximately $495,000. There were no options exercised in the ninemonths ended September 30, 2009.

 

Asof September 30, 2010, total unrecognized stock-based compensation expenserelated to non-vested stock options was approximately $1.6 million, which weexpect to recognize over a weighted average period of 2.0 years.

 

*Restricted Shares*

 

Restrictedshare activity as of September 30, 2010 was as follows:

 
| ** **                         | ** ** | **Shares** | ** ** | **Weighted  Average  Fair Value** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|----------------------------------------|------------|------------|------------|------------|------------|------------|
| Outstanding at  December 31, 2009  |       | 81,113     |       | $                                      | 11.00      |       |       |       |       |       |   |
| Granted                            |       | 533,437    |       | 2.42                                   |       |       |       |       |       |       |
| Vested                             |       | (450,348)  |       | 3.37                                   |       |       |       |       |       |       |
| Forfeited                          |       | (4,738)    |       | 6.97                                   |       |       |       |       |       |       |
| Outstanding at  September 30, 2010 |       | 159,464    |       | $                                      | 3.97       |       |       |       |       |       |   |

 

Restrictedstock awards for executive officers and employees vest ratably over threeyears, excluding shares granted in March 2010 which vest ratably over ninemonths. Fair value of our restricted shares is based on our closing stock priceon the date of grant.  As of September 30, 2010, total unrecognizedstock-based compensation expense related to non-vested restricted shares was$0.3 million, which is expected to be recognized over a weighted average periodof approximately 0.2 years.

 

**NOTE C**—**CHANGES IN STOCKHOLDERS’ EQUITY**

 

Thepreferred stock pays an 8% cumulative dividend which is treated as a deductionof additional paid in capital, due to insufficient retained earnings. Theholders of the preferred stock are not entitled to vote except as defined bythe agreement or as provided by applicable law. The preferred stock may be voluntarily converted, at the election of theholder, into common stock of the Company based on a conversion rate of oneshare of preferred stock for 0.50 shares of common stock. The accrual of thedividend is deducted from earnings in the calculation of earnings attributableto common stockholders.

 

Additionally,commencing October 1, 2009, holders of the preferred stock can elect torequire the Company to redeem their preferred stock at a redemption price equalto the liquidation value of $12.00 per share, plus accrued but unpaiddividends, 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 amount equal to theRedemption Price or (2) issue to the holder shares of common stock in anamount equal to 125% of the redemption price and any accrued and unpaiddividends, based on the weighted average closing “bid” price of the Company’scommon stock for the thirty trading days immediately preceding the date of thewritten redemption election by the holder up to a maximum of 1.5 shares ofcommon stock for each one share of preferred stock redeemed. The Company hasaccreted the carrying value of its preferred stock to its redemption priceusing the effective interest method with changes recorded to additional paid incapital. The accretion of preferred stock results in a reduction of earningsapplicable to common stockholders. For the nine months ended September 30,2010, the Company redeemed 87,409 shares of preferred stock for an aggregateredemption amount of approximately $1.0 million.

 

Notwithstandingthe forgoing, if the closing “bid” price of the Company’s publicly tradedcommon stock as reported by the NASDAQ stock market, or any exchange on whichthe shares of common stock are traded, exceeds 133% of the conversion pricethen in effect for the convertible preferred shares for at least 10 days duringany 30-day trading period, the Company has the right to redeem in whole or inpart the convertible preferred stock at a redemption price of $12 per share(plus any accrued unpaid dividends) or convert the convertible preferred shares(plus any accrued unpaid dividends) into common stock at the then applicableconversion rate.

 

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**NOTED—EARNINGS (LOSS) PER SHARE**

 

Basicearnings (loss) per share is computed by dividing net earnings (loss)applicable to common stockholders by the weighted average number of shares ofcommon stock outstanding during the period. Diluted earnings (loss) per shareis based on the assumption that stock options and warrants are converted intocommon shares using the treasury stock method and convertible bonds and preferredstock are converted using the if-converted method. Conversion is not assumed ifthe results are anti-dilutive.  Potentialcommon shares for the nine months ended September 30, 2010 and September 30,2009 of 52,522 and 96,941 respectively, relating to convertible bonds andpreferred stock, were excluded from the computation of diluted earnings (loss)per share because they are anti-dilutive. Potential common shares of  2,402,963 and 3,552,191 respectively, relatingto stock options, warrants and restricted stock were excluded from thecomputation of diluted earnings (loss) per share for the nine months ended September 30,2010 and 2009, respectively, because they are anti-dilutive. Stock options havea weighted average exercise price of $4.78 and $6.02 at September 30, 2010and September 30, 2009, respectively. At September 30, 2010, theconvertible bonds may be converted from the date of issuance until maturity at100% of principal amount into common stock of the Company at a price of $35 to$50.  The preferred stock may beconverted at the discretion of the holder or upon meeting certain conditions atthe discretion of the Company (see Note C).

 

Basicand diluted net earnings (loss) per share are computed based on the followinginformation:

 
| ** **                                            | ** ** | **Three Months Ended  September 30, 2010**          | ** ** | **Three Months Ended  September 30, 2009**          | ** ** | **Nine Months Ended  September 30, 2010** | ** ** | **Nine Months Ended  September 30, 2009** | ** ** |
|-------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|-------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                            | ** ** | **(in thousands, except for per  share data)** | ** ** | **(in thousands, except for per  share data)** | ** ** |
| Net earnings (loss) available to common  shareholders |       | $                                                                       | 4,317      |                                                                    | $          | 2,169                                                         |       | $                                                             | 20,053     |   | $ | (13,603 | ) |
|                                                  |       |                                                                    |       |                                                                    |       |                                                          |       |                                                          |       |
| Weighted average shares outstanding - basic           |       | 70,463,901                                                              |       | 58,243,910                                                              |       | 70,305,292                                                    |       | 58,231,570                                                    |       |
| Effect of dilutive securities — stock options    |       | 1,084,569                                                               |       | 1,128,774                                                               |       | 1,050,561                                                     |       | —                                                        |       |
| Effect of dilutive securities — preferred stock  |       | —                                                                  |       | —                                                                  |       | —                                                        |       | —                                                        |       |
| Effect of dilutive securities — warrants         |       | —                                                                  |       | —                                                                  |       | —                                                        |       | —                                                        |       |
|                                                  |       |                                                                    |       |                                                                    |       |                                                          |       |                                                          |       |
| Weighted average shares outstanding - diluted         |       | 71,548,470                                                              |       | 59,372,684                                                              |       | 71,355,853                                                    |       | 58,231,570                                                    |       |
|                                                  |       |                                                                    |       |                                                                    |       |                                                          |       |                                                          |       |
| Basic net earnings (loss) per share                   |       | $                                                                       | 0.06       |                                                                    | $          | 0.04                                                          |       | $                                                             | 0.29       |   | $ | (0.23 | ) |
| Diluted net earnings (loss) per share                 |       | $                                                                       | 0.06       |                                                                    | $          | 0.04                                                          |       | $                                                             | 0.28       |   | $ | (0.23 | ) |

 

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**NOTEE—LONG-TERM LIABILITIES**

 

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

 
| ** **                            | ** ** | **September 30,  2010** | ** ** | **December 31,  2009** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------------------------|------------|-----------------------------|------------|------------|------------|------------|------------|------------|
| ** **                            | ** ** | **(in thousands)**      | ** ** | ** **                  | ** ** | ** ** | ** ** | ** ** |
| Line of Credit                        |       | $                            | 82,500     |                        | $          | 89,900     |       |       |       |       |   |   |
| Convertible debentures                |       | 1,651                        |       | 1,651                       |       |       |       |       |       |       |
| Debt collateralized by treasury stock |       | 278                          |       | 374                         |       |       |       |       |       |       |
| Asset retirement obligations          |       | 8,844                        |       | 8,689                       |       |       |       |       |       |       |
| Litigation allowance                  |       | 3,100                        |       | 3,100                       |       |       |       |       |       |       |
| Drilling rig note payable             |       | 3,267                        |       | —                      |       |       |       |       |       |       |
|                                  |       | 99,640                       |       | 103,714                     |       |       |       |       |       |       |
| Less current portion                  |       | 3,400                        |       | 1,051                       |       |       |       |       |       |       |
| Long-term portion                     |       | $                            | 96,240     |                        | $          | 102,663    |       |       |       |       |   |   |

 

OnNovember 19, 2007, the Company entered into a five year, $250 millioncredit agreement with Merrill Lynch Capital (now owned by GE Business FinancialServices, Inc.). The Credit Facility provides for a revolving credit lineup to the lesser of (i) the borrowing base, (ii) $250 million or (iii) thedraw limit requested by the Company. The Credit Facility matures on November 19,2012. It is secured by substantially all of our assets. The borrowing base willbe determined by the lenders at least semi-annually on each April 1 and October 1and is based in part on the proved reserves of the Company. The currentborrowing base is $120 million. Interest payments are made in arrears. TheCompany repaid $4.9 million under the Credit Facility during the first quarterof 2010, and $2.6 million during the second quarter of 2010 leaving $37.5million of currently available credit. Credit line interest of approximately$0.1 million was accrued as of September 30, 2010. As of September 30,2010, the Company has $82.5 million outstanding on its borrowing base.

 

TheCompany is subject to certain covenants under the terms of the Credit Facilitywhich include, but are not limited to, the maintenance of the followingfinancial ratios (1) minimum current ratio of current assets (includingunused borrowing base in current assets) to current liabilities of 1.0 to 1.0and (2) a minimum annualized consolidated EBITDAX (as defined by theCredit Facility) to net interest expense of 2.5 to 1.0. The Company is incompliance with these covenants as of September 30, 2010.

 

Dependingon the current level of borrowing base usage, the annual interest rate on eachbase rate borrowing under the Credit Facility will be at our option either:(a) a “Base Rate Loan”, or any other Obligation other than a LIBOR Loan,which has an interest rate equal to the sum of the “Base Rate” plus theapplicable “Base Rate Margin”, calculated to be the higher of (i) theAgent’s prime rate of interest announced from time to time, or (ii) theFederal Funds rate most recently determined by the Agent, plus 3.0% per annum,plus an applicable margin that ranges from 1.5% to 2.25%, or (b) a “LIBORLoan”, which has an interest rate equal to the sum of the applicable LIBORperiod plus the applicable “LIBOR Margin”, that ranges from 2.75% to 3.50%.

 

Theconvertible bonds may be converted from the date of issuance until maturity at100% of principal amount into common stock of the Company at prices rangingfrom $35 to $50. Each year the holders of the convertible bonds may tender tothe Company up to 10% of the aggregate bonds issued and outstanding. During thenine months ended September 30, 2010, there were no bond redemptions.

 

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**NOTE F—ASSET RETIREMENT OBLIGATION**

 

Theestimated fair value of the future costs associated with dismantlement,abandonment and restoration of oil and gas properties is recorded generallyupon acquisition or completion of a well. The net estimated costs arediscounted to present values using a risk adjusted rate over the estimatedeconomic life of the oil and gas properties. Such costs are capitalized as partof the related asset. The asset is depleted on the units-of-production method.The associated liability is classified in other long-term liabilities, net ofcurrent portion, in the accompanying Consolidated Balance Sheets. The liabilityis periodically adjusted to reflect (1) new liabilities incurred,(2) liabilities settled during the period, (3) accretion expense, and(4) revisions to estimated future cash flow requirements. The accretionexpense is recorded as a component of depreciation, depletion and amortization.The Company has cash held in escrow with a fair market value of$3.2 million that is legally restricted for potential plugging andabandonment liability in the Wilmington field which is recorded in other assetsin the Consolidated Balance Sheets. A reconciliation of the Company’s assetretirement obligations is as follows:

 
| ** **                             | ** ** | **September 30,  2010** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                             | ** ** | **(in thousands)**      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Balance at beginning of period         |       | $8,689                       |       |       |       |       |       |       |       |       |       |
| Liabilities incurred in current period |       | 106                          |       |       |       |       |       |       |       |       |       |
| Liabilities settled in current period  |       | (565                         | )          |       |       |       |       |       |       |       |       |
| Accretion expense                      |       | 614                          |       |       |       |       |       |       |       |       |       |
| Balance at end of period               |       | $8,844                       |       |       |       |       |       |       |       |       |       |

 

**NOTE G—CONTINGENCIES**

 

In2005, Warren recorded a provision for $1.8 million relating to acontingent liability that the Company may face as a result of a lawsuitoriginally filed in 1998 by Gotham Insurance Company in the 81st JudicialDistrict Court of Frio County, Texas (*GothamInsurance Company v. Pedeco, Inc., et al.,*) seeking a refund ofapproximately $1.8 million paid by Gotham and other insurers under aninsurance policy issued for a well blow-out that occurred in 1997. Afterseveral appeals to the Texas Court of Appeals and the Texas Supreme Court, thecase was remanded to the trial court for further proceedings. Both partiesfiled Motions for Summary Judgment in mid-2009, and on November 19, 2009,the trial court heard oral arguments on both Motions for Summary Judgment. OnJanuary 22, 2010, the court granted Gotham’s Motion for Summary Judgmentfor restitution in the amount of $1,823,156 and also awarded prejudgmentinterest at the rate of 5% per annum in the amount of $976,011. As a result ofthe January 2010 Summary Judgment, Warren recorded an additional provisionof $1.3 million in the fourth quarter of 2009 relating to this contingentliability. On July 7, 2010, Warren E&P posted a supersedeas bond withthe court and commenced the appeal the order of the trial court to the TexasCourt of Appeals. Although Warren believes that it has meritorious grounds forthe appeal, if its appeal is unsuccessful, it will pay the amount ofrestitution to Gotham, as ordered by the trial court.

 

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

 

**NOTEH—COMPREHENSIVE INCOME**

 

Othercomprehensive income consists primarily of net unrealized investment gains andlosses, net of income tax effect. Total comprehensive income for the periods isas follow:

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                                | ** ** | **(in  thousands)**              | ** ** |
| Net income (loss)                                         |       | $                                | 4,320      |                            | $          | 2,193 |   | $ | 20,069 |   | $ | (13,531 | ) |
| Financial assets                                          |       |                             |       |                            |       |   |   |   |   |
| Holding gains (losses) on available for sale  investments |       | 39                               |       | 27                              |       | 103 |   | (59 | ) |
| Comprehensive income (loss)                               |       | $                                | 4,359      |                            | $          | 2,220 |   | $ | 20,172 |   | $ | (13,590 | ) |

 

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**NOTE I—FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

Theestimated fair values of financial instruments recognized in the ConsolidatedBalance Sheets or disclosed within these Notes to Consolidated FinancialStatements have been determined using available market information, informationfrom unrelated third party financial institutions and appropriate valuationmethodologies, primarily discounted projected cash flows. However, considerablejudgment is required when interpreting market information and other data todevelop estimates of fair value.

 

*Short-term Assets andLiabilities.*****The fair values of cash andcash equivalents, accounts receivable, accounts payable and accrued expensesand other current liabilities approximate their carrying values because oftheir short-term nature.

 

*U.S. Treasury Bonds - Trading and Available-For-Sale Securities.*  The fair values are based upon quoted marketprices for those or similar investments and are reported on the ConsolidatedBalance Sheets at fair value.

 

*Collateral Security Agreement Account (included in other non-currentassets).*The balance sheet carrying amount approximates fairvalue, as it earns a market rate.

 

*Convertible Debentures*:****Fair values offixed rate convertible debentures were calculated using interest rates ineffect as of period end for similar instruments with the other terms unchanged.

 

*OtherLong-Term Liabilities*.  Thecarrying amount approximates fair value due the current rates offered to theCompany for long-term liabilities of the same remaining maturities.

 

*Line ofCredit.*The carrying amount approximates fair value due thecurrent rates offered to the Company for lines of credit.

 

*Derivatives.*The fair values are based upon quoted market prices for those or similarderivatives and are reported on the Consolidated Balance Sheets at fair value.

 
| ** **                  | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|-----------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                  | ** ** | **Fair**                         | ** ** | **Carrying**                    | ** ** | **Fair** | ** ** | **Carrying** | ** ** |
| ** **                  | ** ** | **value**                        | ** ** | **amount**                      | ** ** | **value** | ** ** | **amount** | ** ** |
| ** **                  | ** ** | **(in thousands)**          | ** ** |
| Financial assets            |       |                             |       |                            |       |   |   |   |   |
| U.S. Treasury Bonds         |       | $                                | 1,181      |                            | $          | 1,181 |   | $ | 972 |   | $ | 972 |   |
| Collateral security account |       | 3,159                            |       | 3,159                           |       | 3,158 |   | 3,158 |   |
| Derivatives                 |       | —                           |       | —                          |       | 421 |   | 421 |   |
|                        |       |                             |       |                            |       |   |   |   |   |
| Financial liabilities       |       |                             |       |                            |       |   |   |   |   |
| Fixed rate debentures       |       | $                                | 2,041      |                            | $          | 1,651 |   | $ | 1,760 |   | $ | 1,651 |   |
| Other long-term liabilities |       | 3,545                            |       | 3,545                           |       | 373 |   | 373 |   |
| Line of credit              |       | 82,500                           |       | 82,500                          |       | 89,900 |   | 89,900 |   |
| Derivatives                 |       | 4,420                            |       | 4,420                           |       | 10,798 |   | 10,798 |   |

 

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**FAIRVALUE MEASUREMENTS:**

 

Fairvalue as defined by authoritative literature is the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date and establishesa three level hierarchy for measuring fair value. The literature requires fairvalue measurements be classified and disclosed in one of the followingcategories:

 

*Level 1**:*  Quoted prices (unadjusted) in active markets for identical assetsand liabilities that we have the ability to access at the measurement date.

 

*Level 2**:*  Inputsother than quoted prices included within Level 1 that are either directly orindirectly observable for the asset or liability, including quoted prices forsimilar assets or liabilities in active markets, quoted prices for identical orsimilar assets or liabilities in inactive markets, inputs other than quotedprices that are observable for the asset or liability, and inputs that arederived from observable market data by correlation or other means. Instrumentscategorized in Level 2 include non-exchange traded derivatives such asover-the-counter forwards and swaps.

 

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

 

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

 

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

 
| **September 30,  2010**                                                          |       |                |       |        |       |        |       |      |       |
|---------------------------------------------------------------------------------------|------------|---------------------|------------|-------------|------------|-------------|------------|-----------|------------|
| ** **                                                                            | ** ** | **Level 1**         | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|                                                                                  |       | **(in  thousands)** |       |
| **Assets**                                                                            |       |                |       |        |       |        |       |      |       |
| Restricted investments in US Treasury Bonds —  available for sale, at fair value |       | $                   | 1,181      |        | $          | —      |       | $         | —     |   | $ | 1,181 |   |
|                                                                                  |       |                |       |        |       |        |       |      |       |
| ** **                                                                            | ** ** | **Level 1**         | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|                                                                                  |       | **(in  thousands)** |       |
| **Liabilities**                                                                       |       |                |       |        |       |        |       |      |       |
| Commodity  derivative liability                                                       |       | $                   | —     |        | $          | 4,420       |       | $         | —     |   | $ | 4,420 |   |
|                                                                                  |       |                |       |        |       |        |       |      |       |
| **December 31,  2009**                                                           |       |                |       |        |       |        |       |      |       |
| ** **                                                                            | ** ** | **Level 1**         | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|                                                                                  |       | **(in  thousands)** |       |
| **Assets**                                                                            |       |                |       |        |       |        |       |      |       |
| Restricted investments in US Treasury Bonds —  available for sale, at fair value |       | $                   | 972        |        | $          | —      |       | $         | —     |   | $ | 972 |   |
| Commodity  derivative asset                                                           |       | $                   | —     |        | $          | 421         |       | $         | —     |   | $ | 421 |   |
|                                                                                  |       |                |       |        |       |        |       |      |       |
| ** **                                                                            | ** ** | **Level 1**         | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|                                                                                  |       | **(in  thousands)** |       |
| **Liabilities**                                                                       |       |                |       |        |       |        |       |      |       |
| Commodity  derivative liability                                                       |       | $                   | —     |        | $          | 10,798      |       | $         | —     |   | $ | 10,798 |   |

 

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**NOTE J—DERIVATIVE FINANCIAL INSTRUMENTS**

 

Tominimize the effect of a downturn in oil and gas prices and protect ourprofitability and the economics of our development plans, we enter into crudeoil and natural gas hedge contracts. The terms of contracts depend on variousfactors, including management’s view of future crude oil and natural gasprices. This price hedging program is designed to moderate the effects of acrude oil and natural gas price downturn while allowing us to participate in somecommodity price increases. Management regularly monitors the crude oil andnatural gas markets and our financial commitments to determine if, when, and atwhat level some form of crude oil and/or natural gas hedging and/or basisadjustments or other price protection is appropriate. Currently, ourderivatives are in the form of swaps, calls and a costlesscollar.  However, we may use a variety of derivative instruments inthe future to hedge. The Company has not designated these derivatives as hedgesfor accounting purposes.

 

Thefollowing table summarizes the open financial derivative positions as of September 30,2010, related to oil and gas production. The Company will receive prices asnoted in the table below and will pay a counterparty market price based on theNYMEX (for natural gas production) or WTI (for oil production) index price,settled monthly.

 
| **Product** | ** ** | **Type**    | ** ** | **Contract Period**      | ** ** | **Volume**    | ** ** | **Price per  Mcf or Bbl** | ** ** |
|-------------|------------|-------------|------------|-------------------------------|------------|---------------|------------|------------------------------------------|------------|
| Gas         |       | Swap        |       | 02/01/09 - 12/31/10 |       | 3,000 Mcf/d   |       | $6.88                                    |       |
| Gas         |       | Swap        |       | 03/01/09 - 02/28/11 |       | 3,000 Mcf/d   |       | $6.02                                    |       |
| Oil         |       | Collar      |       | 01/01/10 - 12/31/10 |       | 1,000 Bbld    |       | $65 - $106.50                  |       |
| Oil         |       | Swap        |       | 01/01/11 - 12/31/11 |       | 840 Bbld      |       | $61.80                                   |       |
| Gas         |       | Swap        |       | 02/01/10 - 12/31/10 |       | 6,500 Mmbtu/d |       | -$0.38*                                  |       |
| Gas         |       | Swap        |       | 04/01/10 - 11/30/10 |       | 2,500 Mmbtu/d |       | -$0.64*                                  |       |
| Gas         |       | Swap        |       | 01/01/11 - 12/31/11 |       | 6,500 Mmbtu/d |       | -$0.44*                                  |       |
| Gas         |       | Swap        |       | 04/01/11 - 11/30/11 |       | 2,500 Mmbtu/d |       | -$0.71*                                  |       |
| Gas         |       | Swap        |       | 01/01/12 - 12/01/12 |       | 3,000 Mmbtu/d |       | -$0.51*                                  |       |
| Oil         |       | Short  Call |       | 01/01/11 - 01/31/11 |       | 25,000 Bbl    |       | $100.00**                                |       |
| Oil         |       | Long  Call  |       | 04/01/11 - 04/30/11 |       | 25,000 Bbl    |       |   $80.00**                     |       |
| Oil         |       | Short  Call |       | 04/01/11 - 04/30/11 |       | 25,000 Bbl    |       | $100.00**                                |       |
| Oil         |       | Long  Call  |       | 07/01/11 - 07/31/11 |       | 25,000 Bbl    |       |   $80.00**                     |       |
| Oil         |       | Short  Call |       | 07/01/11 - 07/31/11 |       | 25,000 Bbl    |       | $100.00**                                |       |
| Oil         |       | Long  Call  |       | 10/01/11 - 10/31/11 |       | 25,000 Bbl    |       |   $80.00**                     |       |
| Oil         |       | Short  Call |       | 10/01/11 - 10/31/11 |       | 25,000 Bbl    |       | $100.00**                                |       |
| Oil         |       | Long  Call  |       | 01/01/12 - 01/31/12 |       | 25,000 Bbl    |       |   $80.00**                     |       |

----

*                 This represents a differential spread betweenNYMEX and CIG pricing.

**          The Company paid $685,000 innet premiums for these calls.

 

Thetables below summarize the amount of gains (losses) recognized in income fromderivative instruments not designated as hedging instruments under authoritativeguidance.

 
| ** **                                                          | ** ** | **For the Three Months** | ** ** | **For the Nine Months** | ** ** |
|---------------------------------------------------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|
| **Derivatives not designated as**                    | ** ** | **Ended September 30,**       | ** ** | **Ended September 30,**      | ** ** |
| **Hedging Instrument under  authoritative guidance** | ** ** | **2010**                                | ** ** | **2009**                               | ** ** | **2010** | ** ** | **2009** | ** ** |
| **(in thousands)**                                             | ** ** | ** **                              | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                                |       |                                    |       |                                   |       |   |   |   |   |
| Realized cash settlements on hedges                                 |       | $                                       | 1,655      |                                   | $          | (539 | ) | $ | 1,636 |   | $ | 853 |   |
| Unrealized gain (loss) on hedges                                    |       | (2,401                                  | )          | 1,437                                  |       | 3,881 |   | (8,685 | ) |
|                                                                |       |                                    |       |                                   |       |   |   |   |   |
| Total                                                               |       | $                                       | (746       | )                                      | $          | 898 |   | $ | 5,517 |   | $ | (7,832 | ) |

 

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InMay 2010, the Company repurchased 385 Bbld (approximately 141,000 Bbls intotal) under our 2011 $61.80 price swap for $2 million, which is included inrealized cash settlements in gain (loss) on derivative financial instruments.

 

Wepresent our derivative assets and liabilities in our Consolidated BalanceSheets on a net basis. All derivatives are held with one counter party andgains and losses are offset in the Balance Sheet presentation. The table belowreflects the line item in our Consolidated Balance Sheet where the fair valueof our net derivatives, are included.

 
| **September 30, 2010**                         | ** ** | **Derivative Liabilities**  | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|
| **(in thousands)**                                  | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** | ** ** |
| Commodity—Natural Gas                               |       | current                          |       | 1,607 |   |
| Commodity—Natural Gas                               |       | Non -current                     |       | 5 |   |
| Commodity—Oil                                       |       | current                          |       | (4,764 | ) |
| Commodity—Oil                                       |       | Non-current                      |       | (1,268 | ) |
| Total derivatives not designated as hedging  instruments |       |                             |       | $ | (4,420 | ) |
|                                                          |            |                                  |            |  |  |  |

 
| **December 31, 2009**                          | ** ** | **Derivative Assets**       | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|
| **(in thousands)**                                  | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** | ** ** |
| Commodity—Natural Gas                               |       | current                          |       | 1,239 |   |
| Commodity—Oil                                       |       | current                          |       | (818 | ) |
| Total derivatives not designated as hedging  instruments |       |                             |       | $ | 421 |   |
|                                                          |            |                                  |            |  |  |  |

 
| ** **                                               | ** ** | **Derivative Liabilities**  | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|
| **(in thousands)**                                  | ** ** | **Balance Sheet  Location** | ** ** | **Fair Value** | ** ** |
| Commodity—Natural Gas                               |       | Non-current                      |       | (120 | ) |
| Commodity—Oil                                       |       | Non-current                      |       | (10,678 | ) |
| Total derivatives not designated as hedging  instruments |       |                             |       | $ | (10,798 | ) |
|                                                          |            |                                  |            |  |  |  |

 

**NOTE K—RECENTLY ISSUED ACCOUNTING STANDARDS**

 

InJanuary 2010, the Financial Accounting Standards Board (“FASB”) issued newguidance and clarifications for improving disclosures about fair valuemeasurements.  This guidance requires enhanced disclosures regardingtransfers in and out of the levels within the fair valuehierarchy.  Separate disclosures are required for transfers in andout of Level 1 and 2 fair value measurements, and the reasons for the transfersmust be disclosed.  The new disclosures and clarifications ofexisting disclosures are effective for interim and annual reporting periodsbeginning after December 15, 2009. The adoption of this guidance did nothave any effect on the financial statements.

 

**NOTE L—INCOME TAXES**

 

TheCompany’s effective tax rate differs from the federal statutory tax rate due tochanges in the valuation allowance on the Company’s net deferred tax asset.

 

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**Item 2. *Management’s Discussion and Analysis ofFinancial Conditions and Results of Operations***

 

**CAUTIONARY NOTE REGARDING FORWARD-LOOKINGSTATEMENTS**

 

*The Company has made in this report, and may from time totime otherwise make in other public filings, press releases and discussionswith Company management, forward-looking statements within the meaning ofSection 27A of the Securities Act of 1933 and Section 21E of theSecurities Exchange Act of 1934 concerning the Company’s operations, economicperformance and financial condition. These forward-looking statements includeinformation concerning future production and reserves, schedules, plans, timingof development, contributions from oil and gas properties, and those statementspreceded by, followed by or that otherwise include the words “believes,” “expects,”“anticipates,” “intends,” “estimates,” “projects,” “target,” “goal,” “plans,” “objective,”“should” or similar expressions or variations on such expressions. For suchstatements, the Company claims the protection of the safe harbor forforward-looking statements contained in the Private Securities LitigationReform Act of 1995. Although the Company believes that the expectationsreflected in such forward-looking statements are reasonable, it can give noassurance that such expectations will prove to have been correct. Importantfactors that could cause actual results to differ materially from the Company’sexpectations include, but are not limited to, the Company’s assumptions aboutenergy markets, production levels, reserve levels, operating results,competitive conditions, technology, the availability of capital resources,capital expenditures and other contractual obligations, the supply and demandfor and the price of oil, natural gas and other products or services, theweather, inflation, the availability of goods and services, drilling risks,future processing volumes and pipeline throughput, general economic conditions,either internationally or nationally or in the jurisdictions in which theCompany or its subsidiaries are doing business, legislative or regulatorychanges, including changes in environmental regulation, environmental risks andliability under federal, state and local environmental laws and regulations,potential environmental obligations, the securities or capital markets, ourability to repay debt and other factors discussed in “Risk Factors” and in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in the Company’s 2009 Annual Report on Form 10-K, this Form 10-Qand in the Company’s other public filings, press releases and discussions withCompany management. Warren undertakes no obligation to publicly update orrevise any forward-looking statement,**whether as a result of newinformation, subsequent events or otherwise, unless otherwise required by law.*

 

**Overview**

 

Weare an independent energy company engaged in the exploration and development ofdomestic onshore oil and natural gas reserves. We focus our efforts primarilyon our waterflood oil recovery programs and horizontal drilling in the Wilmingtonfield within the Los Angeles Basin of California and on the exploration anddevelopment of coalbed methane (“CBM”) properties located in the Rocky Mountainregion. As of September 30, 2010, we owned oil and natural gas leaseholdinterests in approximately 133,095 gross, 70,700 net acres, approximately 80%of which are undeveloped. Substantially all our undeveloped acreage is locatedin the Rocky Mountains.

 

**Liquidity and Capital Resources**

 

Ourcash and cash equivalents decreased $0.9 million to $16.4 million during thenine months ended September 30, 2010. This resulted from cash provided from operating activities of $33.8million offset by cash used in investing activities of $26 mllion and cash usedin financing activities of $8.7 million.

 

Cashprovided by operating activities was primarily generated by oil and gasoperations.  Cash used in financingactivities primarily represents paying down our outstanding debt on our CreditFacility (as discussed in more detail below). Cash used in investing activities was primarily spent on oil and gasproperties and equipment.

 

OnAugust 26, 2010, Warren purchased an oil drilling rig for $7 million.The Company paid $3.5 million at closing and the balance will be payablein fifteen equal monthly installments, commencing September 30, 2010. Thisrig will be used to drill future oil wells on our California properties.

 

OnNovember 19, 2007, Warren entered into a five year, $250 million creditagreement with Merrill Lynch Capital (subsequently sold to GE Business FinancialServices, Inc.) on behalf of itself and a syndicate of five participatingbanks (the “Credit Facility”).   TheCredit Facility provides for a revolving loan up to the lesser of (i) theborrowing base (ii) $250 million or (iii) the draw limit requested bythe Company.  The Credit Facility matureson November 19, 2012.  It is securedby substantially all of our assets.  Theborrowing base will be determined by the lenders at least semi-annually on orabout April 1 and October 1 of each year, and is based in part on theproved reserves of the Company. The current borrowing base is $120 million,representing an immediate availability of $37.5 million as of September 30,2010.  The Company repaid $7.4 millionunder the Credit Facility during the first nine months of 2010.  The Company is subject to certain covenants 

 

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requiredby the Credit Facility which include, but are not limited to the maintenance ofthe following financial ratios (1) a minimum current ratio (including theunused borrowing base and excluding unrealized gains and losses on derivativefinancial instruments) of not less than 1.0 to 1.0 and (2) a minimumannualized consolidated EBITDAX (as defined by the Credit Facility) to netinterest expense of not less than to of 2.5 to 1.0.  As of September 30, 2010, the Companyhad borrowed $82.5 million under the Credit Facility and was in compliance withall covenants.  If the Company fails tosatisfy its Credit Facility covenants, it would be an event of default.  Under such event of default and upon notice,all borrowings would become immediately due and payable to the lending banks.

 

Dependingon the current level of borrowing base usage, the annual interest rate on eachbase rate borrowing under the Credit Facility will be at our option either:(a) a “Base Rate Loan”, or any other Obligation other than a LIBOR Loan,which has an interest rate equal to the sum of the “Base Rate” plus theapplicable “Base Rate Margin”, calculated to be the higher of (i) theAgent’s prime rate of interest announced from time to time, or (ii) theFederal Funds rate most recently determined by the Agent, plus 3.0% per annum, plusan applicable margin that ranges from 1.5% to 2.25%, or (b) a “LIBOR Loan”,which has an interest rate equal to the sum of the applicable LIBOR period plusthe applicable “LIBOR Margin”, that ranges from 2.75% to 3.50%. During thethird quarter of 2010, the Company incurred $0.8 million of interestexpense under the Credit Facility of which approximately $0.1 million wasaccrued for as of September 30, 2010. The weighted average interest rateas of September 30, 2010, was 3.4%.

 

Ouroperations are affected by local, national and worldwide economic conditions.We have relied on the capital markets, particularly for equity securities, aswell as the banking and debt markets, to meet financial commitments andliquidity needs if internally generated cash flow from operations is notadequate to fund our capital requirements. Capital markets in the United Statesand elsewhere have been experiencing extreme adverse volatility and disruptionfor more than 24 months, due in part to the financial stresses affectingthe liquidity of the banking system, the real estate mortgage industry and thefinancial markets generally. In recent months, this volatility and disruptionhas been reduced. As a result, our access to capital has improved as evidencedby our $29 million equity offering during October 2009.

 

Ifoil and gas commodity prices go lower, the Company may not generate sufficientcash flows to cover capital expenditures. In such case, the availability offunds under our Credit Facility is critical to our Company. The borrowing baseis scheduled to be redetermined in November 2010. If the Credit Facility’sborrowing base is reduced to a level below current borrowings, the Companywould be obligated to begin reducing the deficiency by 25% within 90 daysafter the deficiency occurs and the remaining 75% within 180 days afterthe deficiency occurs.

 

Thecontinuing crisis in the U.S. and world financial and securities markets couldhave a material adverse effect on our business and operations. Additionally,low commodity prices may restrict our ability to meet our current obligations.As a result, Management has taken several actions to ensure that the Companywill have sufficient liquidity to meet its obligations through the next twelvemonths, including a 2010 capital expenditure budget which is expected to befunded by discretionary cash flow, entered into price swap agreements, collarsand differential swap agreements for a portion of its 2010 production to reduceprice volatility, temporarily shut-in three pilot areas in the Atlantic Rimthat are uneconomic at current prices to reduce lease operating expenses,employee reductions and reductions in discretionary expenditures. As of September 30,2010, approximately 50% of the Company’s natural gas production and 35% of theCompany’s oil production are covered by price swaps and collars. It is notanticipated that these percentages will change significantly during theremainder of 2010. If the liquidity of the Company should worsen, the Companywould evaluate other measures to further improve its liquidity, including, thesale of equity or debt securities, the sale of certain assets, entering intojoint ventures with third parties, volumetric production payments, additionalcommodity price hedging and other monetization of assets strategies. There isno assurance that the Company will be successful in these capital raisingefforts that may be necessary to fund operations during the next twelve months.

 

Duringthe third quarter of 2010, the Company had net income of $4.3 million(which included $2.4 million of unrealized losses on derivative financialinstruments). This compares to the third quarter of 2009 when the Company hadnet income of $2.2 million (which included a $1.4 million unrealizedgain on derivative financial instruments). At September 30, 2010, currentassets were $4.7 million more than current liabilities. Currently, theCompany has a borrowing base of $120 million and $82.5 millionoutstanding under the Credit Facility.

 

Inthe future, if natural gas inventories rise to levels such that no natural gasstorage capacity exists, certain U.S. natural gas production will need to bereduced or shut in.  Additionally, ifcommodity prices decline to levels that make it uneconomic to produce oil andnatural gas, the Company or its partners may elect to shut in or reduceproduction.  As a result, some or all ofthe Company’s oil and natural gas production may be shut in or curtailed duringthe next 12 months, which would have a material adverse effect on operations.

 

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TheCompany’s proved reserves may decline in future years.  Due to current commodity prices, compared tothe cost of developing our undeveloped reserves and our estimated leaseoperating expenses, a portion of our future projects may becomeuneconomic.  The Company’s projects havematerial lease operating expenses.  Ouroil operations include a secondary recovery waterflood with significant fixedcosts.  During the third quarter of 2010,our oil lease operating expenses were $15.63 per net barrel of oil produced.Our natural gas operations include reinjecting the produced water into deepformations and compressing and transporting the gas with significant fixed costs.During the third quarter of 2010, our natural gas lease operating expenses were$2.81 per net mcf of gas produced.

 

AtSeptember 30, 2010, we had approximately 1.4 million vested outstandingstock options issued under our stock based equity compensation plans. Of thetotal 1.4 million outstanding vested options, 1.1 million had exercise pricesabove the closing market price $3.97 of our common stock on September 30,2010.

 

*ContractualObligations*

 

Thecontractual obligations table below assumes the maximum amount under contractis tendered each year. The table does not give effect to the conversion of anybonds to common stock which would reduce payments due. All bonds are secured atmaturity by zero coupon U.S. treasury bonds deposited into an escrow accountequaling the par value of the bonds maturing on or before the maturity of thebonds. Such U.S. treasury bonds had a fair market value of $1.2 million at September 30,2010.  The table below does not reflectthe release of escrowed U.S. treasury bonds to us upon redemption.

 
| ** **                                                                     | ** ** | **Payments due by period *** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Contractual Obligations  As of September 30, 2010** | ** ** | **Total**                                        | ** ** | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                                                                     | ** ** | **(in thousands)**                          | ** ** |
| Line of credit                                                                 |       | $                                                | 82,500     |   | $ | — |   | $ | 82,500 |   | $ | — |   | $ | — |   |
| Bonds                                                                          |       | 1,651                                            |       | 165 |   | 282 |   | 229 |   | 975 |   |
| Drilling rig note payable                                                      |       | 3,267                                            |       | 2,800 |   | 467 |   | — |   | — |   |
| Other Accounts Payable                                                         |       | 306                                              |       | 160 |   | 146 |   | — |   | — |   |
| Leases                                                                         |       | 2,006                                            |       | 648 |   | 1,028 |   | 330 |   | — |   |
| Total                                                                          |       | $                                                | 89,730     |   | $ | 3,773 |   | $ | 84,423 |   | $ | 559 |   | $ | 975 |   |

----

*                 Does notinclude estimated interest of $3.0 million less than one year, $3.6 million 1-3years, $0.4 million 3-5 years and $1.3 million thereafter.

 

**RESULTSOF OPERATIONS:**

 

**Three months Ended September 30, 2010 Compared to Three MonthsEnded September 30, 2009**

 

*Oil andgas sales.* Revenue from oil and gas sales increased $6.7million in the third quarter of 2010 to $23.1 million, a 41% increase comparedto the same quarter in 2009.  Thisincrease resulted from an increase in realized energy prices and production ofoil and gas.  The average realized priceper barrel of oil for the three months ended September 30, 2010 and 2009was $68.87 and $60.51, respectively. Additionally, the average realized price per Mcf of gas for the threemonths ended September 30, 2010 and 2009 was $3.87 and $2.71, respectively.  Net oil production for the three months endedSeptember 30, 2010 and 2009 was 265 Mbbls and 226 Mbbls,respectively.  Net gas production for thethree months ended September 30, 2010 and 2009 was 1.3 Bcf and 1.0 Bcf,respectively.

 

*Leaseoperating expense.* Lease operating expense for the third quarter of2010 increased 33% to $7.7 million ($2.70 per Mcfe) compared to $5.8 million($2.43 per Mcfe) in the comparable period of 2009. Primarily, this increaseresulted from higher production and increased maintenance and plugging andabandonment obligations for our California oil properties.

 

*Depreciation,depletion and amortization.*Depreciation, depletion andamortization expense increased $0.4 million for the third quarter of 2010 to$5.6 million, a 7% increase compared to the corresponding quarter lastyear.  The increase in depletion expenseresulted from an increase in oil and gas production.  The 2010 depletion rate decreased to $1.97per mcfe

 

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comparedto $2.21 per mcfe in 2009.  The decreasein the depletion rate on a mcfe basis reflects a reduction in estimated futuredevelopment costs.

 

*Generaland administrative expenses.* General and administrativeexpenses increased $1.5 million in the third quarter of 2010 to $4.0 million, a60% increase compared to the corresponding quarter last year.  This increase resulted from a $1.0 million incentivecompensation accrual.  The Companyanticipates paying year end incentive compensation amounts in March 2011based upon reaching certain operational goals in our incentive compensationplan.  Additionally, audit and legalexpense increased $0.2 million compared to the prior period.

 

*Interestexpense.* Interest expense decreased 46% to $0.9 million inthe third quarter of 2010 compared to the same quarter last year.  The decrease results from a decrease inborrowings under our Credit Facility and a lower effective interest ratethroughout 2010.

 

*Interestand other income.* Interest and other income increased $74 thousand inthe third quarter of 2010 to $97 thousand, a 331% increase compared to the samequarter in 2009. This represents an increase in interest earned due to highercash balances during the current quarter as compared to the correspondingquarter last year.

 

*Gain (loss) on derivative financial instruments.*  Derivative losses of $0.7 million wererecorded during the third quarter of 2010. This amount reflects $1.7 millionof realized gains offset by $2.4 million of unrealized losses resultingfrom mark to market accounting of our oil and gas swaps and costless collarpositions.

 

**Nine months Ended September 30, 2010 Compared to Nine Months EndedSeptember 30, 2009**

 

*Oil andgas sales.* Revenue from oil and gas sales increased $22.5million in the first nine months of 2010 to $65.7 million, a 52% increasecompared to the same period in 2009. This increase resulted from an increase in realized energy prices andproduction of oil and gas.  The averagerealized price per barrel of oil for the nine months ended September 30,2010 and 2009 was $69.65 and $49.33, respectively.  Additionally, the average realized price perMcf of gas for the nine months ended September 30, 2010 and 2009 was $4.29and $2.75, respectively.  Net oilproduction for the nine months ended September 30, 2010 and 2009 was 729Mbbls and 716 Mbbls, respectively.  Netgas production for the nine months ended September 30, 2010 and 2009 was3.5 Bcf and 2.9 Bcf, respectively.

 

*Leaseoperating expense.* Lease operating expense for the first nine monthsof 2010 increased 8% to $21.6 million ($2.75 per Mcfe) compared to $20.0million ($2.79 per Mcfe) in the comparable period of 2009.  Primarily, this increase resulted fromincreased production.

 

*Depreciation,depletion and amortization.*Depreciation, depletion andamortization expense decreased $0.2 million for the first nine months of 2010to $15.5 million, a 1% decrease compared to the corresponding period lastyear.  The 2010 depletion rate decreasedto $1.98 per mcfe compared to $2.20 per mcfe in 2009.  The decrease in the depletion rate on a mcfebasis reflects a reduction in estimated future development costs.  The decrease in depletion expense waspartially offset by an increase in oil and gas production.

 

*Generaland administrative expenses.* General and administrativeexpenses increased $3.0 million in the first nine months of 2010 to $11.6million, a 35% increase compared to the corresponding period last year.  This increase resulted from a $2.0 millionincentive compensation accrual.  TheCompany anticipates paying year end incentive compensation amounts in March 2011based upon reaching certain operational goals in our incentive compensationplan.  Additionally, stock option expenseincreased $0.5 million compared to the prior period.

 

*Interestexpense.* Interest expense decreased 44% to $2.6 million inthe first nine months of 2010 compared to the same period last year.  The decrease results from a decrease inborrowings under our Credit Facility and a lower effective interest ratethroughout 2010.

 

*Interestand other income.* Interest and other income increased $82 thousand inthe first nine months of 2010 to $225 thousand, a 57% increase compared to the sameperiod in 2009. This represents an increase in interest earned due to highercash balances during the current period as compared to the corresponding periodlast year.

 

*Gain (loss) on derivative financial instruments.*  Derivative gains of $5.5 million wererecorded during the first nine months of 2010. This amount reflects $1.6million of realized gains and $3.9 million of unrealized gains resultingfrom mark to market accounting of our oil and gas swaps and costless collarpositions.  Additionally during theperiod, the Company 

 

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repurchasedapproximately 31% of its 2011 oil price swaps (141,000 barrels in theaggregate) for $2 million, which is included in realized cash settlements.

 

**CRITICALACCOUNTING POLICIES**

 

Ourdiscussion and analysis of our financial condition and results of operationsare based on consolidated financial statements that have been prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andjudgments that affect the reported amounts of assets, liabilities, revenues andexpenses. Our 2009 Form 10-K includes a discussion of our criticalaccounting policies.

 

**Item 3. ****Quantitativeand Qualitative Disclosures About Market Risk**

 

***Energy Price Risk***

 

TheCompany’s most significant market risk is the pricing for natural gas and crudeoil. Management expects energy prices to remain volatile and unpredictable. Ifenergy prices decline significantly, revenues and cash flow would significantlydecline. Below is a sensitivity analysis of the Company’s commodity pricerelated derivative instruments.

 

***Commodity Risk***

 

Ourprimary market risk exposure is in the price we receive for our natural gas andoil production. Realized pricing is primarily driven by the prevailingworldwide price for crude oil and spot regional market prices applicable to ourU.S. natural gas production. Pricing for natural gas and oil production hasbeen volatile and unpredictable for several years, and we expect thisvolatility to continue in the future. The prices we receive for productiondepend on many factors outside of our control, including volatility in thedifferences between product prices at sales points and the applicable indexprice.

 

In2009 and 2010 we entered into several financial derivative swap contracts,calls and a costless collar to hedge our exposure to commodity price riskassociated with anticipated future oil and gas production. We believe we willhave more predictability of our crude oil and gas revenues as a result of thesefinancial derivative contracts.

 

Thefollowing table summarizes our open financial derivative positions as of November 3,2010 related to oil and gas production. The Company will receive prices asnoted in the table below and will pay a counterparty market price based on theNYMEX (for natural gas production) or WTI (for oil production) index price,settled monthly.

 
| **Product** | ** ** | **Type**    | ** ** | **Contract Period**      | ** ** | **Volume**    | ** ** | **Price per  Mcf or Bbl** | ** ** |
|-------------|------------|-------------|------------|-------------------------------|------------|---------------|------------|------------------------------------------|------------|
| Gas         |       | Swap        |       | 02/01/09 - 12/31/10 |       | 3,000 Mcf/d   |       | $6.88                                    |       |
| Gas         |       | Swap        |       | 03/01/09 - 02/28/11 |       | 3,000 Mcf/d   |       | $6.02                                    |       |
| Oil         |       | Collar      |       | 01/01/10 - 12/31/10 |       | 1,000 Bbld    |       | $65 - $106.50                  |       |
| Oil         |       | Collar      |       | 01/01/11 - 12/31/11 |       | 700 Bbld      |       | $70 - $101                     |       |
| Oil         |       | Swap        |       | 01/01/11 - 12/31/11 |       | 840 Bbld      |       | $61.80                                   |       |
| Gas         |       | Swap        |       | 02/01/10 - 12/31/10 |       | 6,500 Mmbtu/d |       | -$0.38*                                  |       |
| Gas         |       | Swap        |       | 04/01/10 - 11/30/10 |       | 2,500 Mmbtu/d |       | -$0.64*                                  |       |
| Gas         |       | Swap        |       | 01/01/11 - 12/31/11 |       | 6,500 Mmbtu/d |       | -$0.44*                                  |       |
| Gas         |       | Swap        |       | 04/01/11 - 11/30/11 |       | 2,500 Mmbtu/d |       | -$0.71*                                  |       |
| Gas         |       | Swap        |       | 01/01/12 - 12/01/12 |       | 3,000 Mmbtu/d |       | -$0.51*                                  |       |
| Oil         |       | Short  Call |       | 01/01/11 - 01/31/11 |       | 25,000 Bbl    |       | $100.00**                                |       |
| Oil         |       | Long  Call  |       | 04/01/11 - 04/30/11 |       | 25,000 Bbl    |       |   $80.00**                     |       |
| Oil         |       | Short  Call |       | 04/01/11 - 04/30/11 |       | 25,000 Bbl    |       | $100.00**                                |       |
| Oil         |       | Long  Call  |       | 07/01/11 - 07/31/11 |       | 25,000 Bbl    |       |   $80.00**                     |       |
| Oil         |       | Short  Call |       | 07/01/11 - 07/31/11 |       | 25,000 Bbl    |       | $100.00**                                |       |
| Oil         |       | Long  Call  |       | 10/01/11 - 10/31/11 |       | 25,000 Bbl    |       |   $80.00**                     |       |
| Oil         |       | Short  Call |       | 10/01/11 - 10/31/11 |       | 25,000 Bbl    |       | $100.00**                                |       |
| Oil         |       | Long  Call  |       | 01/01/12 - 01/31/12 |       | 25,000 Bbl    |       |   $80.00**                     |       |

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*                 This represents a differential spread betweenNYMEX and CIG pricing.

**          The Companypaid $685,000 in net premiums for these calls.

 

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***Interest Rate Risk***

 

AtSeptember 30, 2010, we had debt outstanding under our Credit Facility of$82.5 million.  Depending on the currentlevel of borrowing base usage, the annual interest rate on each base rateborrowing under the Credit Facility will be at our option either: (a) a “BaseRate Loan”, or any other Obligation other than a LIBOR Loan, which has aninterest rate equal to the sum of the “Base Rate” plus the applicable “BaseRate Margin”, calculated to be the higher of (i) the Agent’s prime rate ofinterest announced from time to time, or (ii) the Federal Funds rate mostrecently determined by the Agent, plus 3.0% per annum, plus an applicablemargin that ranges from 1.5% to 2.25%, or (b) a “LIBOR Loan”, which has aninterest rate equal to the sum of the applicable LIBOR period plus theapplicable “LIBOR Margin”, that ranges from 2.75% to 3.50%.

 

***Other*** ***Financial Instruments***

 

Otherfinancial instruments consist of the following: cash and cash equivalents, U.S.treasury bonds, collateral security accounts, line of credit and otherlong-term liabilities. The carrying amounts of these instruments approximatefair market value due to the highly liquid nature of these short-terminstruments or they are reported at fair value.

 

***Inflation and Changes in Prices***

 

Thegeneral level of inflation affects our costs. Salaries and other general andadministrative expenses are impacted by inflationary trends and the supply anddemand of qualified professionals and professional services. Inflation andprice fluctuations affect the costs associated with exploring for and producingnatural gas and oil, which have a material impact on our financial performance.

 

***Forward-Looking Statements and Risk***

 

Certainstatements in this report, including statements of the future plans,objectives, and expected performance of the company, are forward-lookingstatements that are dependent upon certain events, risks and uncertainties thatmay be outside the company’s control, and which could cause actual results todiffer materially from those anticipated. Some of these include, but are notlimited to, the market prices of oil and gas, economic and competitiveconditions, exploration risks such as drilling unsuccessful wells,higher-than-expected costs, potential liability for remedial actions underexisting or future environmental regulations and litigation, potentialliability resulting from pending or future litigation,  environmental and regulatory uncertaintiesthat could delay or prevent drilling, and not successfully completing, or anymaterial delay of, any development of new or existing fields, expansion, orcapital expenditure, legislative and regulatory changes, financial marketconditions, political and economic uncertainties of foreign governments, futurebusiness decisions, and other uncertainties, all of which are difficult topredict. Forward-looking statements are generally accompanied by words such as “estimate”,“project”, “predict”, “will”, “anticipate”, “plan”, “intend”, “believe”, “expect”or similar expressions that convey the uncertainty of future events oroutcomes. You should not place undue reliance on these forward-lookingstatements, which speak only as of the date of this report. Unless legallyrequired, Warren does not undertake any obligation to update anyforward-looking statements, as a result of new information, future events orotherwise. Certain risks that may affect Warren’s results of operations andfinancial position appear in Part 1, Item 1A “Risk Factors” of Warren’s2009 Annual Report on Form 10-K.

 

Thereare numerous uncertainties inherent in estimating quantities of proved oil andgas reserves and in projecting future rates of production and the timing ofdevelopment expenditures. The total amount or timing of actual futureproduction may vary significantly from reserves and production estimates. Thedrilling of exploratory wells can involve significant risks, including thoserelated to timing, success rates and cost overruns. Lease and rig availability,complex geology and other factors can affect these risks. Fluctuations in oiland natural gas prices or a prolonged continuation of low prices may adverselyaffect the company’s financial position, results of operations and cash flows.

 

**Item 4. ****Controlsand Procedures**

 

***Evaluation of Disclosure Controls and Procedures***

 

Our management, under the supervision and with the participation of ourChief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), hasevaluated the effectiveness of our disclosure controls and procedures asdefined in

 

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Securities and Exchange Commission (“SEC”) Rule 13a-15(e) and15d-15(e) as of the end of the period covered by this report.  Based upon that evaluation, management  has concluded that our  disclosure controls  and  procedures are  effective to ensure  that information  we are required to disclose in reports thatwe file or submit under the Securities Exchange Act is communicated tomanagement, including the CEO and CFO, as appropriate to allow timelydecisions  regarding required disclosureand is  recorded,  processed, summarized  and  reported within the time periods specified in the SEC’s rules and forms.

 

***Changes in Internal Control over Financial Reporting***

 

Therehave been no changes in our internal controls over financial reporting or inother factors during the quarter ended September 30, 2010, that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting.

 

**PART II—OTHER INFORMATION**

 

**Item 1. *Legal Proceedings***

 

Informationwith respect to this item may be found in Note G to the Consolidated FinancialStatements (Part I, Item 1), which is incorporated herein byreference.

 

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

 

Ourbusiness has many risks. In addition to the other information set forth in thisreport and our press releases and other reports and materials that we file withthe Securities and Exchange Commission, you should carefully consider thefactors discussed in Part I, “Item 1A. Risk Factors” in our Annual Reporton Form 10-K for the year ended December 31, 2009, and in ourRegistration Statement on Form S-3, and the prospectus supplement thereto,in connection with our public offering on October 23, 2009, which couldmaterially affect our business, financial condition, operating results orliquidity and the trading price of our common stock.  Additionalrisks and uncertainties not currently known to us or that we currently deem tobe immaterial also may materially adversely affect our business, financial conditionand/or operating results.

 

**Item 2. *Unregistered Sales of Equity Securities andUse of Proceeds***

 

a.    Notapplicable

 

b.    Notapplicable

 

c.    Notapplicable

 

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

 

Not applicable.

 

**Item 4. *Removed and Reserved***

 

**Item 5. *Other Information***

 

Not applicable.

 

**Item 6. *Exhibits***

*** ***

**a)**                                      **Exhibits**

Exhibitsnot incorporated by reference to a prior filing are designated by an (*) andare filed herewith; all exhibits not so designated are incorporated herein byreference to a prior filing as indicated.

 

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Table ofContents

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

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*    Filed herewith.

 

**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 

|                         | WARREN  RESOURCES, INC.  (Registrant) |
|------------------------------|--------------------------------------------|
|                         |                                       |   |
| Date:  November 3, 2010 |                                       | /s/  Timothy A. Larkin |   |
|                         | By:                                        | Timothy  A. Larkin*Executive Vice President,  Chief Financial Officer and  Principal Accounting Officer* |

 

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