Table of Contents

** **

 

** **

**UNITEDSTATES**

**SECURITIESAND 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 EndedSeptember 30, 2009**

** **

**OR**

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

 

**For thetransition period from       to       **

 

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

# ** **

**WARRENRESOURCES, INC.**

(Exact Name ofRegistrant as Specified in its Charter.)

 

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

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

 

Registrant’stelephone number, including area code:

**(212)697-9660**

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13and 15 (d) of the Securities Exchange Act of 1934 during the preceding 12months and (2) has been subject to such filing requirements for the past90 days.  Yes x  No o

 

Indicate by check mark whether the registrant hassubmitted electronically and posted on its corporate Web site, if any, every

Interactive DataFile required to be submitted and posted pursuant to Rule 405 of Regulation S-T(§232.405 of this chapter) during the

preceding 12months (or for such shorter period that the registrant was required to submitand post such files).  Yes o  Noo

 

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

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No x

 

The aggregate number of Registrant’s outstanding shares on November 4,2009 was 70,651,160 shares of Common Stock, $0.0001 par value.

 

 

 

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Table of Contents

 

**WARRENRESOURCES, INC.**

 

**TABLE OFCONTENTS**

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

 

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**PART I—FINANCIAL INFORMATION**

 

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

###### ** **

**Warren Resources, Inc. and Subsidiaries**

**CONSOLIDATED BALANCE SHEETS**

 
| ** **                                                                                                                                                                                                                                                                          | ** ** | **September 30,  2009  (Unaudited)**            | ** **  | **December 31,  2008** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|-------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                          | ** ** | **(in thousands, except share  and per share data)** | ** **  |
| **ASSETS**                                                                                                                                                                                                                                                                          |       |                                                 |        |                        |       |
| Current  Assets                                                                                                                                                                                                                                                                     |       |                                                 |        |                        |       |
| Cash  and cash equivalents                                                                                                                                                                                                                                                          |       | $                                                    | 8,736       |                        | $          | 29,688 |   |
| Accounts  receivable – trade                                                                                                                                                                                                                                                   |       | 9,745                                                |        | 9,680                       |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                                                               |       | 103                                                  |        | 109                         |       |
| Inventory                                                                                                                                                                                                                                                                           |       | 2,019                                                |        | —                      |       |
| Other  current assets                                                                                                                                                                                                                                                               |       | 737                                                  |        | 734                         |       |
|                                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Total  current assets                                                                                                                                                                                                                                                               |       | 21,340                                               |        | 40,211                      |       |
|                                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Other  Assets                                                                                                                                                                                                                                                                       |       |                                                 |        |                        |       |
| Oil and gas properties—at cost, based on full cost  method of accounting, net ofaccumulated depreciation, depletion and  amortization (includes unprovedproperties excluded from amortization of  $26,353 and $27,116 as ofSeptember 30, 2009 and December 31, 2008) |       | 226,018                                              |        | 239,438                     |       |
| Property  and equipment—at cost, net                                                                                                                                                                                                                                           |       | 1,534                                                |        | 2,011                       |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                                                               |       | 929                                                  |        | 985                         |       |
| Other  assets                                                                                                                                                                                                                                                                       |       | 4,137                                                |        | 3,988                       |       |
|                                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Total  other assets                                                                                                                                                                                                                                                                 |       | 232,618                                              |        | 246,422                     |       |
| ** **                                                                                                                                                                                                                                                                          | ** ** | **$**                                                | **253,958** | ** **                  | **$**      | **286,633** | ** ** |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                       |       |                                                 |        |                        |       |
| Current  Liabilities                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Current  maturities of debentures and other long-term liabilities                                                                                                                                                                                                                   |       | $                                                    | 413         |                        | $          | 315 |   |
| Accounts  payable and accruals                                                                                                                                                                                                                                                      |       | 17,863                                               |        | 49,616                      |       |
| Derivative  financial instruments                                                                                                                                                                                                                                                   |       | 1,754                                                |        | —                      |       |
|                                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Total  current liabilities                                                                                                                                                                                                                                                          |       | 20,030                                               |        | 49,931                      |       |
|                                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Long-Term  Liabilities                                                                                                                                                                                                                                                              |       |                                                 |        |                        |       |
| Debentures,  less current portion                                                                                                                                                                                                                                                   |       | 1,508                                                |        | 1,508                       |       |
| Other  long-term liabilities, less current portion                                                                                                                                                                                                                                  |       | 10,390                                               |        | 10,769                      |       |
| Derivative  financial instruments                                                                                                                                                                                                                                                   |       | 7,211                                                |        | —                      |       |
| Line  of credit                                                                                                                                                                                                                                                                     |       | 115,000                                              |        | 112,400                     |       |
|                                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
|                                                                                                                                                                                                                                                                                |       | 134,109                                              |        | 124,677                     |       |
|                                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Commitments  and Contingencies                                                                                                                                                                                                                                                      |       |                                                 |        |                        |       |
|                                                                                                                                                                                                                                                                                |       |                                                 |        |                        |       |
| Stockholders’  Equity                                                                                                                                                                                                                                                          |       |                                                 |        |                        |       |
| 8% convertible preferred stock, par value $.0001;  authorized 10,000,000 shares,  issued and  outstanding, 98,112 shares in 2009 and 2008, respectively  (aggregate liquidation preference $1,178 in  2009 and $1,177 in 2008)                                                      |       | 1,179                                                |        | 1,177                       |       |
| Common  stock - $.0001 par value; authorized, 100,000,000 shares; issued 58,876,160  shares in 2009 and 58,825,881 shares in 2008                                                                                                                                                   |       | 6                                                    |        | 6                           |       |
| Additional  paid-in-capital                                                                                                                                                                                                                                                         |       | 431,626                                              |        | 430,243                     |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                |       | (332,412                                             | )           | (318,881                    | )          |
| Accumulated  other comprehensive income, net of applicable income taxes of $74 in 2009 and  $137 in 2008                                                                                                                                                                            |       | 148                                                  |        | 208                         |       |
|                                                                                                                                                                                                                                                                                |       | 100,547                                              |        | 112,753                     |       |
| Less  common stock in Treasury—at cost; 632,250 shares in 2009 and 2008                                                                                                                                                                                                        |       | 728                                                  |        | 728                         |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                                    |       | 99,819                                               |        | 112,025                     |       |
| ** **                                                                                                                                                                                                                                                                          | ** ** | **$**                                                | **253,958** | ** **                  | **$**      | **286,633** | ** ** |

 

The accompanyingnotes are an integral part of these financial statements.

 

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** **

**WarrenResources, Inc. and Subsidiaries**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                 | ** ** | **Three Months Ended**             | ** ** | **Nine Months Ended**              | ** ** |
|------------------------------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| ** **                                                 | ** ** | **September 30, (Unaudited)** | ** ** | **September 30, (Unaudited)** | ** ** |
| ** **                                                 | ** ** | **(in thousands, except share**    | ** ** | **(in thousands, except share**    | ** ** |
| ** **                                                 | ** ** | **and per share data)**            | ** ** | **and per share data)**            | ** ** |
| ** **                                                 | ** ** | **2009**                           | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Operating revenues                                         |       |                               |       |                               |       |   |   |   |   |
| Oil and gas sales                                          |       | $                                  | 16,439     |                               | $          | 33,926 |   | $ | 43,204 |   | $ | 91,646 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Operating expenses                                         |       |                               |       |                               |       |   |   |   |   |
| Lease operating expense and taxes                          |       | 5,771                              |       | 8,304                              |       | 19,975 |   | 20,687 |   |
| Depreciation,  depletion and amortization                  |       | 5,253                              |       | 5,175                              |       | 15,760 |   | 13,601 |   |
| General  and administrative                                |       | 2,502                              |       | 3,640                              |       | 8,582 |   | 11,438 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Total  operating expenses                                  |       | 13,526                             |       | 17,119                             |       | 44,317 |   | 45,726 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Income  (loss) from operations                             |       | 2,913                              |       | 16,807                             |       | (1,113 | ) | 45,920 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Other  income (expense)                                    |       |                               |       |                               |       |   |   |   |   |
| Interest  and other income                                 |       | 22                                 |       | 297                                |       | 143 |   | 866 |   |
| Interest  expense                                          |       | (1,658                             | )          | (1,283                             | )          | (4,690 | ) | (3,856 | ) |
| Gain  (loss) on derivative financial instruments           |       | 898                                |       | —                             |       | (7,832 | ) | — |   |
| Net  gain on investments                                   |       | —                             |       | —                             |       | — |   | 93 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Total  other income (expense)                              |       | (738                               | )          | (986                               | )          | (12,379 | ) | (2,897 | ) |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Income  (loss) before taxes                                |       | 2,175                              |       | 15,821                             |       | (13,492 | ) | 43,023 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Deferred  income tax expense (benefit)                     |       | (18                                | )          | (2                                 | )          | 39 |   | 34 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Net  income (loss)                                         |       | 2,193                              |       | 15,823                             |       | (13,531 | ) | 42,989 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Less  dividends and accretion on preferred shares          |       | 24                                 |       | 23                                 |       | 72 |   | 77 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Net  income (loss) applicable to common stockholders       |       | $                                  | 2,169      |                               | $          | 15,800 |   | $ | (13,603 | ) | $ | 42,912 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Earnings  (loss) per share – Basic                    |       | $                                  | 0.04       |                               | $          | 0.27 |   | $ | (0.23 | ) | $ | 0.74 |   |
| Earnings  (loss) per share – Diluted                  |       | 0.04                               |       | 0.27                               |       | (0.23 | ) | 0.73 |   |
|                                                       |       |                               |       |                               |       |   |   |   |   |
| Weighted  average common shares outstanding – Basic   |       | 58,243,910                         |       | 58,832,654                         |       | 58,231,570 |   | 57,935,207 |   |
| Weighted  average common shares outstanding – Diluted |       | 59,372,684                         |       | 59,359,482                         |       | 58,231,570 |   | 58,660,202 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

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**Warren Resources, Inc. and Subsidiaries**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **For the nine months ended********September 30, (Unaudited)** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **(in thousands)**                                                  | ** ** |
| ** **                                                                         | ** ** | **2009**                                                            | ** ** | **2008** | ** ** |
| ** **                                                                         | ** ** | ** **                                                          | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                             |       |                                                                |       |   |   |
| Net income (loss)                                                                  |       | $                                                                   | (13,531    | ) | $ | 42,989 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                                                |       |   |   |
| Accretion of  discount on available-for-sale debt securities                       |       | (36                                                                 | )          | (40 | ) |
| Amortization and  write-off of deferred bond offering costs                        |       | 153                                                                 |       | 122 |   |
| Gain on sale of  US treasury bonds — available for sale                       |       | —                                                              |       | (93 | ) |
| Depreciation,  depletion and amortization and impairment                           |       | 15,760                                                              |       | 13,601 |   |
| Loss on  derivative financial instruments                                          |       | 8,965                                                               |       | — |   |
| Stock option  expense                                                              |       | 1,455                                                               |       | 1,724 |   |
| Deferred tax  expense                                                              |       | 39                                                                  |       | 34 |   |
| Change in assets and  liabilities:                                                 |       |                                                                |       |   |   |
| Increase in  accounts receivable—trade                                        |       | (64                                                                 | )          | (6,193 | ) |
| Decrease  (Increase) in other assets                                               |       | (5                                                                  | )          | 1,142 |   |
| Decrease in  accounts payable and accruals                                         |       | 1,803                                                               |       | 2,221 |   |
|                                                                               |       |                                                                |       |   |   |
| Net cash  provided by operating activities                                         |       | 14,539                                                              |       | 55,507 |   |
|                                                                               |       |                                                                |       |   |   |
| Cash flows from  investing activities:                                             |       |                                                                |       |   |   |
| Purchase,  exploration and development of oil and gas properties                   |       | (37,705                                                             | )          | (85,375 | ) |
| Purchase of  property and equipment                                                |       | —                                                              |       | (246 | ) |
| Proceeds from  U.S. Treasury Bonds—available-for-sale                         |       | —                                                              |       | 426 |   |
|                                                                               |       |                                                                |       |   |   |
| Net cash used in  investing activities                                             |       | (37,705                                                             | )          | (85,195 | ) |
|                                                                               |       |                                                                |       |   |   |
| Cash flows from  financing activities:                                             |       |                                                                |       |   |   |
| Proceeds from  line of credit                                                      |       | 7,050                                                               |       | 51,248 |   |
| Payments on debt  and debentures                                                   |       | (4,836                                                              | )          | (853 | ) |
| Issuance of  common stock, net                                                     |       | —                                                              |       | 2,942 |   |
| Proceeds from  short swing sale of stock                                           |       | —                                                              |       | 92 |   |
| Repurchase of  preferred stock, net                                                |       | —                                                              |       | (2,025 | ) |
|                                                                               |       |                                                                |       |   |   |
| Net cash  provided by financing activities                                         |       | 2,214                                                               |       | 51,404 |   |
|                                                                               |       |                                                                |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | (20,952                                                             | )          | 21,716 |   |
|                                                                               |       |                                                                |       |   |   |
| Cash and cash  equivalents at beginning of period                                  |       | 29,688                                                              |       | 12,815 |   |
|                                                                               |       |                                                                |       |   |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                                   | 8,736      |   | $ | 34,531 |   |
|                                                                               |       |                                                                |       |   |   |
| Supplemental disclosure  of cash flow information                                  |       |                                                                |       |   |   |
| Cash paid for  interest                                                            |       | $                                                                   | 4,697      |   | $ | 3,192 |   |
| Noncash  investing and financing activities                                        |       |                                                                |       |   |   |
| Accrued preferred stock dividend                                                   |       | 71                                                                  |       | 73 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

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**WARRENRESOURCES, INC. AND SUBSIDIARIES**

 

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

 

**NOTE A—ORGANIZATION**

 

Warren Resources, Inc.(the “Company” or “Warren”), was originally formed on June 12, 1990 forthe purpose of acquiring and developing oil and gas properties. The Company isincorporated under the laws of the state of Maryland. The Company’s propertiesare primarily located in Wyoming, California and New Mexico.

 

Theaccompanying unaudited financial statements and related notes present theCompany’s consolidated financial position as of September 30, 2009 and December 31,2008, the consolidated results of operations for the three and nine monthsended September 30, 2009 and 2008 and consolidated cash flows for the ninemonths ended September 30, 2009 and 2008. 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, 2009, are not necessarilyindicative of the results that may be expected for the fiscal year ending December 31,2009. 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, 2008. These interim financial statements and notesthereto should be read in conjunction with the consolidated financialstatements presented in the Company’s 2008 Annual Report on Form 10-K.

 

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

 

At September 30,2009, the Company had cash and cash equivalents of $8.7 million, a workingcapital surplus of $1.3 million (including a net unrealized loss in currentliabilities of $1.5 million related to the derivative financial instruments)and had earnings of $2.2 million (including a unrealized gain of $1.4 millionrelated to the mark-to-market of derivative financial instruments) for thethree months ended September 30, 2009. In order to improve its liquidity position, on October 23, 2009,the Company sold 11.8 million shares of common stock at $2.60 per share.  The Company received net proceeds of $28.9million.  Warren used $7.6 million of theproceeds to pay down debt under its Credit Facility which will subsequently bedrawn in order to finance existing development activities and general corporatepurposes.  The Company depends on itsCredit Facility, as described in Note F, for a portion of its operating andcapital needs.  Currently the Company has$107.4 million outstanding under the Credit Facility which matures in November 2012and has a borrowing base of $120 million. The borrowing base was re-determinedduring the fourth quarter of 2009.  Ifthe borrowing base is reduced to a level below the current outstanding balance,the Company would be obligated to reduce the deficiency by 25% within 90 daysand has an additional 90 days to cure the remaining deficiency.

 

Management has takenseveral actions to ensure that the Company will have sufficient liquidity tomeet its obligations through December 31, 2009, including selling commonshares and receiving net proceeds of $28.9 million during October 2009,reducing its 2009 capital expenditure budget to $9 million, entering into priceswap agreements for a portion of its 2009 production to reduce pricevolatility, temporarily shutting-in three pilot areas in the Atlantic Rim thatare uneconomic at current prices to reduce lease operating expenses, reducingits employee workforce and reducing in discretionary expenditures, includingelimination of year-end bonuses and implementation of a salary freeze in 2009.The Company is also evaluating other measures to further improve its liquidity,including volumetric production payments, additional commodity price hedgingand other monetization of assets strategies. Management believes that theseactions will enable the Company to meet its liquidity requirements through thenext twelve months.

 

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

##### ** **

*Stock Options*

 

Compensation expense related to stock options andrestricted stock awards recognized in operating results (general andadministrative expenses) was approximately $0.5 and $0.6 million for the threemonths ended September 30, 2009 and September 30, 2008, respectively,and $1.5 million and $1.7 million for the nine months ended September 30,2009 and September 30, 2008, respectively.

 

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

 
| ** **               | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------|------------|------------------------------------------|------------|
| ** **               | ** ** | **2009**                                 | ** ** | **2008** | ** ** |
| Dividend  yield          |       | 0                                        | %          | 0 | % |
| Expected  volatility     |       | 69.59                                    | %          | 48.22 | % |
| Risk-free  interest rate |       | 1.54                                     | %          | 2.06 | % |
| Fair  value of options   |       | $                                        | 0.28       |   | $ | 4.20 |   |
| Expected  life           |       | 3.5 years                                |       | 3.5 years |   |
|                          |            |                                          |            |  |  |  |  |

 
| ** **                              | ** ** | ** **     | ** ** | **Weighted** | ** ** | **Weighted**        | ** ** | ** **          | ** ** |
|-----------------------------------------|------------|----------------|------------|--------------|------------|---------------------|------------|---------------------|------------|
| ** **                              | ** ** | ** **     | ** ** | **Average**  | ** ** | **Average**         | ** ** | **Aggregate**       | ** ** |
| ** **                              | ** ** | **Number**     | ** ** | **Exercise** | ** ** | **Remaining**       | ** ** | **Intrinsic Value** | ** ** |
| ** **                              | ** ** | **of Options** | ** ** | **Price**    | ** ** | **Term (in years)** | ** ** | **(in thousands)**  | ** ** |
| Outstanding  at December 31, 2008  |       | 2,477,715      |       | $            | 10.15      |                |       |                |       |   |
| Granted                                 |       | 1,619,874      |       | 0.56         |       |                |       |                |       |
| Exercised                               |       | —         |       | —       |       |                |       |                |       |
| Forfeited  or expired                   |       | (678,549       | )          | 8.06         |       |                |       |                |       |
| Outstanding  at September 30, 2009 |       | 3,419,040      |       | $            | 6.02       |                | 3.02       |                | $          | 3,888 |   |
|                                    |       |           |       |         |       |                |       |                |       |
| Exercisable  at September 30, 2009 |       | 1,417,330      |       | $            | 10.85      |                | 1.39       |                | $          | — |   |

 

Thetotal intrinsic value of options exercised during the nine months ended September 30,2008 was $5.2 million. There were no options exercised in the nine months endedSeptember 30, 2009.

 

As of September 30,2009, total unrecognized stock-based compensation expense related to non-vestedstock options was $1.6 million, which we expect to recognize over a weightedaverage period of 1.4 years.

 

*RestrictedShares*

 

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

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

 

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Restricted stock awardsfor executive officers and employees vest ratably over three years. Fair valueof our restricted shares is based on our closing stock price on the date ofgrant.  As of September 30, 2009, total unrecognized stock-basedcompensation expense related to non-vested restricted shares was $0.7 million,which is expected to be recognized over a weighted average period of approximately1.3 years.

 

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

#### ** **

The preferred stock paysan 8% cumulative dividend which is treated as a deduction of additional paid incapital, due to insufficient retained earnings. The holders of the preferredstock are not entitled to vote except as defined by the agreement or asprovided by applicable law.  Thepreferred stock may be voluntarily converted, at the election of the holder,into common stock of the Company based on a conversion rate of one share ofpreferred stock for 0.50 shares of common stock. The accrual of the dividend isdeducted from earnings in the calculation of earnings attributable to commonstockholders.

 

Additionally, commencing October 1,2009, holders of the preferred stock can elect to require the Company to redeemtheir preferred stock at a redemption price equal to the liquidation value of$12.00 per share, plus accrued but unpaid dividends, if any, (“Redemption Price”).  Upon the receipt of a redemption election,the Company, at its option, shall either: (1) pay the holder cash in theamount equal to the Redemption Price or (2) issue to the holder shares ofcommon stock in an amount equal to 125% of the redemption price and any accruedand unpaid dividends, based on the weighted average closing “bid” price of theCompany’s common stock for the thirty trading days immediately preceding thedate of the written redemption election by the holder up to a maximum of 1.5shares of common stock for each one share of preferred stock redeemed. TheCompany is accreting the carrying value of its preferred stock to itsredemption price using the effective interest method with changes recorded toadditional paid in capital. The accretion of preferred stock results in areduction of earnings applicable to common stockholders.

 

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

 

**NOTE E—EARNINGS (LOSS) PER SHARE**

 

Basic earnings (loss) pershare is computed by dividing net earnings (loss) applicable to commonstockholders by the weighted average number of shares of common stockoutstanding during the period. Diluted earnings (loss) per share is based onthe assumption that stock options and warrants are converted into common sharesusing the treasury stock method and convertible bonds and preferred stock areconverted using the if-converted method. Conversion is not assumed if theresults are anti-dilutive.  Potentialcommon shares for the nine months ended September 30, 2009 and September 30,2008 of  96,941 and 48,743 respectively,relating to convertible bonds and preferred stock, were excluded from thecomputation of diluted earnings (loss) per share because they areanti-dilutive. Potential common shares of 3,552,191 and 2,875,526 respectively, relating to stock options,warrants and restricted stock were excluded from the computation of dilutedearnings (loss) per share for the nine months ended September 30, 2009 and2008, respectively, because they are anti-dilutive. Stock options have aweighted average exercise price of $6.02 and $10.20 at September 30, 2009and September 30, 2008, respectively. At September 30, 2009, 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 D).

 

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

 
| ** **                                            | ** ** | **Three Months  Ended********September 30,  2009** | ** ** | **Three Months  Ended********September 30, 2008** | ** ** | **Nine Months  Ended********September 30,  2009** | ** ** | **Nine Months  Ended********September 30,  2008** | ** ** |
|-------------------------------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                            | ** ** | **(in thousands, except for per  share data)**          | ** ** | **(in thousands, except for per  share data)**              | ** ** |
| Net  earnings (loss) available to common shareholders |       | $                                                       | 2,169      |                                                        | $          | 15,800                                                 |       | $                                                      | (13,603    | ) | $ | 42,912 |   |
|                                                  |       |                                                    |       |                                                        |       |                                                   |       |                                                   |       |
| Weighted  average shares outstanding - basic          |       | 58,243,910                                              |       | 58,832,654                                                  |       | 58,231,570                                             |       | 57,935,207                                             |       |
| Effect  of dilutive securities – stock options   |       | 1,128,774                                               |       | 312,834                                                     |       | —                                                 |       | 389,673                                                |       |
| Effect  of dilutive securities – preferred stock |       | —                                                  |       | 50,763                                                      |       | —                                                 |       | 50,763                                                 |       |
| Effect  of dilutive securities – warrants        |       | —                                                  |       | 163,231                                                     |       | —                                                 |       | 284,559                                                |       |
|                                                  |       |                                                    |       |                                                        |       |                                                   |       |                                                   |       |
| Weighted  average shares outstanding - diluted        |       | 59,372,684                                              |       | 59,359,482                                                  |       | 58,231,570                                             |       | 58,660,202                                             |       |
|                                                  |       |                                                    |       |                                                        |       |                                                   |       |                                                   |       |
| Basic  net earnings (loss) per share                  |       | $                                                       | 0.04       |                                                        | $          | 0.27                                                   |       | $                                                      | (0.23      | ) | $ | 0.74 |   |
| Diluted  net earnings (loss) per share                |       | $                                                       | 0.04       |                                                        | $          | 0.27                                                   |       | $                                                      | (0.23      | ) | $ | 0.73 |   |

 

**NOTE F—LONG-TERM LIABILITIES**

 

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

 

| ** **                             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2009**               | ** ** | **2008**              | ** ** |
| ** **                             | ** ** | **(in thousands)**     | ** ** |
|                                   |       |                   |       |                  |       |
| Line  of Credit                        |       | $                      | 115,000    |                  | $          | 112,400 |   |
| Convertible  debentures                |       | 1,676                  |       | 1,676                 |       |
| Debt  collateralized by treasury stock |       | 404                    |       | 489                   |       |
| Asset  retirement obligations          |       | 8,408                  |       | 8,604                 |       |
| Litigation  allowance                  |       | 1,823                  |       | 1,823                 |       |
|                                   |       | 127,311                |       | 124,992               |       |
| Less  current portion                  |       | 413                    |       | 315                   |       |
| Long-term  portion                     |       | $                      | 126,898    |                  | $          | 124,677 |   |

 

On November 19,2007, the Company entered into a five year, $250 million credit agreement withMerrill Lynch Capital (now owned by GE Business Financial Services, Inc.)The Credit Facility provides for a revolving credit line up to the lesser of (i) theborrowing base, (ii) $250 million or (iii) the draw limit requestedby the Company. The Credit Facility matures on November 19, 2012. It issecured by substantially all of our assets. The borrowing base will bedetermined by the lenders at least semi-annually on each April 1 and October 1and is based in part on the proved reserves of the Company. The currentborrowing base is $120 million. Interest payments are made quarterly inarrears. During the first quarter of 2009 the Company drew down approximately$7.35 million under this facility. During April 2009 and October 2009,the Company repaid $4.75 million and $7.6 million respectively, of theborrowings, leaving $12.6 million of currently available credit. Credit lineinterest of approximately $0.4 million was accrued as of September 30,2009. Currently the Company has $107.4 million outstanding on its borrowingbase.

 

The Company is subject tocertain covenants under the terms of the Credit Facility which include, but arenot limited to, the maintenance of the following financial ratios (1) minimumcurrent ratio of current assets (including unused borrowing base in currentassets) to current liabilities of 1.0 to 1.0 and (2) a minimum annualizedconsolidated EBITDAX (as defined by 

 

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the Credit Facility) tonet interest expense to of 2.5 to 1.0. As of September 30, 2009, the Company has borrowed $115 millionunder the Credit Facility and was in compliance with all covenants.

 

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

 

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

 

#### **NOTE G—CONTINGENCIES**

#### ** **

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

 

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

 

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

 

**NOTE H—COMPREHENSIVE INCOME**

 

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

 
| ** **                              | ** ** | **2009**            | ** ** | **2008** | ** ** |
|-----------------------------------------|------------|---------------------|------------|----------|------------|
| ** **                              | ** ** | **(in  thousands)** | ** ** |
| Nine  Months ending September 30,  |       | $                   | (13,591    | )        | $          | 42,938 |   |
| Three  Months ending September 30, |       | $                   | 2,220      |     | $          | 15,828 |   |

 

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

#### ** **

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

 

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

 

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

 

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

 

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

 

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

 

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

 
| ** **                   | ** ** | **September 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|------------------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                   | ** ** | **Fair**                    | ** ** | **Carrying**               | ** ** | **Fair** | ** ** | **Carrying** | ** ** |
| ** **                   | ** ** | **value**                   | ** ** | **amount**                 | ** ** | **value** | ** ** | **amount** | ** ** |
| ** **                   | ** ** | **(in thousands)**          | ** ** |
|                         |       |                        |       |                       |       |   |   |   |   |
| Financial  assets            |       |                        |       |                       |       |   |   |   |   |
| U.S.  Treasury Bonds         |       | $                           | 1,031      |                       | $          | 1,031 |   | $ | 1,094 |   | $ | 1,094 |   |
| Collateral  security account |       | 3,157                       |       | 3,157                      |       | 3,154 |   | 3,154 |   |
| Financial  liabilities       |       |                        |       |                       |       |   |   |   |   |
| Fixed  rate debentures       |       | $                           | 1,876      |                       | $          | 1,676 |   | $ | 2,543 |   | $ | 1,676 |   |
| Other  long-term liabilities |       | 404                         |       | 404                        |       | 489 |   | 489 |   |
| Derivatives                  |       | 8,965                       |       | 8,965                      |       | — |   | — |   |
| Line  of credit              |       | 115,000                     |       | 115,000                    |       | 112,400 |   | 112,400 |   |

 

**FAIRVALUE MEASUREMENTS:**

 

Fair value as defined byauthoritative literature is the price that would be received to sell an assetor paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date and establishes a three level hierarchy formeasuring fair value. The statement requires fair value measurements beclassified and disclosed in one of the following categories:

 

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

 

*Level 2**:*  Inputs other than quoted prices includedwithin Level 1 that are either directly or indirectly observable for the assetor liability, including quoted prices for similar assets or liabilities inactive markets, quoted prices for identical or similar assets or liabilities ininactive markets, inputs other than quoted prices that are observable for theasset or liability, 

 

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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**:*  Unobservable inputs for the asset orliability, including situations where there is little, if any, market activityfor 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, 2009**                  | ** ** | **Level 1**         | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|----------------------------------------------|------------|---------------------|------------|-------------|------------|-------------|------------|-----------|------------|
| ** **                                   | ** ** | **(in thousands)**  | ** ** |
| **Assets**                                   |       |                |       |        |       |        |       |      |       |
| Restricted  investments in US Treasury Bonds |       |                |       |        |       |        |       |      |       |
| –  available for sale, at fair value    |       | $                   | 1,031      |        | $          | —      |       | $         | —     |   | $ | 1,031 |   |
|                                         |       |                |       |        |       |        |       |      |       |   |   |   |   |
| ** **                                   | ** ** | **Level 1**         | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|                                         |       |                |       |        |       |        |       |      |       |
| **Liabilities**                              |       |                |       |        |       |        |       |      |       |
| Commodity  derivative liability              |       | $                   | 280        |        | $          | 8,685       |       | $         | —     |   | $ | 8,965 |   |
|                                         |       |                |       |        |       |        |       |      |       |   |   |   |   |
| **December 31, 2008**                   | ** ** | **Level 1**         | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| ** **                                   | ** ** | **(in  thousands)** | ** ** |
| **Assets**                                   |       |                |       |        |       |        |       |      |       |
| Restricted  investments in US Treasury Bonds |       |                |       |        |       |        |       |      |       |
| –  available for sale, at fair value    |       | $                   | 1,094      |        | $          | —      |       | $         | —     |   | $ | 1,094 |   |

 

**NOTE J —DERIVATIVE FINANCIAL INSTRUMENTS**

 

To minimize the effect ofa downturn in oil and gas prices and protect our profitability and theeconomics of our development plans, we enter into crude oil and natural gashedge contracts. The terms of contracts depend on various factors, includingmanagement’s view of future crude oil and natural gas prices. This pricehedging program is designed to moderate the effects of a crude oil and naturalgas price downturn while allowing us to participate in some commodity priceincreases. Management regularly monitors the crude oil and natural gas marketsand our financial commitments to determine if, when, and at what level someform of crude oil and/or natural gas hedging and/or basis adjustments or otherprice protection is appropriate. Currently, our derivatives are in the form ofswaps.  However, we may use a variety of derivative instruments inthe future to hedge. The Company has not designated these derivatives ashedges.

 

The following tablesummarizes the open financial derivative positions as of September 30, 2009related to oil and gas production. The Company will receive prices as noted inthe table below and will pay a counterparty market price based on the NYMEX(for natural gas production) or WTI (for oil production) index price, settledmonthly.

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

 

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

 

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| **Derivatives  not designated as Hedging**    | ** ** | **Amount of Gain (Loss)  Recognized in Income for  Derivatives not designated as  Hedging Instruments under  authoritative guidance** | ** ** | **Amount of Gain (Loss)  Recognized in Income for  Derivatives not designated as  Hedging Instruments under  authoritative guidance** | ** ** |
|-----------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Instrument  under authoritative  guidance** | ** ** | **Three months ended September  30, 2009 (in thousands)**                                                                             | ** ** | **Nine months ended September  30, 2009 (in thousands)**                                                                              | ** ** |
| Realized  cash settlements on hedges          |       | $                                                                                                                                     | (539       | )                                                                                                                                     | $          | 853 |   |
| Unrealized  gain (loss) on hedges             |       | 1,437                                                                                                                                 |       | (8,685                                                                                                                                | )          |
| Total                                         |       | $                                                                                                                                     | 898        |                                                                                                                                  | $          | (7,832 | ) |

 

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

 
| ** **                                                                   | ** ** | **Derivative Liabilities** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------|------------|
| **(in thousands)**                                                           | ** ** | **Balance Sheet Location** | ** ** | **Fair Value** | ** ** |
| Commodity  – Natural Gas                                                |       | current                    |       | $ | 1,635 |   |
| Commodity  – Natural Gas                                                |       | Non-current                |       | (393 | ) |
| Commodity  – Oil                                                        |       | current                    |       | (3,389 | ) |
| Commodity  – Oil                                                        |       | Non-current                |       | (6,818 | ) |
|                                                                         |       |                       |       |   |   |
| Total  derivatives not designated as hedging instruments under Statement 133 |       |                       |       | $ | (8,965 | ) |

 

**NOTE K — RECENTLYISSUED ACCOUNTING STANDARDS**

 

In June 2009, theFASB issued guidance on the FASBAccounting Standards Codification and the Hierarchy of Generally AcceptedAccounting Principles. This guidance establishes the Codification as theauthoritative source of generally accepted accounting principles in the UnitedStates. Rules and interpretive releases of the Securities and ExchangeCommission (SEC) under federal securities laws are also sources ofauthoritative GAAP for SEC registrants. The codification changes thereferencing and organization on financial standards and is effective forfinancial statements issued for interim and annual periods ending after September 15,2009. As codification is not intended to change the existing accountingguidance, its adoptions did not have an impact on our financial statements.

 

In April 2009, theFASB issued guidance on Interim Disclosures about Fair Value of FinancialInstruments.  This guidance requires that interim disclosures on thefair value of financial instruments be reported in interim reporting as well asin annual financial statements.  The adoption of this guidance didnot have a material impact on our financial statements.

 

In April 2009, theFASB issued guidance on SubsequentEvents. This guidance establishes general standards of accounting forand disclosure of events that occur after the balance sheet date but beforefinancial statements are issued or available to be issued. We adopted thisguidance beginning in the second quarter of 2009, in accordance with theeffective date. The Company has evaluated subsequent events through November 4,2009, which is the date these financial statements were issued.

 

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In December 2007,the FASB issued guidance on Business Combinations which established principlesand requirements on how the acquirer recognizes and measures in its financialstatements the assets acquired, the liabilities assumed, any noncontrollinginterest in the acquiree and the goodwill acquired. This statement appliesprospectively and was effective for the Company beginning January 1, 2009but will only impact the Company if and when the Company becomes party to abusiness combination.

 

In March 2008,the FASB issued guidance on disclosures about derivative instruments andhedging activities. This guidance is intended to improve financial reportingabout derivative instruments and hedging activities by requiring companies toenhance disclosure about how these instruments and activities affect theirfinancial position, performance and cash flows. It seeks to achieve theseimprovements by requiring disclosure of the fair values of derivativeinstruments and their gains and losses in a tabular format. It also seeks toimprove the transparency of the location and amounts of derivative instrumentsin a company’s financial statements and how they are accounted for. Thisguidance was effective for the Company beginning January 1, 2009.

 

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

 

**NOTE L —NATURAL GAS AND OIL RESERVES**

 

The following tablepresents our estimated proved natural gas and oil reserves and the PV-10 valueof our interests in net reserves in producing properties as of December 31,2008, 2007 and 2006 based on reserve reports prepared by Williamson PetroleumConsultants, Inc. The PV-10 values shown in the table are not intended torepresent the current market value of the estimated natural gas and oilreserves we own.

 

For2006, a portion of our proved developed reserves had been accumulated throughour interests in drilling programs for which we served as managing generalpartner. These estimates of future net cash flows and their present values,based on period end prices, were based upon certain assumptions that thedrilling programs in which we owned interests would achieve payout status inthe future. During 2007, we acquired all oil and gas properties and associatedreserves from the drilling partnerships.

 

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| ** **                                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                  | ** ** | **2008**                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| **Estimated Proved Natural Gas and Oil Reserves:**                          |       |                              |       |   |   |   |   |
| Net  natural gas reserves (MMcf):                                           |       |                              |       |   |   |   |   |
| Proved  developed                                                           |       | 52,762                            |       | 21,852 |   | 9,264 |   |
| Proved  undeveloped                                                         |       | 20,063                            |       | 15,916 |   | 15,561 |   |
| Total                                                                       |       | 72,825                            |       | 37,768 |   | 24,825 |   |
| Net  oil reserves (MBbls):                                                  |       |                              |       |   |   |   |   |
| Proved  developed                                                           |       | 6,498                             |       | 11,202 |   | 9,583 |   |
| Proved  undeveloped                                                         |       | 2,916                             |       | 41,908 |   | 44,494 |   |
| Total(1)                                                                    |       | 9,414                             |       | 53,110 |   | 54,077 |   |
| **Estimated Present Value of Net Proved Reserves:**                         |       |                              |       |   |   |   |   |
| PV-10  Value (in thousands)                                                 |       |                              |       |   |   |   |   |
| Proved  developed                                                           |       | $                                 | 157,855    |   | $ | 464,331 |   | $ | 205,683 |   |
| Proved  undeveloped                                                         |       | 36,133                            |       | 583,637 |   | 403,201 |   |
| Total(2)                                                                    |       | 193,988                           |       | 1,047,968 |   | 608,884 |   |
| Less:  future income taxes, discounted at 10%                               |       | —                            |       | 228,817 |   | 196,308 |   |
| Standardized  measure of discounted future net cash flows (in thousands)(3) |       | $                                 | 193,988    |   | $ | 819,151 |   | $ | 412,576 |   |
| **Prices Used in Calculating Reserves:**                                    |       |                              |       |   |   |   |   |
| Natural  Gas (per Mcf)                                                      |       | $                                 | 4.80       |   | $ | 5.02 |   | $ | 4.35 |   |
| Oil  (per Bbl)                                                              |       | $                                 | 32.92      |   | $ | 86.21 |   | $ | 50.60 |   |
| **Proved Developed Reserves (MMcfe)**                                       |       | 91,749                            |       | 89,062 |   | 66,763 |   |

 

**Summary of Changes in Proved Reserves**

 
| ** **                       | ** ** | **Year ended December 31,** | ** ** |
|----------------------------------|------------|----------------------------------|------------|
| ** **                       | ** ** | **2008**                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                       | ** ** | **MBbls**                        | ** ** | **Mmcf** | ** ** | **MBbls** | ** ** | **Mmcf** | ** ** | **MBbls** | ** ** | **Mmcf** | ** ** |
| Proved  reserves                 |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Beginning  of year               |       | 53,110                           |       | 37,768 |   | 54,077 |   | 24,825 |   | 50,415 |   | 24,353 |   |
| Purchase  of reserves in place   |       | —                           |       | — |   | 62 |   | 10,936 |   | 164 |   | 814 |   |
| Discoveries  and extensions      |       | —                           |       | 40,265 |   | 2,583 |   | 8,608 |   | 4,421 |   | 7,202 |   |
| Revisions  of previous estimates |       | (42,685                          | )(1)       | (2,278 | ) | (2,787 | ) | (5,346 | ) | (467 | ) | (6,492 | ) |
| Production                       |       | (1,011                           | )          | (2,930 | ) | (825 | ) | (1,255 | ) | (456 | ) | (1,052 | ) |
| End  of year                     |       | 9,414                            |       | 72,825 |   | 53,110 |   | 37,768 |   | 54,077 |   | 24,825 |   |
| Proved  developed reserves       |       |                             |       |   |   |   |   |   |   |   |   |   |   |
| Beginning  of year               |       | 11,202                           |       | 21,852 |   | 9,583 |   | 9,264 |   | 2,939 |   | 10,829 |   |
| End  of year                     |       | 6,498                            |       | 52,763 |   | 11,202 |   | 21,852 |   | 9,583 |   | 9,264 |   |

 

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(1)                                  At year-end 2008, we revised our provedoil reserves downward by a total of 42,685 MBbls as follows: Due to asignificant decrease in realized oil prices from $86.21 per barrel at December 31,2007 to $32.92 per barrel at 

 

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December 31, 2008,20,210 MBbls of proved undeveloped oil reserves in the WTU property and 18,360MBbls of proved undeveloped oil reserves in the NWU property were deemednon-economic and revised downward at year-end 2008. Also, due to lower realizedoil prices, 755 MBbls of proved developed producing oil reserves in the NWUwere revised downward at year-end 2008. As a result of these revisions, all ofthe proved oil reserves in the NWU were eliminated at year-end 2008. Inaddition, 3,360 MBbls of proved developed producing oil reserves in the WTUwere revised downward primarily due to the decrease in realized oil prices,and, to a lesser extent, due to downward revisions to estimated oil recoveriesin the WTU Upper Terminal and Ranger waterflood projects. Lower prices decreasethe economic lives of the underlying oil and natural gas properties and therebydecrease the estimated future reserves.

 

(2)                                  The PV-10 Value represents the discountedfuture net cash flows attributable to our proved oil and gas reserves beforeincome tax, discounted at 10% per annum. Although it is a non-GAAP measure, webelieve that the presentation of the PV-10 Value is relevant and useful to ourinvestors because it presents the discounted future net cash flows attributableto our proved reserves prior to taking into account corporate future incometaxes and our current tax structure. We use this measure when assessing thepotential return on investment related to our oil and gas properties. Ourreconciliation of this non-GAAP financial measure is shown in the table as thePV-10, less future income taxes, discounted at 10% per annum, resulting in thestandardized measure of discounted future net cash flows. The standardizedmeasure of discounted future net cash flows represents the present value offuture cash flows attributable to our proved oil and natural gas reserves afterincome tax, discounted at 10%. In accordance with SEC requirements, ourreserves and the future net revenues were determined using realized prices fornatural gas and oil at each of December 31, 2008, 2007, and 2006. Theseprices reflect adjustments by lease for quality, transportation fees andregional price differences.

 

(3)                                  Standardized measure of discounted futurenet cash flows differs from PV-10 value because it includes the effect offuture income taxes.

 

The data in the abovenatural gas and oil reserves table represents estimates only. Oil and naturalgas reserve engineering is inherently a subjective process of estimatingunderground accumulations of oil and natural gas that cannot be measuredexactly. The accuracy of any reserve estimate is a function of the quality ofavailable data and engineering and geological interpretation and judgment.

 

Accordingly, reserveestimates may vary from the quantities of oil and natural gas that areultimately recovered. See “Risk Factors”.

 

PV-10 is equal to thefuture net cash flows from our proved reserves at December 31, 2008,excluding any future income taxes, discounted at 10% per annum (“PV-10”).Proved developed reserves are reserves that can be expected to be recoveredthrough existing wells with existing equipment and operating methods. Provedundeveloped reserves are proved reserves that are expected to be recovered fromnew wells drilled to known reservoirs on undrilled acreage for which theexistence and recoverability of such reserves can be estimated with reasonablecertainty, or from existing wells on which a relatively major expenditure isrequired to establish production. PV-10 may be considered a non-GAAP financialmeasure as defined by Item 10(e) of Regulation S-K and isderived from the standardized measure of discounted future net cash flows whichis the most directly comparable GAAP financial measure. PV-10 is a computationof the standardized measure of discounted future net cash flows on a pre-taxbasis. We believe that the presentation of the PV-10 is relevant and useful toinvestors because it presents the discounted future net cash flows attributableto our proved reserves prior to taking into account corporate future incometaxes and it is a useful measure for evaluating the relative monetarysignificance of our oil and natural gas properties. Further, investors mayutilize the measure as a basis for comparison of the relative size and value ofour reserves to other companies. We use this measure when assessing thepotential return on investment related to our oil and natural gas properties.However, PV-10 is not a substitute for the standardized measure of discountedfuture net cash flows.

 

Due tothe volatility of commodity prices, the oil and gas prices on the last day ofthe period significantly impact the calculation of the PV-10 and thestandardized measure of discounted future net cash flows. The present value offuture net cash flows does not purport to be an estimate of the fair marketvalue of the Company’s proved reserves. An estimate of fair value would alsotake into account, among other things, anticipated changes in future prices andcosts, the expected recovery of reserves in excess of proved reserves and adiscount factor more representative of the time value of money and the risksinherent in producing oil and gas. Future prices received for production andcosts may vary, perhaps significantly,

 

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from the prices and costsassumed for purposes of these estimates. The 10% discount factor used tocalculate present value, which is required by Financial Accounting StandardBoard pronouncements, may not necessarily be the most appropriate discountrate. The present value, no matter what discount rate is used, is materiallyaffected by assumptions as to timing of future production, which may prove tobe inaccurate.

 

There are numerousuncertainties in estimating quantities of proved reserves and in projectingfuture rates of production and the timing of development expenditures,including many factors beyond our control. The reserve data set forth in thisannual report are only estimates. Although we believe these estimates to bereasonable, reserve estimates are imprecise and may be expected to change asadditional information becomes available. Estimates of natural gas and oilreserves, of necessity, are projections based on engineering data and there areuncertainties inherent in the interpretation of this data, as well as theprojection of future rates of production and the timing of developmentexpenditures. Reservoir engineering is a subjective process of estimatingunderground accumulations of natural gas and oil that cannot be exactlymeasured. Therefore, estimates of the economically recoverable quantities ofnatural gas and oil attributable to any particular group of properties,classifications of the reserves based on risk of recovery and the estimates area function of the quality of available data and of engineering and geologicalinterpretation and judgment and the future net cash flows expected there from,prepared by different engineers or by the same engineers at different times,may vary substantially. There also can be no assurance that the reserves setforth herein will ultimately be produced or that the proved undevelopedreserves will be developed within the periods anticipated. Actual production, revenuesand expenditures with respect to our reserves will likely vary from estimates,and such variances may be material. In addition, the estimates of future netrevenues from our proved reserves and the present value thereof are based uponcertain assumptions about future production levels, prices and costs that maynot be correct.

 

With respect to theestimates prepared by Williamson Petroleum Consultants, Inc., PV-10 valueshould not be construed as representative of the fair market value of our provednatural gas and oil properties since discounted future net cash flows are basedupon projected cash flows which do not provide for changes in natural gas andoil prices or for the escalation of expenses and capital costs. Themeaningfulness of such estimates is highly dependent upon the accuracy of theassumptions upon which they are based. Actual future prices and costs maydiffer materially from those estimated. You are cautioned not to place unduereliance on the reserve data included in this annual report. Under SECguidelines, estimates of the PV-10 value of proved reserves must be made usingoil and gas sales prices at the date for the valuation, which prices are heldconstant throughout the life of the properties.

 

**NOTE M —SUBSEQUENT EVENTS**

 

On October 23, 2009,we completed the sale of 11,775,000 shares of our common stock through anunderwritten offering at a share price of $2.60 per share ($2.46 net to us).This sale resulted in the Company receiving net proceeds of approximately $28.9million after underwriting discounts and commissions but before offeringexpenses.  On October 28, 2009, theCompany paid down $7.6 million of its credit line.

 

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

 

**CAUTIONARY NOTE REGARDINGFORWARD-LOOKING STATEMENTS**

 

*TheCompany has made in this report, and may from time to time otherwise make inother public filings, press releases and discussions with Company management,forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934 concerning the Company’s operations, economic performance and financialcondition. These forward-looking statements include information concerningfuture production and reserves, schedules, plans, timing of development,contributions from oil and gas properties, and those statements preceded by,followed by or that otherwise include the words “believes,” “expects,” “anticipates,”“intends,” “estimates,” “projects,” “target,” “goal,” “plans,” “objective,” “should”or similar expressions or variations on such expressions. For such statements,the Company claims the protection of the safe harbor for forward-lookingstatements contained in the Private Securities Litigation Reform Act of 1995.Although the Company believes that the expectations reflected in such*

 

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*forward-lookingstatements are reasonable, it can give no assurance that such expectations willprove to have been correct. Important factors that could cause actual resultsto differ materially from the Company’s expectations include, but are notlimited to, the Company’s assumptions about energy markets, production levels,reserve levels, operating results, competitive conditions, technology, theavailability of capital resources, capital expenditures and other contractualobligations, the supply and demand for and the price of oil, natural gas andother products or services, the weather, inflation, the availability of goodsand services, drilling risks, future processing volumes and pipelinethroughput, general economic conditions, either internationally or nationallyor in the jurisdictions in which the Company or its subsidiaries are doingbusiness, legislative or regulatory changes, including changes in environmentalregulation, environmental risks and liability under federal, state and localenvironmental laws and regulations, potential environmental obligations, thesecurities or capital markets, our ability to repay debt and other factorsdiscussed in “Risk Factors” and in “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” included in the Company’s 2008Annual Report on Form 10-K, this Form 10-Q and in the Company’s otherpublic filings, press releases and discussions with Company management. Warrenundertakes no obligation to publicly update or revise any forward-looking statement,**whether as a result of newinformation, subsequent events or otherwise, unless otherwise required by law.*

 

**Overview**

 

We are an independentenergy company engaged in the exploration and development of domestic onshoreoil and natural gas reserves. We focus our efforts primarily on our waterfloodoil recovery programs and horizontal drilling in the Wilmington field withinthe Los Angeles Basin of California and on the exploration and development ofcoalbed methane (“CBM”) properties located in the Rocky Mountain region. As of September 30,2009, we owned natural gas and oil leasehold interests in approximately 160,450gross, 85,730 net acres, approximately 80% of which are undeveloped.Substantially all our undeveloped acreage is located in the Rocky Mountains.

 

**Liquidity and CapitalResources**

** **

On October 23,2009, the Company sold 11.8 million shares of common stock at $2.60 pershare.  The Company received net proceedsof $28.9 million after deducting $1.8 million of issuance costs.  Warren used $7.6 million of the proceeds topay down debt under our Credit Facility (discussed in more detail below) whichcan subsequently be drawn in order to finance existing development activitiesand general corporate purposes.

 

Our cashand cash equivalents decreased $20.9 million during the nine months of 2009 to$8.7 million at September 30, 2009. This resulted from cash used ininvesting activities of $37.7 million. This was partially offset by cash provided by operating activities of$14.5 million and cash provided by financing activities of $2.2 million.

 

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

 

The Company recorded animpairment expense of $272.3 million at December 31, 2008 relating to itsceiling test on the carrying costs of its oil and gas properties and goodwillimpairments.  This resulted primarilyfrom realized oil prices decreasing 62% from $86.21 at December 31, 2007to $32.92 at December 31, 2008.  Asa result of oil price declines, many of our proved undeveloped reserves wereremoved from the proved category. Additionally, the Company wrote off approximately $3.4 million ofgoodwill at December 31, 2008.  TheCompany had no impairment charges during the nine months ended September 30,2009.

 

On November 19,2007, Warren entered into a five year, $250 million credit agreement withMerrill Lynch Capital (subsequently sold to GE Business Financial Services, Inc.)on behalf of itself and a syndicate of five participating banks (the “CreditFacility”).   The Credit Facility providesfor a revolving loan up to the lesser of (i) the borrowing base (ii) $250million or (iii) the draw limit requested by the Company.  The Credit Facility matures on November 19,2012.  It is secured by substantially allof our assets.  The borrowing base willbe determined by the lenders at least semi-annually on April 1 and October 1of each year, and is based in part on the proved reserves of the Company. Thecurrent borrowing base is $120 million, representing an immediate availabilityof $5 million as of September 30, 2009. On October 28, 2009, theCompany paid down $7.6 million of the credit line, leaving a credit linebalance outstanding as of that date of $107.4 million. The Company is subjectto certain covenants required by the Credit Facility which include, but are notlimited to the maintenance of the following financial ratios (1) a minimumcurrent ratio (including the unused borrowing base and excluding unrealizedgains and losses on derivative financial instruments) of not less than 1.0 to1.0 and (2) a minimum 

 

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annualizedconsolidated EBITDAX (as defined by the Credit Facility) to net interest expenseof not less than to of 2.5 to 1.0.  As ofSeptember 30, 2009, the Company had borrowed $115 million under the CreditFacility and was in compliance with all covenants.  If the Company fails to satisfy its CreditFacility 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.

 

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

 

Duringthe third quarter of 2009, the Company incurred $1.7 million of interestexpense under the Credit Facility of which approximately $0.4 million wasaccrued as of September 30, 2009. The weighted average interest rate as ofSeptember 30, 2009, was 4.81%.

 

The availability of fundsunder our Credit Facility is critical to our Company.  The borrowing base will be re-determinedduring the fourth quarter of 2009.  Ifthe Credit Facility’s borrowing base is reduced to a level below currentborrowings, the Company would be obligated to begin reducing the deficiency by25% within 90 days after the deficiency occurs and the remaining 75% within 180days after the deficiency occurs.

 

The continuing crisis inthe U.S. and world financial and securities markets could have a materialadverse effect on our business and operations. Additionally, low commodity prices may restrict our ability to meet ourcurrent obligations.  As a result,Management has taken several actions to ensure that the Company will havesufficient liquidity to meet its obligations through September 30, 2010,including selling common shares and receiving net proceeds of $28.9 million asreferred to above, a reduction in its 2009 capital expenditure budget to $9 million,entered into price swap agreements for a portion of its 2009 production toreduce price volatility, temporarily shut-in three pilot areas in the AtlanticRim that are uneconomic at current prices to reduce lease operating expenses,headcount reductions and reductions in discretionary expenditures, includingelimination of year-end bonuses. The Company is also evaluating other measuresto further improve its liquidity, including, the sale of certain assets,entering into joint ventures with third parties, volumetric productionpayments, additional commodity price hedging and other monetization of assetsstrategies. Management believes that these actions will enable the Company tomeet its liquidity requirements through September 30, 2010. The Company hashired outside consultants to assist us in these endeavors.

 

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

 

During the first ninemonths of 2009, operating results declined significantly compared to 2008.  Primarily, this resulted from the significantdecline in oil and gas commodity prices. Additionally during the first nine months of 2009, the Company incurreda net loss of $13.6 million (including $8.7 million in unrealized losses relatingto the mark-to-market of derivative financial instruments) as compared to netincome of $42.9 million for the comparable period of 2008.  At September 30, 2009, current assetswere approximately $1.3 million more than current liabilities (including $1.4million in unrealized losses in current liabilities relating to derivativefinancial instruments).   As mentionedpreviously, the unused availability under the Credit Facility is added tocurrent assets when calculating the current ratio covenant.  Additionally, current assets and current liabilitiesrelating to unrealized gains and losses from derivative financial instrumentsare excluded from this calculation.

 

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

 

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The Company’s provedreserves declined significantly compared to prior years and may decline infuture years.  Due to current commodityprices, compared to the cost of developing our undeveloped oil reserves and ourestimated lease operating expenses, a significant portion of our futureprojects are or may be uneconomic at this time. As a result, a significant portion of our proved undeveloped reservesare no longer in the proved category. The Company’s projects have material lease operating expenses.  Our oil operations include a secondaryrecovery waterflood with significant fixed costs.  During the third quarter of 2009, our oil leaseoperating expenses were $14.95 per barrel of oil produced. Our natural gasoperations include reinjecting the produced water into deep formations andcompressing and transporting the gas with significant fixed costs. During thethird quarter of 2009, our natural gas lease operating expenses were $2.35 permcf of gas produced. The Company’s proved reserves are based on assumptionsthat may prove to be inaccurate.

 

At September 30,2009, we had approximately 1.4 million vested outstanding stock options issuedunder our stock based equity compensation plans. Of the total 1.4 millionoutstanding vested options, all had exercise prices above the closing marketprice $2.96 of our common stock on September 30, 2009.

 

*Contractual Obligations*

 

The contractualobligations table below assumes the maximum amount is tendered each year. Thetable does not give effect to the conversion of any bonds to common stock whichwould reduce payments due. All bonds are secured at maturity by zero couponU.S. treasury bonds deposited into an escrow account equaling the parvalue of the bonds maturing on or before the maturity of the bonds. Such U.S.treasury bonds had a fair market value of $1.0 million at September 30,2009.  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, 2009** | ** ** | **Total**                   | ** ** | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                                                  | ** ** | ** **                  | ** ** | ** ** | ** ** | **(in  thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Line  of credit                                             |       | $                           | 115,000    |   | $ | — |   | $ | — |   | $ | 115,000 |   | $ | — |   |
| Bonds                                                       |       | 1,676                       |       | 167 |   | 287 |   | 232 |   | 990 |   |
| Leases                                                      |       | 2,619                       |       | 644 |   | 1,260 |   | 593 |   | 122 |   |
| Total                                                       |       | $                           | 119,295    |   | $ | 811 |   | $ | 1,547 |   | $ | 115,825 |   | $ | 1,112 |   |

 

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| * | Does not include  estimated interest of $5,805,000 less than one year, $11,626,000 1-3 years,  $1,170,000 3-5 years and $1,434,000 thereafter. |
|---|-----------------------------------------------------------------------------------------------------------------------------------------------------|

 

**RESULTS OF OPERATIONS:**

 

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

** **

*Oil and gas sales.* Revenue from oil and gas sales decreased$17.5 million in the third quarter of 2009 to $16.4 million, a 52% decreasecompared to the same quarter in 2008. This decrease resulted from a decrease in realized energy prices.  The average realized price per barrel of oilfor the three months ended September 30, 2009 and 2008 was $60.51 and$106.82, respectively.  Additionally, theaverage realized price per Mcf of gas for the three months ended September 30,2009 and 2008 was $2.71 and $6.42, respectively.  Net oil production for the three months endedSeptember 30, 2009 and 2008 was 226 Mbbls and 263 Mbbls,respectively.  Net gas production for thethree months ended September 30, 2009 and 2008 was 1.0 Bcf and 0.9 Bcf,respectively.

 

*Lease operating expense.* Lease operating expense for the thirdquarter of 2009 decreased 30% to $5.8 million ($2.43 per Mcfe) compared to $8.3million ($3.34 per Mcfe) in the comparable period of 2008. Primarily, thisdecrease resulted from reduced lease operating expenses in our Atlantic RimProject resulted from shutting in uneconomic wells and reduced workovers onwells.  Additionally, this decrease resultedfrom reduced field expenses in our California oil properties.

 

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*Depreciation, depletion andamortization .*Depreciation,depletion and amortization expense increased $0.1 million for the third quarterof 2009 to $5.3 million, a 1% increase compared to the corresponding quarterlast year. This increase reflects an increase in the depletion rate resultingfrom a decrease in proved reserves compared to the same quarter in 2008.

 

*General and administrativeexpenses.* Generaland administrative expenses decreased $1.1 million in the third quarter of 2009to $2.5 million, a 31% decrease compared to the corresponding quarter lastyear.  This reflects a decrease inpersonnel as a result of cost cutting activities.

 

*Interest expense.* Interest expense increased $0.4 millionin the third quarter of 2009 to $1.7 million compared to the same quarter lastyear.  The increase results from interestexpense relating to the drawdown under our Credit Facility.

 

*Interest and other income.* Interest and other income decreased $0.3million in the third quarter of 2009 to $22 thousand, a 92% decrease comparedto the same quarter in 2008. This represents a decrease in interest earned dueto lower cash and cash equivalents balances and lower interest rates ascompared to the corresponding quarter last year.

 

*Gain(Loss) on derivative financial instruments.*Derivative gains of $0.9 million were recorded in thethird quarter of 2009. This amount reflects $1.4 million of unrealized gains,resulting from mark to market accounting of our oil and gas swaps and ispartially offset by $0.5 million of realized losses in the quarter from our oiland gas swap positions.

 

**Nine months Ended September 30, 2009 Compared toNine Months Ended September 30, 2008**

** **

*Oil and gas sales.* Revenue from oil and gas sales decreased$48.4 million during the first nine months of 2009 to $43.2 million, a 53%decrease compared to the same period in 2008. This decrease resulted from a decrease in realized energy prices.  The average realized price per barrel of oilfor the nine months ended September 30, 2009 and 2008 was $49.67 and$101.68, respectively.  Additionally, theaverage realized price per Mcf of gas for the nine months ended September 30,2009 and 2008 was $2.75 and $7.38, respectively.  Net oil production for the nine months ended September 30,2009 and 2008 was 716 Mbbls and 759 Mbbls, respectively.  Net gas production for the nine months ended September 30,2009 and 2008 was 2.9 Bcf and 2.0 Bcf, respectively.

 

*Lease operating expense.* Lease operating expense for the firstnine months of 2009 decreased 3% to $20.0 million ($2.78 per Mcfe) compared to$20.7 million ($3.17 per Mcfe) in the comparable period of 2008.  Primarily, this decrease resulted fromreduced lease operating expenses in our Atlantic Rim Project resulted fromshutting in uneconomic wells and reduced workovers on wells.  Additionally, this decrease resulted fromreduced field expenses in our California oil properties.

 

*Depreciation, depletion andamortization .*Depreciation,depletion and amortization expense increased $2.2 million for the first ninemonths of 2009 to $15.8 million, a 16% increase compared to the correspondingperiod last year. This increase reflects an increase in production and anincrease in the depletion rate resulting from a decrease in proved reservescompared to the same period in 2008. Production increased 10% during thisperiod.

 

*General and administrative expenses.* General and administrative expensesdecreased $2.9 million in the first nine months of 2009 to $8.6 million, a 25%decrease compared to the corresponding period last year.  This reflects a decrease in personnel as aresult of cost cutting activities.

 

*Interest expense.* Interest expense increased $0.8 millionin the first nine months of 2009 to $4.7 million compared to the same periodlast year.  The increase results frominterest expense relating to the drawdown under our Credit Facility.

 

*Interest and other income.* Interest and other income decreased $0.7million in the first nine months of 2009 to $0.1 million, an 83% decreasecompared to the same period in 2008. This represents a decrease in interestearned due to lower cash and cash equivalents balances and lower interest ratesas compared to the corresponding period last year.

 

*Loss onderivative financial instruments.*Derivative losses of $7.8 million were recorded in thefirst nine months of 2009. This amount reflects $8.7 million of unrealized lossesresulting from mark to market accounting of our oil and gas swaps positions andis partially offset by $0.9 million of realized gains from our natural gas swappositions.

 

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**CRITICAL ACCOUNTING POLICIES**

 

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

 

**Item 3. ****Quantitative and QualitativeDisclosures About Market Risk**

 

***Energy PriceRisk***

 

The Company’s mostsignificant market risk is the pricing for natural gas and crude oil.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.

 

***CommodityRisk***

 

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

 

In 2009 we entered intoseveral financial derivative swap contracts to hedge our exposure to commodityprice risk associated with anticipated future oil and gas production. Through aprice swap, we have fixed the price we will receive on a portion of our naturalgas and oil production. In a swap transaction, the counterparty is required tomake a payment to us for the difference between the fixed price and thesettlement price if the settlement price is below the fixed price. We are requiredto make a payment to the counterparty for the difference between the fixedprice and the settlement price if the fixed price is below the settlementprice. We believe we will have more predictability of our crude oil and gasrevenues as a result of these financial derivative contracts.

 

The following tablesummarizes our open financial derivative positions as of November 4, 2009related to oil and gas production. The Company will receive prices asnoted in the table below and will pay a counterparty market price based on theNYMEX (for natural gas production) or WTI (for oil production) index price,settled monthly.

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

 

***InterestRate Risk***

 

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

 

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

 

***Financial Instruments***

 

Our financial instrumentsconsist of the following, cash and cash equivalents, U.S. treasury bonds,collateral security accounts, line of credit and other long-term liabilities.The carrying amounts of these instruments approximate fair market value due tothe highly liquid nature of these short-term instruments or they are reportedat fair value.

 

***Inflation and Changes in Prices***

 

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

 

***Forward-LookingStatements and Risk***

 

Certain statements inthis report, including statements of the future plans, objectives, and expectedperformance of the company, are forward-looking statements that are dependentupon certain events, risks and uncertainties that may be outside the company’scontrol, and which could cause actual results to differ materially from those anticipated.Some of these include, but are not limited to, the market prices of oil andgas, economic and competitive conditions, exploration risks such as drillingunsuccessful wells, higher-than-expected costs, potential liability forremedial actions under existing or future environmental regulations andlitigation, potential liability resulting from pending or futurelitigation,  environmental and regulatoryuncertainties that could delay or prevent drilling, and not successfullycompleting, or any material delay of, any development of new or existingfields, expansion, or capital expenditure, legislative and regulatory changes,financial market conditions, political and economic uncertainties of foreigngovernments, future business decisions, and other uncertainties, all of whichare difficult to predict. Forward-looking statements are generally accompaniedby words such as “estimate”, “project”, “predict”, “will”, “anticipate”, “plan”,“intend”, “believe”, “expect” or similar expressions that convey theuncertainty of future events or outcomes. You should not place undue relianceon these forward-looking statements, which speak only as of the date of thisreport. Unless legally required, Warren does not undertake any obligation toupdate any forward-looking statements, as a result of new information, futureevents or otherwise. Certain risks that may affect Warren’s results ofoperations and financial position appear in Part 1, Item 1A “Risk Factors”of Warren’s 2008 Annual Report on Form 10-K.

 

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

 

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

#### ** **

***Evaluation ofDisclosure Controls and Procedures***

 

Our management,under the supervision and with the participation of our Chief Executive Officer(“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness ofour disclosure controls and procedures as defined in Securities and ExchangeCommission (“SEC”) Rule 13a-15(e) and 15d-15(e) as of the end ofthe period covered by this 

 

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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 inInternal Control over Financial Reporting***

 

There have been nochanges in our internal controls over financial reporting or in other factorsduring the quarter ended September 30, 2009, that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

 

## **PART II—OTHERINFORMATION**

## ** **

**Item 1. *Legal Proceedings***

 

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

 

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

 

Our business has manyrisks. In addition to the other information set forth in this report and ourpress releases and other reports and materials that we file with the Securitiesand Exchange Commission, you should carefully consider the factors discussed inPart I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K forthe year ended December 31, 2008, and in our RegistrationStatement on Form S-3, and the prospectus supplement thereto, inconnection with our public offering on October 23, 2009, whichcould materially 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, financialcondition and/or operating results.

 

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

** **

a.    Not applicable

 

b.    Notapplicable

 

c.    Notapplicable

 

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

 

Notapplicable.

 

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

 

None held in thethird quarter of 2009.

 

**Item 5. *Other Information***

 

Not applicable.

 

**Item 6. *Exhibits***

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

 

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

 

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

 

**SIGNATURES**

 

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

 
|                         | WARREN RESOURCES, INC.  (Registrant) |
|------------------------------|--------------------------------------|
|                         |                                 |   |
| Date: November 4,  2009 |                                 | /s/ Timothy A. Larkin |
|                         |                                 |   |
|                         | By:                                  | Timothy A. Larkin |
|                         |                                 | *Executive Vice President,  Chief Financial Officer and   Principal Accounting Officer* |

 

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