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

 

**FORM 10-Q**

 

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

**For theQuarterly Period Ended March 31, 2005**

 

# **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**                                                     | ** ** | **11-3024080**                           |
|------------------------------------------------------------------|------------|------------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | ** ** | (I.R.S. Employer  Identification Number) |
|                                                             | ** ** |                                     |
| **489  Fifth Avenue, New York,** **New York**               | ** ** | **10017**                                |
| (Address of  Principal Executive Offices)                        | ** ** | (Zip Code)                               |

 

Registrant’stelephone number, including area code:

 

**(212)697-9660**

 

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

Yes ý No o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Exchange Act).

Yes o No ý

 

 

Theaggregate number of Registrant’s outstanding shares on May 10, 2005 was 36,611,528shares of Common Stock, $0.0001 par value.

 

 

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**WARRENRESOURCES, INC.**

**INDEX**
| ** **         |                                                                                                  |   |   |
|--------------------|-------------------------------------------------------------------------------------------------------|--------|--------|
| PART I—  | FINANCIAL INFORMATION                                                                                 |   |   |
|               |                                                                                                  |   |   |
|               | Item 1. Financial Statements                                                                          |   |   |
|               |                                                                                                  |   |   |
|               | Consolidated balance  sheets as of March 31, 2005 (Unaudited) and December 31, 2004                   |   |   |
|               |                                                                                                  |   |   |
|               | Consolidated  statements of operations (Unaudited) for three months ended March 31, 2005  and 2004    |   |   |
|               |                                                                                                  |   |   |
|               | Consolidated statements of cash flows (Unaudited)  for the three months ended March 31, 2005 and 2004 |   |   |
|               |                                                                                                  |   |   |
|               | Notes to the consolidated financial statements  (Unaudited)                                           |   |   |
|               |                                                                                                  |   |   |
|               | Item 2. Management’s discussion and analysis of  financial conditions and results of operations  |   |   |
|               |                                                                                                  |   |   |
|               | Item 3. Quantitative and Qualitative Disclosures  About Market Risk                                   |   |   |
|               |                                                                                                  |   |   |
|               | Item 4. Evaluation of Disclosure Controls and  Procedures                                             |   |   |
|               |                                                                                                  |   |   |
| PART II— | OTHER INFORMATION                                                                                     |   |   |
|               |                                                                                                  |   |   |
|               | Item 1. Legal Proceedings                                                                             |   |   |
|               |                                                                                                  |   |   |
|               | Item 2. Unregistered Sales of Equity Securities  and Use of Proceeds                                  |   |   |
|               |                                                                                                  |   |   |
|               | Item 3. Defaults upon Senior Securities                                                               |   |   |
|               |                                                                                                  |   |   |
|               | Item 4. Submission of Matters to a Vote of  Security Holders                                          |   |   |
|               |                                                                                                  |   |   |
|               | Item 5. Other Information                                                                             |   |   |
|               |                                                                                                  |   |   |
|               | Item 6. Exhibits                                                                                      |   |   |
|               |                                                                                                  |   |   |
|               | Signatures                                                                                            |   |   |

 

2

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**PART I****—FINANCIAL INFORMATION**

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

 

**Warren Resources, Inc. and SubsidiariesCONSOLIDATED BALANCE SHEETS**
| ** **                                                                                                                                                                                                                                           | ** ** | **March 31,  2005** | ** **      | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------|-----------------|------------------------|------------|
| ** **                                                                                                                                                                                                                                           | ** ** | **(Unaudited)**     | ** **      | ** **             | ** ** |
| **ASSETS**                                                                                                                                                                                                                                           |       |                |            |                   |       |
| CURRENT ASSETS                                                                                                                                                                                                                                       |       |                |            |                   |       |
| Cash and cash  equivalents                                                                                                                                                                                                                           |       | $                   | 61,207,699      |                   | $          | 99,920,885 |   |
| Accounts  receivable – trade                                                                                                                                                                                                                    |       | 1,735,666           |            | 1,481,925              |       |
| Accounts  receivable from affiliated partnerships                                                                                                                                                                                                    |       | 135,772             |            | 143,297                |       |
| Trading  securities                                                                                                                                                                                                                                  |       | 43,795              |            | 174,247                |       |
| Restricted  investments in U.S. Treasury Bonds—available-for-sale, at fair value  (amortized cost of $6,095,961in 2005 and $5,944,587 in 2004)                                                                                                  |       | 6,352,762           |            | 6,099,968              |       |
| Other current  assets                                                                                                                                                                                                                                |       | 178,896             |            | 211,509                |       |
|                                                                                                                                                                                                                                                 |       |                |            |                   |       |
| Total current  assets                                                                                                                                                                                                                                |       | 69,654,590          |            | 108,031,831            |       |
|                                                                                                                                                                                                                                                 |       |                |            |                   |       |
| OTHER ASSETS                                                                                                                                                                                                                                         |       |                |            |                   |       |
| Oil and gas  properties—at cost, based on successful efforts method of accounting, net of  accumulated depreciation, depletion and amortization                                                                                                 |       | 132,491,151         |            | 116,595,306            |       |
| Property and  equipment—at cost, net                                                                                                                                                                                                            |       | 437,890             |            | 395,444                |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value  (amortized cost of $5,742,186 in 2005 and $10,778,899 in 2004)                                                                                                |       | 6,639,819           |            | 12,062,085             |       |
| Deferred bond  offering costs (net of accumulated amortization of $4,914,142 in 2005 and  $4,080,257 in 2004)                                                                                                                                        |       | 1,526,927           |            | 2,360,812              |       |
| Goodwill                                                                                                                                                                                                                                             |       | 3,430,246           |            | 3,430,246              |       |
| Other assets                                                                                                                                                                                                                                         |       | 3,926,893           |            | 4,034,937              |       |
|                                                                                                                                                                                                                                                 |       |                |            |                   |       |
| Total other  assets                                                                                                                                                                                                                                  |       | 148,452,926         |            | 138,878,830            |       |
| ** **                                                                                                                                                                                                                                           | ** ** | **$**               | **218,107,516** |                   | **$**      | **246,910,661** |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                       |       |                |            |                   |       |
| CURRENT  LIABILITIES                                                                                                                                                                                                                                 |       |                |            |                   |       |
| Current  maturities of debentures                                                                                                                                                                                                                    |       | $                   | 14,803,050      |                   | $          | 17,316,070 |   |
| Current  maturities of other long-term liabilities                                                                                                                                                                                                   |       | 354,679             |            | 353,516                |       |
| Accounts payable  and accrued expenses                                                                                                                                                                                                               |       | 8,681,801           |            | 16,153,851             |       |
| Deferred  income—turnkey drilling contracts with affiliated partnerships                                                                                                                                                                        |       | 9,629,072           |            | 11,908,389             |       |
|                                                                                                                                                                                                                                                 |       |                |            |                   |       |
| Total current  liabilities                                                                                                                                                                                                                           |       | 33,468,602          |            | 45,731,826             |       |
|                                                                                                                                                                                                                                                 |       |                |            |                   |       |
| LONG-TERM  LIABILITIES                                                                                                                                                                                                                               |       |                |            |                   |       |
| Debentures, less  current portion                                                                                                                                                                                                                    |       | 15,847,650          |            | 29,160,630             |       |
| Other long-term  liabilities, less current portion                                                                                                                                                                                                   |       | 3,470,986           |            | 3,207,809              |       |
|                                                                                                                                                                                                                                                 |       |                |            |                   |       |
|                                                                                                                                                                                                                                                 |       | 19,318,636          |            | 32,368,439             |       |
|                                                                                                                                                                                                                                                 |       |                |            |                   |       |
| MINORITY  INTEREST                                                                                                                                                                                                                                   |       | 9,473,420           |            | 11,240,990             |       |
|                                                                                                                                                                                                                                                 |       |                |            |                   |       |
| STOCKHOLDERS’  EQUITY                                                                                                                                                                                                                           |       |                |            |                   |       |
| 8% convertible preferred stock, par value $.0001; authorized 10,000,000  shares, issued and outstanding, 6,517,960 shares in 2005 and 6,560,809 shares  in 2004 (aggregate liquidation preference $78,215,520  in 2005 and $78,729,708 in 2004) |       | 76,832,347          |            | 77,270,413             |       |
| Common stock —  $.0001 par value; authorized, 100,000,000 shares; issued 34,706,437 in 2005  and 34,347,854 shares in 2004                                                                                                                      |       | 3,471               |            | 3,435                  |       |
| Additional  paid-in-capital                                                                                                                                                                                                                          |       | 158,461,034         |            | 157,847,314            |       |
| Accumulated  deficit                                                                                                                                                                                                                                 |       | (79,417,582         | )               | (77,689,476            | )          |
| Accumulated  other comprehensive income, net of applicable income taxes of $462,000 in  2005 and $576,000 in 2004                                                                                                                                    |       | 695,643             |            | 865,775                |       |
|                                                                                                                                                                                                                                                 |       | 156,574,913         |            | 158,297,461            |       |
| Less common  stock in Treasury—at cost; 632,250 shares in 2005 and 2004                                                                                                                                                                         |       | 728,055             |            | 728,055                |       |
| Total  stockholders’ equity                                                                                                                                                                                                                     |       | 155,846,858         |            | 157,569,406            |       |
| ** **                                                                                                                                                                                                                                           | ** ** | **$**               | **218,107,516** |                   | **$**      | **246,910,661** |   |

 

The accompanyingnotes are an integral part of these financial statements

 

3

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**Warren Resources, Inc.and SubsidiariesCONSOLIDATED STATEMENTS OF OPERATIONS**
| ** **                                                           | ** ** | **Three Months Ended  March 31, (Unaudited)** | ** **     |
|----------------------------------------------------------------------|------------|-----------------------------------------------|----------------|
| ** **                                                           | ** ** | **2005**                                      | ** **     | **2004** | ** ** |
| **REVENUES**                                                         |       |                                          |           |   |   |
| Turnkey  contracts with affiliated partnerships                      |       | $                                             | 2,279,317      |   | $ | 908,934 |   |
| Oil and gas  sales from marketing activities                         |       | 2,196,074                                     |           | 1,383,575 |   |
| Well services                                                        |       | 540,659                                       |           | 230,605 |   |
| Oil and gas  sales                                                   |       | 2,176,587                                     |           | 1,226,475 |   |
| Net gain on  investments                                             |       | 31,460                                        |           | 49,813 |   |
| Interest and  other income                                           |       | 892,701                                       |           | 532,900 |   |
|                                                                 |       | 8,116,798                                     |           | 4,332,302 |   |
|                                                                 |       |                                          |           |   |   |
| **EXPENSES**                                                         |       |                                          |           |   |   |
| Turnkey  contracts                                                   |       | 2,021,001                                     |           | 1,433,440 |   |
| Cost of marketed  oil and gas purchased from affiliated partnerships |       | 2,165,092                                     |           | 1,348,219 |   |
| Well services                                                        |       | 194,389                                       |           | 111,878 |   |
| Production &  exploration                                        |       | 673,162                                       |           | 998,417 |   |
| Depreciation,  depletion, amortization and impairment                |       | 761,895                                       |           | 402,145 |   |
| General and  administrative                                          |       | 1,465,344                                     |           | 1,172,288 |   |
| Interest                                                             |       | 1,106,754                                     |           | 108,853 |   |
| Retirement of debt                                                   |       | 1,175,233                                     |           | — |   |
|                                                                 |       | 9,562,870                                     |           | 5,575,240 |   |
|                                                                 |       |                                          |           |   |   |
| Loss before  provision for income taxes                              |       | (1,446,072                                    | )              | (1,242,938 | ) |
|                                                                 |       |                                          |           |   |   |
| Deferred income  tax expense (benefit)                               |       | 114,000                                       |           | (214,000 | ) |
|                                                                 |       |                                          |           |   |   |
| Net loss before  minority interest                                   |       | (1,560,072                                    | )              | (1,028,938 | ) |
|                                                                 |       |                                          |           |   |   |
| Minority  interest                                                   |       | (168,034                                      | )              | (29,928 | ) |
|                                                                 |       |                                          |           |   |   |
| Net loss                                                             |       | (1,728,106                                    | )              | (1,058,866 | ) |
|                                                                 |       |                                          |           |   |   |
| Less dividends  and accretion on preferred shares                    |       | 1,640,432                                     |           | 1,645,925 |   |
|                                                                 |       |                                          |           |   |   |
| Net loss applicable  to common stockholders                          | ** ** | **$**                                         | **(3,368,538** | **)** | **$** | **(2,704,791** | **)** |
|                                                                 |       |                                          |           |   |   |
| Basic and  diluted loss per common share                             |       | $                                             | (0.10          | ) | $ | (0.15 | ) |
|                                                                 |       |                                          |           |   |   |
| Weighted average  common shares outstanding                          |       | 33,358,796                                    |           | 17,973,963 |   |

 

The accompanyingnotes are an integral part of these financial statements

 

4

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**Warren Resources, Inc.and SubsidiariesCONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                   | ** ** | **For the three months ended  March 31, (Unaudited)** | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2005**                                              | ** ** | **2004** | ** ** |
| Cash flows from  operating activities:                                       |       |                                                  |       |   |   |
| Net loss                                                                     |       | $                                                     | (1,728,106 | ) | $ | (1,058,866 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |                                                  |       |   |   |
| Accretion of  discount on available-for-sale debt securities                 |       | (202,277                                              | )          | (166,065 | ) |
| Amortization and  write-off of deferred bond offering costs                  |       | 833,885                                               |       | 113,692 |   |
| Gain on sale of  US treasury bonds—available for sale                   |       | (22,777                                               | )          | — |   |
| Depreciation,  depletion, amortization and impairment                        |       | 761,895                                               |       | 402,145 |   |
| Accretion of  asset retirement obligation                                    |       | 13,959                                                |       | 16,416 |   |
| Deferred tax  expense (benefit)                                              |       | 114,000                                               |       | (214,000 | ) |
| Change in assets  and liabilities:                                           |       |                                                  |       |   |   |
| (Increase)  decrease in trading securities                                   |       | 130,452                                               |       | (78,124 | ) |
| Increase in  accounts receivable—trade                                  |       | (253,741                                              | )          | (821,165 | ) |
| Decrease in  accounts receivable from affiliated partnerships                |       | 7,525                                                 |       | 139,494 |   |
| (Increase)  decrease in other assets                                         |       | 140,657                                               |       | (25,625 | ) |
| Decrease in  accounts payable and accrued expenses                           |       | (4,219,079                                            | )          | (1,079,998 | ) |
| Decrease in  deferred income from affiliated partnerships                    |       | (2,279,317                                            | )          | (908,934 | ) |
| Decrease in  other long term liabilities                                     |       | (30,166                                               | )          | (73,291 | ) |
|                                                                         |       |                                                  |       |   |   |
| Net cash used in  operating activities                                       |       | (6,733,090                                            | )          | (3,754,321 | ) |
|                                                                         |       |                                                  |       |   |   |
| Cash flows from  investing activities:                                       |       |                                                  |       |   |   |
| Purchases of oil  and gas properties                                         |       | (21,333,221                                           | )          | (3,560,471 | ) |
| Purchase of  property and equipment                                          |       | (77,878                                               | )          | (3,827 | ) |
| Proceeds from  the sale of oil and gas properties, net of selling fees       |       | —                                                |       | 3,500 |   |
| Proceeds from  U.S. Treasury Bonds—available-for-sale                   |       | 5,110,394                                             |       | 52,512 |   |
|                                                                         |       |                                                  |       |   |   |
| Net cash used in  investing activities                                       |       | (16,300,705                                           | )          | (3,508,286 | ) |
|                                                                         |       |                                                  |       |   |   |
| Cash flows from  financing activities:                                       |       |                                                  |       |   |   |
| Payments on debt  and debentures                                             |       | (14,104,797                                           | )          | (852,016 | ) |
| Issuance of  common stock, net                                               |       | —                                                |       | 14,175,000 |   |
| Issuance of  preferred stock, net                                            |       | —                                                |       | 126,730 |   |
| Dividends paid  on preferred stock                                           |       | (1,574,594                                            | )          | (1,500,064 | ) |
|                                                                         |       |                                                  |       |   |   |
| Net cash  provided by (used in) financing activities                         |       | (15,679,391                                           | )          | 11,949,650 |   |
|                                                                         |       |                                                  |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                        |       | (38,713,186                                           | )          | 4,687,043 |   |
| Cash and cash  equivalents at beginning of period                            |       | 99,920,885                                            |       | 24,528,999 |   |
|                                                                         |       |                                                  |       |   |   |
| Cash and cash  equivalents at end of period                                  |       | $                                                     | 61,207,699 |   | $ | 29,216,042 |   |
| Supplemental  disclosure of cash flow information                            |       |                                                  |       |   |   |
| Cash paid for  interest, net of amount capitalized                           |       | $                                                     | 952,523    |   | $ | — |   |
| Cash paid for  income taxes                                                  |       | —                                                |       | — |   |

 

The accompanyingnotes are an integral part of these financial statements

 

5

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** **

**WARRENRESOURCES, INC. AND SUBSIDIARIES**

** **

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

** **

**NOTE 1—ORGANIZATION**

 

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

 

The accompanyingunaudited financial statements and related notes present the Company’sconsolidated financial position as of March 31, 2005 and December 31, 2004, theconsolidated results of operations for the three months ended March 31, 2005and 2004 and consolidated cash flows for the three months ended March 31, 2005and 2004. The unaudited financial statements have been prepared in accordancewith accounting principles generally accepted in the United States of Americafor interim financial information and with the instructions of Form 10-Q andArticle 10 of Regulation S-X. Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements. In theopinion of management, all adjustments (consisting of normal recurringaccruals) considered necessary for a fair presentation have been included.Operating results for the three months ended March 31, 2005, are notnecessarily indicative of the results that may be expected for the fiscal yearending December 31, 2005. The accounting policies followed by the Company areset forth in Note A to the Company’s financial statements on Form 10-K for theyear ended December 31, 2004. These interim financial statements and notesthereto should be read in conjunction with the consolidated financialstatements presented in the Company’s 2004 Annual Report on Form 10-K.

 

##### **NOTE 2**—STOCKOPTIONS

 

At March 31, 2005, theCompany had stock-based compensation plans. The Company accounts for thoseplans under the recognition and measurement principles of Accounting PrinciplesBoard (APB) Opinion No. 25, *Accounting for StockIssued to Employees*, and related interpretations. The followingtable illustrates the effect on net income (loss) and income (loss) per shareif the Company had applied the fair-value recognition provisions of FinancialAccounting Standards Board (FASB) Statement No. 123, *Accountingfor Stock-Based Compensation*, to stock-based employee compensation:

 
| ** **                                                                                                                                    | ** ** | **Three months ended March 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                         | ** ** | **2004** | ** ** |
| Net loss  applicable to common stockholders, as reported                                                                                      |       | $                                | (3,368,538 | ) | $ | (2,704,791 | ) |
|                                                                                                                                          |       |                             |       |   |   |
| Deduct: Total  stock-based employee compensation expense determined under fair-value-based  method for all awards, net of related tax effects |       | (2,614,482                       | )          | (17,498 | ) |
|                                                                                                                                          |       |                             |       |   |   |
| Pro forma net  loss applicable to common stockholders                                                                                         |       | $                                | (5,983,020 | ) | $ | (2,722,289 | ) |
|                                                                                                                                          |       |                             |       |   |   |
| Basic and  diluted loss per share:                                                                                                            |       |                             |       |   |   |
| As reported -                                                                                                                                 |       | $                                | (0.10      | ) | $ | (0.15 | ) |
| Pro forma -                                                                                                                                   |       | $                                | (0.18      | ) | $ | (0.15 | ) |

 

 

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

 

6

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**NOTE 3—PLUGGING AND ABANDONMENTLIABILITY**

 

The Company accounts forAsset Retirement Obligations under SFAS No. 143. During the three months endingMarch 31, 2005 and 2004 the asset retirement liability was increased byapproximately $14,000 and $16,000 respectively, as a result of accretion andrecorded as interest expense. Additionallyduring the three months ended March 31, 2005, the asset retirement obligationwas increased by $299,000 resulting from the acquisition of an additionalinterest in the Wilmington field. During the three months ended March31, 2005, there have been no significant changes in cash flow assumptions forthe liability or liabilities incurred or settled during the period. The Companyhas treasury bills held in escrow with a fair market value of $2,748,000 whichare legally restricted for potential plugging and abandonment liability in theWilmington field.

#### ** **

#### **NOTE 4**—CHANGES INSTOCKHOLDERS’ EQUITY

 

As of March 31, 2005,6,517,960 shares of cumulative convertible preferred stock were issued andoutstanding. Preferred dividends of approximately $1.6 million and $1.6 millionwere accrued at March 31, 2005 and December 31, 2004, respectively. The accrueddividend at March 31, 2005 has not been paid as of the date of this filing. TheCompany has incurred cumulative issuance costs of approximately $2.1 million inrelation to these shares. The preferred stock pays an 8% cumulative dividend,which is payable quarterly, and is treated as a deduction in additional paid incapital. The holders of the preferred stock are not entitled to vote except asdefined by the agreement or as provided by applicable law.  The preferred stock may be voluntarilyconverted at the election of the holder, commencing one year after the date ofissuance.  Each outstanding redeemableconvertible preferred share is convertible into common stock of the Companybased on the table below.  The conversionrate is subject to adjustment from time to time as defined by the agreement.

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

 

With respect to 1,048,336shares of preferred stock that are not subject to the above conversion rates,all of which consist of series A institutional 8% cumulative convertiblepreferred stock, the following conversion rates apply. At the election of theholder, until the later to occur of June 30, 2005 and one year after theeffective date with the SEC of a registration statement, each share ofpreferred stock is convertible into one share of our common stock. Thereafter,until June 30, 2006, each share of preferred stock is convertible into 0.75shares of common stock, and commencing July 1, 2006 and thereafter, each shareof preferred stock is convertible into 0.50 shares of common stock.

 

Additionally, commencingseven years after the date of issuance, holders of the preferred stock mayelect to require the Company to redeem their preferred stock at a redemptionprice equal to the liquidation value of $12.00 per share, plus accrued butunpaid dividends, if any (“Redemption Price”). Upon the receipt of a redemption election, the Company, at its option,shall either: (1) pay the holder cash in the amount equal to the RedemptionPrice or (2) issue to holder shares of common stock up to a maximum of 1.5shares of common stock for each one share of preferred stock redeemed. TheCompany is accreting the carrying value of its preferred stock to itsredemption price using the effective interest method with changes recorded toadditional paid in capital. The accretion of preferred stock results in areduction of earnings per share applicable to common stockholders.

 

During the three monthsended March 31, 2005, the Company issued 315,734 shares of common stock tocertain convertible debenture holders and issued 42,849 shares to preferredstock holders who converted to common stock.

 

**NOTE 5—LOSS PER SHARE**

 

Basic loss per share iscomputed by dividing net loss applicable to common stockholders by the weightedaverage number of shares of common stock outstanding during the period. Dilutedloss per share is based on the assumption that stock options are converted intocommon shares using the treasury stock method and convertible bonds, debenturesand preferred stock are converted using the if-converted method. Conversion isnot assumed if the results are anti-dilutive. Potential common shares at March 31, 2005 and March 31, 2004, of 11,053,011and 11,881,840 respectively, relating to convertible bonds, debentures andpreferred stock, 3,343,706 and 2,241,012, respectively, relating to incentivestock options and 3,161,681and 1,184,643 potential shares relating to warrantsat March 31, 2005 and March 31, 2004, respectively, were excluded from thecomputation of diluted loss per share because they are anti-dilutive. Incentivestock options have a weighted average exercise price of $6.39 and $5.10 atMarch 31, 2005 and March 31, 2004, respectively. Warrants have a weightedaverage exercise price of $11.18 and $11.07 at March 31, 2005 and March 31,2004, respectively. The convertible bonds and debentures may be converted fromthe date of issuance until maturity at 100% of principal amount into commonstock of the Company at prices ranging from $5 to $50.  The preferred stock may be converted at thediscretion of the holder (see Note 4).

 

7

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**NOTE 6—LONG-TERM DEBT**

 

Theconvertible bonds and debentures may be converted from the date of issuanceuntil maturity at 100% of principal amount into common stock of the Company atprices ranging from $5 to $50. Each year the holders of the convertibledebentures may tender to the Company up to 10% of the aggregate debenturesissued and outstanding.

Bondsand debentures outstanding are as follows:
| ** **                                                             | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------------------------------------------------------------|------------|---------------------|------------|------------------------|------------|
|                                                                   |       |                |       |                   |       |
| 12% Sinking Fund  Debentures, due December 31, 2007 (1)                |       | $                   | —     |                   | $          | 9,036,000 |   |
| 12% Secured  Convertible Debentures, due December 31, 2009 (2)         |       | 735,000             |       | 770,000                |       |
| 12% Secured  Convertible Bonds, due December 31, 2010 (2)              |       | 1,685,000           |       | 1,700,000              |       |
| 13.02% Sinking  Fund Convertible Debentures, due December 31, 2010 (4) |       | 13,042,200          |       | 14,372,200             |       |
| 13.02% Sinking  Fund Convertible Debentures, due December 31, 2015 (3) |       | 11,267,500          |       | 11,632,500             |       |
| 12% Secured  Convertible Bonds, due December 31, 2016 (2)              |       | 1,300,000           |       | 1,305,000              |       |
| 12% Sinking Fund  Convertible Debentures, due December 31, 2017 (1)    |       | —              |       | 5,040,000              |       |
| 12% Secured  Convertible Bonds, due December 31, 2020 (3)              |       | 1,485,000           |       | 1,485,000              |       |
| 12% Secured  Convertible Bonds, due December 31, 2022 (3)              |       | 1,136,000           |       | 1,136,000              |       |
|                                                                   |       |                |       |                   |       |
|                                                                   |       | 30,650,700          |       | 46,476,700             |       |
| Less current  portion                                                  |       | 14,803,050          |       | 17,316,070             |       |
|                                                                   |       |                |       |                   |       |
| Long-term  portion                                                     |       | $                   | 15,847,650 |                   | $          | 29,160,630 |   |

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(1) In January 2005, theCompany called for full redemption on March 31, 2005, certain sinking funddebentures. The 2007 and 2017 bonds were called at a premium of 2% and 6%,respectively, which resulted in an expense of approximately $482,000 in thefirst quarter of 2005 relating to retirement of this debt. Also in the firstquarter of 2005, the Company wrote off approximately $694,000 of deferredoffering costs relating to these bonds. This redemption resulted in a releaseof restricted U.S. Treasury Bonds to the Company, having a fair market value ofapproximately $4,839,000 and will decrease future annual interest expense byapproximately $1,686,000.

 

(2) Debentures can becalled at a premium of 10%, if the Company’s stock trades at or above 133% ofthe conversion price for a period of ninety consecutive trading days.

 

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

#### ** **

#### **(4) On April 29, 2005, theCompany called for full redemption on June 29, 2005 its 2010 sinking fund bondsat a premium of 10%. At any time prior to the close of business on June 29,2005, bondholders may exercise their right to convert their 2010 bonds intoshares of the Company’s common stock at the conversion rate of $5.00 per share.Assuming no conversions, the maximum premium expense in the second quarterrelating to retirement of this debt would be approximately $1,304,000. Thisredemption will result in a release of restricted U.S. Treasury Bonds to theCompany, having a fair market value of approximately $5,718,000 at March 31,2005 and will decrease future annual interest expense by approximately $1,698,000.**

#### ** **

#### **NOTE 7**—CAPITALIZEDINTEREST

 

Interestof approximately $494,000 and $1,501,000 was capitalized during the threemonths ended March 31, 2005 and 2004 respectively relating to the Wyomingproperty in 2005 and Wyoming and California properties in 2004. The Company nolonger capitalizes interest on the California property since development ofthis property is no longer subject to litigation.

 

8

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#### **NOTE 8—CONTINGENCIES**

 

**Litigation**

 

*GothamInsurance Company v. Warren.* In 1998, the Company and its subsidiary, WarrenE&P, Inc., were sued in the 81st Judicial District Court of FrioCounty, Texas by Stricker Drilling Company, Inc. and Manning Safety Systems torecover the value of lost equipment based on a well blow-out. As a result ofthe lawsuit, Gotham Insurance Company, Warren E&P’s well blow-out insurer, intervened.The suit was settled in 1999 with all parties except Gotham and otherunderwriters. Gotham paid approximately $1.8 million under the insurancepolicy and has sought a refund of approximately $1.8 million, is denyingcoverage, and alleging fraud and misrepresentation and a failure of WarrenE&P to act with due diligence and pursuant to safety regulations. WarrenE&P countersued for the remaining proceeds under the policy coverage. Inthe summer and fall of 2000, summary judgments were entered in favor of WarrenE&P on essentially all claims except its bad faith claims against Gotham,and Gotham’s claims were rejected. Final judgment was rendered by the DistrictCourt on May 14, 2001 in Warren E&P’s favor for the remaining policyproceeds, interest and attorneys’ fees. Gotham appealed the final judgment tothe San Antonio Court of Appeals, seeking a refund of approximately$1.5 million. On July 23, 2003, the San Antonio Court of Appealsreversed, in Gotham’s favor, the trial court’s earlier summary judgment forWarren E&P and remanded the case to the trial court for further proceedingsconsistent with the San Antonio Court of Appeals’ decision. A hearing washeld on December 17, 2004 to consider the parties’ motions to determineboth the amount of actual loss incurred by Gotham, the amount of judgmentliability to be paid by Warren and Warren E&P and Warren’s other claimsagainst Gotham that were pending but unheard by the District Court as a resultof the District Court’s granting a summary judgment in Warren E&P’s favorin May 2001. On January 4, 2005, the Company received an order of thetrial court that Warren and Warren E&P were obligated to repay Gotham$1.8 million, along with attorneys’ fees and statutory interest estimatedat $966,000. At December 31, 2004, Warren recorded a provision for $1,800,000relating to this settlement. On April 11, 2005, Warren filed to appeal theorder of the trial court to the Texas Court of Appeals. In connection with theappeal, on April 14, 2005 Warren posted a supersedeas bond with the Court ofAppeals in the amount of $2.9 million to cover the trial court judgment pluspotential legal fees, court costs and statutory interest for the next twoyears. The supersedeas bond was secured by a collateral pledge of U.S. Treasurysecurities owned by Warren in amount of $2.9 million. Although the Companybelieves that it has meritorious grounds for the appeal, if its appeal isunsuccessful, it will be obligated to pay the restitution to Gotham as orderedby the trial court.

 

Warren is also a party tolegal actions arising in the ordinary course of our business.  In the opinion of its management, based inpart on consultation with legal counsel, the liability, if any, under theseclaims is either adequately covered by insurance or would not have a materialadverse effect on the Company.

 **Repurchase Agreements**

 

Undercertain repurchase agreements, the investor partners in certain affiliatedpartnerships have a right to have their interests repurchased by theCompany.  Such purchase price iscalculated at a formula price and is payable in seven to 25 years from the dateof admission to the partnership.  Forcertain affiliated partnerships formed prior to 1998, the maximum purchaseprice for all such interests was fully secured at maturity by zero coupon U.S.treasury bonds (“securities”) held by an independent trust company.  The face amounts of such securities arereleased to the Company when equal amounts of cash distributions are made toinvestors. As a result of the recapitalizations, any payment made under thisguarantee would be recorded as a reduction to minority interest as shown on theCompany’s balance sheet. At March 31, 2005, the maximum cash outlay relating tothese contingent repurchase obligations is approximately $3.4 million. Thisamount is collateralized by U.S. treasury bonds with a face value ofapproximately $0.9 million.

 

Forcertain other repurchase agreements relating to partnerships formed from 1998to 2001, investor partners have a right to have their interests repurchased bythe Company at a formula price seven to 25 years from the date of the originalpartnership investment.  In determiningthe amount of the repurchase obligation, the obligation is computed based on thelesser of a formula purchase price or the estimated cash flows discounted at10% (“PV-10”) from proved developed and undeveloped reserves of eachpartnership. At March 31, 2005, the formula purchase price with respect tothese partnerships was approximately $93.7 million. However, this amount islimited to approximately $19.0 million based on the PV-10 of the assets inthese partnerships. This limitation may increase when we drill the remaining 7 netwells or place the remaining 37 net wells on production on behalf of theseseven drilling programs and will fluctuate due to the variables in determiningdiscounted cash flows, such as price changes, reserve revisions, etc.  In the event of repurchase, the Companyreceives the investor’s interest in the program and the investors pro ratashare of the programs reserves and related future cash flows.

 

9

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**NOTE 9—BUSINESS SEGMENTINFORMATION**

 

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

 
| ** **              | ** ** | **Three Months Ended** | ** ** |
|-------------------------|------------|------------------------|------------|
| ** **              | ** ** | **March 31,  2005**    | ** ** | **March 31,  2004** | ** ** |
| **Revenue**             |       |                   |       |   |   |
| Turnkey  Contracts      |       | $                      | 2,279,317  |   | $ | 908,934 |   |
| Oil and Gas  Marketing  |       | 2,196,074              |       | 1,383,575 |   |
| Oil and Gas  Operations |       | 2,176,587              |       | 1,226,475 |   |
| Well Services           |       | 540,659                |       | 230,605 |   |
| Other                   |       | 924,161                |       | 582,713 |   |
|                    |       |                   |       |   |   |
|                    |       | $                      | 8,116,798  |   | $ | 4,332,302 |   |

 
| ** **                     | ** ** | **March 31  2005** | ** ** | **March 31,  2004** | ** ** |
|--------------------------------|------------|--------------------|------------|---------------------|------------|
| **Operating  Income / (Loss)** |       |               |       |                |       |
| Turnkey  Contracts             |       | $                  | 231,113    |                | $          | (550,052 | ) |
| Oil and Gas  Marketing         |       | 30,982             |       | 35,356              |       |
| Oil and Gas  Operations        |       | 763,495            |       | (94,972             | )          |
| Well Services                  |       | 346,270            |       | 118,727             |       |
| Other                          |       | (2,817,932         | )          | (751,997            | )          |
|                           |       |               |       |                |       |
|                           |       | $                  | (1,446,072 | )                   | $          | (1,242,938 | ) |

 

 

**NOTE 10—COMPREHENSIVE LOSS**

 

Other comprehensive loss consistof net unrealized gains on available for sale investments, net of income taxeffect. Total comprehensive loss for the periods are as follow:

 
| ** **                     | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
|                           |       |     |       |     |       |
| Three months  ending March 31, |       | $        | (1,898,238 | )        | $          | (735,662 | ) |
|                                |            |          |            |          |            |  |  |

 

 

**NOTE 11—GOODWILL**

 

The Company accounts forgoodwill under SFAS No. 142, *Goodwill and OtherIntangible Assets,*and only adjusts the carrying amount of goodwillor indefinite life intangible assets upon an impairment. During the threemonths ended March 31, 2005 and 2004, no events occurred which would indicatethat an impairment of goodwill existed.

 

During the second quarterof 2004, the Company retained an independent outside valuation expert to assistin developing the fair value analysis necessary to conduct the testing forimpairment of its goodwill, all of which arose in its acquisition of WarrenE&P. The results of this analysis indicated that no impairment of goodwillhad occurred in 2004. The 2005 annual impairment testing will be performedduring the second quarter of 2005.

 

10

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**NOTE 12—NEW ACCOUNTINGPRONOUNCEMENTS**

** **

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

 

**NOTE 13 – SUBSEQUENT EVENT**

 

From March 31, 2005 thruMay 10, 2005, the Company has issued 1,710,941 shares of common stock to preferredstock holders who converted to common stock and 165,865 shares of common stockto convertible debenture holders.

 

**Item 2****. *Management’s discussion and analysis of financialconditions and results of operations***

 

**FORWARD-LOOKINGINFORMATION**

 

Forward-lookingstatements for 2005 and later periods are made in this document. Suchstatements represent estimates by management based on the Company’s historicaloperating trends, its proved oil and gas reserves and other informationcurrently available to management. The Company cautions that theforward-looking statements provided herein are subject to all the risks anduncertainties incident to the acquisition, development and marketing of, andexploration for oil and gas reserves. These risks include, but are not limitedto, oil and natural gas price risk, environmental risks, drilling risk, reservequantity risk and operations and production risk. For all the above reasons,actual results may vary materially from the forward-looking statements andthere is no assurance that the assumptions used are necessarily the most likelyto occur.

 

**OVERVIEW:**

 

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

 

Our future success dependsupon the development of our core acreage. During 2005 and subsequent years, we plan to continue to develop ourcore acreage, which includes our coalbed methane acreage in the Atlantic andPacific Rims in the Washakie Basin in Wyoming. Also, because our legal issues in California have been resolved, weintend to continue to develop our secondary recovery project inCalifornia.  See “Legal Proceedings.”

 

**LIQUIDITY AND CAPITALRESOURCES:**

 

Our primary source ofliquidity since our formation has been the private sale of our equity and debtsecurities and by sponsoring drilling programs. These private placementsprimarily were made through a network of independent broker dealers. From 1992to 2003, we raised approximately $228 million through the private placements ofinterests in 31 drilling programs. Additionally, we have raised $71.6 millionthrough the issuance of our debt securities and $174.1 million through theissuance of our equity securities. In our drilling programs, we fund the costsassociated with acreage acquisition and the tangible portion of drillingactivities, while investors in the drilling programs fund all intangibledrilling costs. Our primary use of capital has been for the acquisition,development and exploration of our natural gas and oil properties. Additionaluses of capital include the payment of dividends on our preferred stock,sinking fund requirements related to debentures and operating losses fromoperations.

 

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

 

Our cashand cash equivalents decreased $38.7 million during the three months endedMarch 31, 2005. This resulted from $15.7 million of cash used in financingactivities, $16.3 million of cash used in investing activities and $6.7 millionof cash used in operating activities.

 

11

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Cash used in financingactivities primarily relates to the redemption of debentures.  During the first three months of 2005, weredeemed before maturity all of our outstanding debentures due in 2007 and 2017for cash.  The total redemption amountwas $14.1 million and the total premium paid above par was $0.5 million.  Additionally, we paid dividends on preferredstock totaling $1.6 million.  Cash usedin investing activities of $16.1 million results from $21.3 million inexpenditures on oil and gas properties offset by the release of $5.1 million inU.S. Treasury Bonds relating to the redemption of debentures discussedabove.  Cash used in operating activitiesof $6.7 million primarily relates to drilling wells on behalf of our drillingprograms and operations.

 

Additionally, on April29, 2005, we elected to fully redeem before maturity our 13.02% Sinking FundDebentures due December 31, 2010 (2010 SF Debentures).  As of March 31, 2005, the outstanding 2010 SFDebentures totaled $13.0 million.  Theredemption price premium is 10% above par. Debenture holders may exercise their right to convert their debenturesinto common shares at $5.00 per share. The debentures may be converted at any time prior to the redemption dateof June 29, 2005.

 

Another materialcommitment of funds relates to the drilling programs. Our deferred revenuebalance relating to our drilling commitments totaled $9.6 million at March 31,2005. This commitment approximates 14 net wells, primarily in the WashakieBasin, to be drilled on behalf of our drilling programs formed in 2003 andprior.

 

TheCompany had a net loss before dividends of $1.7 million for the three monthsended March 31, 2005, as compared to a net loss before dividends of $1.1million for the corresponding period ending March 31, 2004. At March 31, 2005,current assets exceeded current liabilities by approximately $36.2 million.

 

*Contractual obligations.*There have been no material changes inthe Company’s contractual obligations outside of the ordinary course ofbusiness from those disclosed in the Company’s Annual Report on Form 10-K forthe year ended December 31, 2004.

 

**RESULTS OF OPERATIONS:**

 

**Threemonths Ended March 31, 2005 Compared to Three Months Ended March 31, 2004**

 

*Turnkey contract revenue andexpenses.* Turnkeycontract revenue increased $1.4 million in the first quarter to $2.3 million, a151% increase compared to the corresponding quarter of the preceding year.Additionally, turnkey contract expense increased $0.6 million during the firstquarter to $2.0 million, a 41% increase compared to the same period in2004.  The drilling activity was moreactive during the first quarter of 2005 compared to the corresponding quarterof 2004.

 

Net incomefrom turnkey activities was $0.3 million for the first quarter. This comparesto a net loss of $0.5 million for the corresponding quarter in 2004. Thisincrease in net gain during the first quarter of 2005 results from drillingcertain shallow re-entry wells in 2005 with higher profit margins. G&Aexpenses allocated to turnkey expense for the three months ended March 31, 2005and 2004 was $0.5 million and $0.8 million, respectively.

 

*Oil and gas sales and costs frommarketing activities.* Oil and gas sales from marketing activities increased $0.8 million inthe first quarter to $2.2 million, a 59% increase compared to the same periodlast year. Cost of oil and gas marketing activities increased $0.8 million inthe quarter to $2.2 million, a 61% increase compared to the same quarter in2004. Oil and gas production from the wells in the drilling programs in whichwe earn a marketing fee for the three months ended March 31, 2005 and 2004 was0.6 Bcfe and 0.3 Bcfe, respectively. The average price per Mcfe during thefirst quarter of 2005 and 2004 was $3.71 and $4.16, respectively.

 

The gross profit frommarketing activities for the first quarter of 2005 was $31 thousand as comparedto $35 thousand in the same period last year.

 

*Well services activities.* Well services revenue increased $310thousand in the first quarter to $0.5 million, a 134% increase compared to thecorresponding quarter of the preceding year. Well services expense increased$83 thousand in the first quarter to $0.2 million. The increase in wellservices revenue results from a joint venture between Anadarko PetroleumCorporation and Warren that commenced during the first quarter of 2005.  Under this joint venture, we charge theworking interest owners in the Atlantic Rim Project in the Washakie Basin a feefor the use of our jointly owned compression facilities and sales lines.

 

12

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Gross profit from wellservices activities was $346 thousand for the first quarter of 2005. Thiscompared to gross profit of $119 thousand for the corresponding quarter of lastyear.  The increase in gross profitduring 2005 results from the Anadarko joint venture discussed above.

 

*Oil and gas sales.* Revenue from oil and gas sales increased$1.0 million in the first quarter to $2.2 million, a 78% increase compared tothe same quarter in 2004.  This increaseresulted from our acquisition of substantially all of the remaining workinginterests in the Wilmington Field in California. Net production for the threemonths ended March 31, 2005 and 2004 was 422 MMcfe and 240 MMcfe, respectively.

 

*Net gain on investments.* Net gain on investments was $31 thousandfor the first quarter of 2005.  Net gainon investments was $50 thousand during the first quarter of 2004.  Primarily, investments represent zero couponU.S. treasury bonds. Fluctuations in net gain or loss on investments resultedfrom changes in long-term interest rates.

 

*Interest and other income.* Interest and other income increased $0.4million in the first quarter to $0.9 million, a 68% increase compared to the samequarter in 2004. This represents an increase in interest earned on idle cashbalances.

 

*Production & exploration.* Production and exploration expensedecreased $0.3 million in the first quarter of 2005 to $0.7 million, a 33%decrease compared to the same quarter in 2004. This decreased resulted from the retroactive reversal of certain leaseoperating expenses previously charged by the former operator of the WilmingtonField in California.

 

*Depreciation, Depletion,Amortization and Impairment.* Depreciation, depletion, amortization and impairmentexpense increased $0.4 million for the quarter to $0.8 million, an 89% increasecompared to the corresponding quarter last year. This increase results from anincrease in oil and gas production. Additionally, this increase results from a higher cost basis in oil andgas properties as a result of our acquisition of the Wilmington Field inCalifornia, resulting in a higher depletion expense.

 

*General and administrativeexpenses.* Generaland administrative expenses increased $0.3 million in the first quarter of 2005to $1.5 million, a 25% increase compared to the corresponding quarter lastyear.  This reflects an increase of $0.3million resulting from allocating certain expenses to general andadministrative expenses during 2005 instead of turnkey expense.

 

*Interest expense.* Interest expense increased $1.0 millionin the first quarter to $1.1 million, a 917% increase compared to the samequarter last year.  Interest expenseincreased significantly during 2005 because we are no longer capitalizinginterest costs related to the Wilmington Field in California.  Since the development of this property is nolonger subject to litigation, interest costs related to this property is not capitalized.

 

*Retirement of debt.* Retirement of debt expense was $1.2million in 2005.  There was no retirementof debt expense in 2004.  This expenserepresents a premium paid on redemption of the debentures and the write off ofunamortized deferred offering costs associated with the 2007 and 2017debentures, which were redeemed before maturity in March 2005.

##### ** **

**Off-Balance Sheet Arrangements**

 

                Under the terms of our drilling programs formed from1998 to 2001, investors have the right to tender their interest back to thedrilling program and other program investors during the period from seven to25 years after the date of the partnership’s formation. To the extent thatan investor tenders a drilling program interest for sale and the drillingprogram and other investors elect not to repurchase the withdrawing partner’sinterest, we will be required to repurchase the interest from the investor. Theprice of our repurchase is fixed by the drilling program agreement to be thelower of the PV-10 value of the assets of the program and a formula based on theamount of the investor’s cash investment reduced by the amount of any cashdistributions received. As of December 31, 2004, based on the December 31, 2004reserve reports of the respective drilling programs, the aggregate PV-10 valueof the assets in these programs is $19.0 million. Because this PV-10 valueis less than the formula price of $93.7 million at December 31, 2004, themaximum repurchase price obligation at December 31, 2004 was $19.0 million.This PV-10 value would be higher if current prices for crude oil and naturalgas were to increase when we drill the remaining 7 net wells or place theremaining 37 net wells on production on behalf of these seven drillingprograms. In the event

 

13

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of repurchase, we receivethe investor’s interest in the program, which includes the investor’sbeneficial share of the program’s reserves and related future net cash flows.

 

                The table below presents the projected timing of ourmaximum potential repurchase commitment associated with these programs as ofMarch 31, 2005:

 
| ** **                                   | ** ** | **Amount of repurchase commitment per period** | ** ** |
|----------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                   | ** ** | **Less Than  1 Year**                          | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** | **Total** | ** ** |
|                                         |       | **(in  thousands)**                            |       |
|                                         |       |                                           |       |   |   |   |   |   |   |   |   |
| Maximum  potential repurchase commitment (1) |       | $                                              | 3,357      |   | $ | 12,774 |   | $ | 2,568 |   | $ | 343 |   | $ | 19,042 |   |
|                                              |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

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(1) Based on the partnership reservestaken from the Williamson partnership reserve report as of December 31, 2004and using pricing at that date. This report does not include reserves for 7 netwells that are scheduled to be drilled for these programs by the fourth quarterof 2005 or for the 37 net wells drilled and waiting to be placed on production.

***AdditionalRepurchase Commitments***

 

     Under the terms of 13 of our drilling programs formed before 1998, the minorityinterest investors have the right to require us to repurchase their interestsin each program for a formula price, to the extent that the drilling programsand other program investors elect not to purchase a withdrawing partner’sinterest. This right is effective either seven years from the date of apartnership’s formation, or between the 15th and 25th anniversary of itsformation. The formula price is computed as the original capital contributionof the investor reduced by the greater of cash distributions we made to theinvestor, or 10% for every $1.00 which the oil price at the repurchase date isbelow $13.00 per barrel adjusted by the CPI changes since the program’sformation. If we purchase interests in drilling programs, we receive theinvestor’s interest in the program, which includes the investor’s beneficialshare of the reserves and related future net cash flows. The table belowpresents the repurchase commitment associated with the pre-1998 drillingprograms, giving no effect to any reserve value that is acquired in repurchase.

 
| ** **                                 | ** ** | **Amount of repurchase commitment per period** | ** ** |
|--------------------------------------------|------------|------------------------------------------------|------------|
| **Other Commitments As of March 31, 2005** | ** ** | **Less Than  1 Year**                          | ** ** | **1-3  Years** | ** ** | **4-5  Years** | ** ** | **More Than  5 Years** | ** ** | **Total** | ** ** |
| ** **                                 | ** ** | **(in thousands)**                             | ** ** |
| Partnership  repurchase commitments:       |       |                                           |       |   |   |   |   |   |   |   |   |
|                                       |       |                                           |       |   |   |   |   |   |   |   |   |
| Pre-1998  Partnerships                     |       | $                                              | 2,532      |   | — |   | $ | 58 |   | $ | 788 |   | $ | 3,378 |   |
|                                            |            |                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**CRITICAL ACCOUNTING POLICIES**

 

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

** **

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

** **

**Capitalizedcosts of producing oil and gas properties are depleted by theunits-of-production method on a field-by-field basis.  Lease costs are depleted using total provedreserves while lease equipment and intangible development costs are depletedusing proved developed reserves.  Ourproved properties are evaluated on a field-by-field basis for impairment.  An impairment loss is indicated whenever netcapitalized costs exceed expected future net cash flow based on engineeringestimates.  In this circumstance, werecognize an impairment loss for the amount by which the carrying value of theproperties exceeds the estimated fair value based on discounted cash flow.**

** **

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

** **

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

** **

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

 

*Revenue Recognition*

 

**Affiliatedpartnerships enter into agreements with us to drill wells to completion for afixed price.  We, in turn, enter intodrilling contracts primarily with unrelated parties to drill wells on a daywork basis.  Therefore, if problems areencountered on a well, the cost of that well will increase and gross profitwill decrease and could result in a loss on the well.  We recognize revenue from the turnkeydrilling agreements on a proportional performance method as services areperformed. This involves management making judgments and estimates as to thevarious stage of completion of each well based on the review of drilling logs,status reports from engineers and historical experience in completing similarwells. When estimates of revenues and expenses indicate a loss, the totalestimated loss is accrued.  Oil and gassales result from undivided interests held by us in various oil and gas properties.  Sales of natural gas and oil produced arerecognized when delivered to or picked up by the purchaser.  Oil and gas sales from marketing activitiesresult from sales by us of oil and gas produced by affiliated joint venturesand partnerships and are recognized when delivered to purchasers.**

 

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*Repurchase Agreements*

 

**Undercertain repurchase agreements, the investors in certain drilling programs havea right to have their interests purchased by a repurchase agent or us.  We unconditionally guarantee the repurchaseagent’s performance.  The repurchaseprice is calculated at a formula based on various factors and is payable fromseven to 25 years from the date of admission to the drilling program.  See “Repurchase Commitments” for a more detaileddescription of the repurchase agreements. For 1997 and prior programs, wedetermine the amount of the repurchase liability by computing the present valueof the excess of the formula price over the estimated discounted present valueof future net revenues of proved developed and undeveloped reserves of eachdrilling program net of future capital costs and our working interests.**

** **

**Thedetermination of whether a repurchase liability exists is based upon estimatesof future net cash flows from reserve studies prepared by petroleumengineers.  These reserve studies areinherently imprecise and will change as future information becomesavailable.  Decreases in prices receivedfor oil and gas produced by drilling programs result in smaller cashdistributions to investors and payout may not occur before the future date atwhich the investors have a right to require repurchase of their interests.  Under the formula for repurchase in 1997 andearlier drilling programs, low oil and gas prices at the future date may resultin us being required to repurchase investor interests at prices greater thanfair value.  An expense recognition wouldtherefore be necessary.**

** **

**If oiland gas prices decrease, we may determine that proved undeveloped leases indrilling programs are not economical to drill and develop.  As a result, cash flow from these leases willnot be distributed to investors and payout may be delayed.  If payout has not occurred in these drillingprograms before the date investors can require repurchase of their interests,we may be required to purchase interests containing proved undeveloped leasesbased on a petroleum engineer’s estimate of the present value of net cashflow.  The price paid may be in excess ofthe fair value of the interest resulting in a charge to expense for 1997 andearlier programs.**

 

*Capitalized Interest*

 

**Statementof Financial Accounting Standards No. 34, *Capitalization of InterestCost*, provides standards for the capitalization of interest cost aspart of the historical cost of acquiring assets.  Costs of investments in unproved propertieson which exploration or development activities are in progress or are thesubject of pending litigation qualify for capitalization of interest.  Capitalized interest is calculated bymultiplying our weighted-average interest rate on debt by the amount ofqualifying costs.  Capitalized interestcannot exceed gross interest expense.**

 

*Asset Retirement Obligations*

 

The Company accounts forAsset Retirement Obligations under SFAS No. 143. During the three months endingMarch 31, 2005 and 2004 the asset retirement liability was increased byapproximately $14,000 and $16,000 respectively, as a result of accretion andrecorded as interest expense. Additionallyduring the three months ended March 31, 2005, the asset retirement obligationwas increased by $299,000 resulting for the acquisition of an additionalinterest in the Wilmington field. During the three months ended March31, 2005, there have been no significant changes in cash flow assumptions forthe liability or liabilities incurred or settled during the period. The Companyhas treasury bills held in escrow with a fair market value of $2,748,000 whichare legally restricted for potential plugging and abandonment liability in theWilmington field.

 

## **New Accounting Pronouncements**

** **

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

** **

**16**

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** **

**Item 3****. *Quantitative and qualitative disclosure aboutmarket risk***

 

## ***Commodity Risk***

**Our major market risk exposure is the commodity pricingapplicable to our natural gas and oil production. Realized commodity pricesreceived for our production are primarily driven by the prevailing worldwideprice for crude oil and spot prices applicable to natural gas. The effects ofprice volatility are expected to continue.**

** **

## ***Interest Rate Risk***

 

**We hold investments in U.S. treasury bonds available forsale, which represents securities held in escrow accounts on behalf of thedrilling programs and purchasers of certain debentures.  Additionally, we hold U.S. treasury bondstrading securities, which predominantly represent U.S. treasury bonds releasedfrom escrow accounts.  The fair marketvalue of these securities will generally increase if the federal discount ratedecreases and decrease if the federal discount rate increases.  All of our convertible debt has fixedinterest rates, so consequently we are not exposed to cash flow or fair valuerisk from market interest rate changes on this debt.**

** **

## ***Financial Instruments***

 

**Ourfinancial instruments consist of cash and cash equivalents, U.S. treasurybonds, accounts receivable and other long-term liabilities.  The carrying amounts of cash and cashequivalents, U.S. treasury bonds, accounts receivable and accounts payableapproximate fair market value due to the highly liquid nature of theseshort-term instruments.  The fair valueof our convertible debt is more than face value.**

** **

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

#### ** **

#### **The general level of inflationaffects our costs.  Salaries and othergeneral and administrative expenses are impacted by inflationary trends and thesupply and demand of qualified professionals and professional services.  Inflation and price fluctuations affect thecosts associated with exploring for and producing natural gas and oil, whichhave a material impact on our financial performance.**

#### ** **

#### **Item 4**. *Evaluation of DisclosureControls 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) and15d-15(e) as of the end of the period covered by this report.  Based upon that evaluation, management  has concluded that our  disclosure controls  and  procedures are  effective  to ensure that information we are required to disclose in reports that we file orsubmit under the Securities Exchange Act is communicated to management,including the CEO and CFO, as appropriate to allow timely decisions  regarding required disclosure and is  recorded, processed,  summarized  and reported  within the time periodsspecified in the SEC’s rules and forms.

 

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

 

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## **PART II**—OTHER INFORMATION

 

**Item 1****. *Legal Proceedings***

 

*GothamInsurance Company v. Warren.* In 1998, we and our subsidiary, Warren E&P, Inc.,were sued in the 81st Judicial District Court of Frio County, Texas byStricker Drilling Company, Inc. and Manning Safety Systems to recover the valueof lost equipment based on a well blow-out. As a result of the lawsuit, GothamInsurance Company, Warren E&P’s well blow-out insurer, intervened. The suitwas settled in 1999 with all parties except Gotham and other underwriters.Gotham paid approximately $1.8 million under the insurance policy and hassought a refund of approximately $1.8 million, is denying coverage, andalleging fraud and misrepresentation and a failure of Warren E&P to actwith due diligence and pursuant to safety regulations. Warren E&Pcountersued for the remaining proceeds under the policy coverage. In the summerand fall of 2000, summary judgments were entered in favor of Warren E&P onessentially all claims except its bad faith claims against Gotham, and Gotham’sclaims were rejected. Final judgment was rendered by the District Court onMay 14, 2001 in Warren E&P’s favor for the remaining policy proceeds,interest and attorneys’ fees. Gotham appealed the final judgment to theSan Antonio Court of Appeals, seeking a refund of approximately$1.5 million. On July 23, 2003, the San Antonio Court of Appealsreversed, in Gotham’s favor, the trial court’s earlier summary judgment for WarrenE&P and remanded the case to the trial court for further proceedingsconsistent with the San Antonio Court of Appeals’ decision. A hearing washeld on December 17, 2004 to consider the parties’ motions to determineboth the amount of actual loss incurred by Gotham, the amount of judgmentliability to be paid by Warren and Warren E&P and Warren’s other claimsagainst Gotham that were pending but unheard by the District Court as a resultof the District Court’s granting a summary judgment in Warren E&P’s favorin May 2001. On January 4, 2005, we received an order of the trial courtthat Warren and Warren E&P were obligated to repay Gotham$1.8 million, along with attorneys’ fees and statutory interest estimatedat $966,000. At December 31, 2004, Warren recorded a provision for $1,800,000relating to this settlement. On April 11, 2005, we filed to appeal the order ofthe trial court to the Texas Court of Appeals. In connection with the appeal,on April 14, 2005 we posted a supersedeas bond with the Court of Appeals in theamount of $2.9 million to cover the trial court judgment plus potential legalfees, court costs and statutory interest for the next two years. Thesupersedeas bond was secured by a collateral pledge of U.S. Treasury securitiesowned by us in amount of $2.9 million. Although we believe that we havemeritorious grounds for the appeal, if its appeal is unsuccessful, we will beobligated to pay the restitution to Gotham as ordered by the trial court.

 

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

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

 

      a.       Notapplicable

 

      b.       Notapplicable

 

      c.       Notapplicable

 

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

 

Notapplicable.

 

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

 

Not applicable.

 

**Item 5****. *Other Information***

 

Not applicable.

 

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**Item 6****. *Exhibits***

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

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

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

 

 

**SIGNATURES**

 

 

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

 
|               | WARREN RESOURCES, INC.  (Registrant) |
|--------------------|--------------------------------------|
|               |                                 |
|               |                                 |
|               |                                 |
| Date: May 10, 2005 | By:                                  | /s/ Timothy A. Larkin |
|               |                                 | Timothy A. Larkin |
|               |                                 | *Executive Vice President, Chief  Financial Officer and Principal Accounting Officer* |

 

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