**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549**

 

**FORM 10-Q**

 

|       |                                                                     |
|------------|--------------------------------------------------------------------------|
| **x**      | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES**  |
| ** ** | **EXCHANGE  ACT OF 1934**                                                |
| ** ** | ** **                                                               |
| ** ** | **For the  Quarterly Period Ended September 30, 2007**                   |
| ** ** | ** **                                                               |
| ** ** | **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 of Registrant 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 check markwhether 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 xNo o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer (asdefined in Rule 12b-2 of the Exchange Act).

 

| Large accelerated filer  o |   | Accelerated filer x |   | Non-accelerated filer o |
|----------------------------|--------|---------------------|--------|-------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes oNo x

 

Theaggregate number of Registrant’s outstanding shares on November 1, 2007 was58,181,916 shares 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  September 30, 2007 and December 31, 2006                            |   |   |
|                |                                                                                                   |   |   |
|                | Consolidated Statements of  Operations for the three and nine months ended September 30, 2007 and 2006 |   |   |
|                |                                                                                                   |   |   |
|                | Consolidated Statements of  Cash Flows for nine months ended September 30, 2007 and 2006               |   |   |
|                |                                                                                                   |   |   |
|                | Notes to the Consolidated  Financial Statements                                                        |   |   |
|                |                                                                                                   |   |   |
|                | Item 2.  Management’s Discussion and Analysis of Financial Conditions and Results of  Operations  |   |   |
|                |                                                                                                   |   |   |
|                | Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                    |   |   |
|                |                                                                                                   |   |   |
|                | Item 4.  Evaluation of Disclosure Controls and Procedures                                              |   |   |
|                |                                                                                                   |   |   |
|  PART II— | OTHER INFORMATION                                                                                      |   |   |
|                |                                                                                                   |   |   |
|                | Item 1. Legal  Proceedings                                                                             |   |   |
|                |                                                                                                   |   |   |
|                | Item 1A. Risk Factors                                                                                  |   |   |
|                |                                                                                                   |   |   |
|                | Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds                                   |   |   |
|                |                                                                                                   |   |   |
|                | Item 3.  Defaults upon Senior Securities                                                               |   |   |
|                |                                                                                                   |   |   |
|                | Item 4.  Submission of Matters to a Vote of Security Holders                                           |   |   |
|                |                                                                                                   |   |   |
|                | Item 5. Other Information                                                                              |   |   |
|                |                                                                                                   |   |   |
|                | Item 6. Exhibits                                                                                       |   |   |
|                |                                                                                                   |   |   |
|                | Signatures                                                                                             |   |   |

 

2

----

 

**PART I—FINANCIAL INFORMATION**

 

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

###### ** **

**WarrenResources, Inc. and Subsidiaries**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

** **
| ** **                                                                                                                                                                                                                                                                            | ** ** | **September 30,  2007** | ** **      | **December 31,  2006**           | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|-----------------|---------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                            | ** ** | ** **                   | ** **      | **(Restated, see  Note B)** | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                            |       |                         |            |                                  |       |
| Current Assets                                                                                                                                                                                                                                                                        |       |                         |            |                                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                            |       | $                            | 11,231,072      |                                  | $          | 43,021,884 |   |
| Accounts  receivable — trade                                                                                                                                                                                                                                                     |       | 8,078,636                    |            | 5,984,259                             |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                                                                 |       | 126,432                      |            | 121,855                               |       |
| Other current  assets                                                                                                                                                                                                                                                                 |       | 638,326                      |            | 3,309,692                             |       |
|                                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
| Total current assets                                                                                                                                                                                                                                                                  |       | 20,074,466                   |            | 52,437,690                            |       |
|                                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
| Other Assets                                                                                                                                                                                                                                                                          |       |                         |            |                                  |       |
| Oil and gas  properties—at cost, based on full cost method of accounting, net of  accumulated depreciation, depletion and amortization (includes unproved  properties excluded from amortization of $74,037,603 and $57,101,675 as of  September 30, 2007 and December 31, 2006) |       | 376,673,054                  |            | 253,592,415                           |       |
| Property and  equipment—at cost, net                                                                                                                                                                                                                                             |       | 2,475,639                    |            | 1,751,146                             |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                                                                 |       | 1,137,890                    |            | 1,096,695                             |       |
| Goodwill                                                                                                                                                                                                                                                                              |       | 3,430,246                    |            | 3,430,246                             |       |
| Other assets                                                                                                                                                                                                                                                                          |       | 4,162,422                    |            | 4,643,155                             |       |
|                                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
| Total other  assets                                                                                                                                                                                                                                                                   |       | 387,879,251                  |            | 264,513,657                           |       |
| ** **                                                                                                                                                                                                                                                                            | ** ** | **$**                        | **407,953,717** | ** **                            | **$**      | **316,951,347** | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                        |       |                         |            |                                  |       |
| ** **                                                                                                                                                                                                                                                                            |       |                         |            |                                  |       |
| Current  Liabilities                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
| Current  maturities of debentures and other long term liabilities                                                                                                                                                                                                                     |       | $                            | 583,484         |                                  | $          | 506,628 |   |
| Accounts payable  and accruals                                                                                                                                                                                                                                                        |       | 22,165,560                   |            | 22,455,043                            |       |
|                                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
| Total current  liabilities                                                                                                                                                                                                                                                            |       | 22,749,044                   |            | 22,961,671                            |       |
|                                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
| Long-Term  Liabilities                                                                                                                                                                                                                                                                |       |                         |            |                                  |       |
| Debentures, less  current portion                                                                                                                                                                                                                                                     |       | 2,241,900                    |            | 2,246,400                             |       |
| Other long-term  liabilities, less current portion                                                                                                                                                                                                                                    |       | 7,522,240                    |            | 6,766,868                             |       |
| Line of credit                                                                                                                                                                                                                                                                        |       | 30,000,000                   |            | —                                |       |
|                                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
|                                                                                                                                                                                                                                                                                  |       | 39,764,140                   |            | 9,013,268                             |       |
|                                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
| Commitments and  Contingencies                                                                                                                                                                                                                                                        |       |                         |            |                                  |       |
|                                                                                                                                                                                                                                                                                  |       |                         |            |                                  |       |
| Stockholders’  Equity                                                                                                                                                                                                                                                            |       |                         |            |                                  |       |
| 8% convertible preferred stock, par value $.0001; authorized 10,000,000  shares, issued and outstanding, 271,436 shares in 2007 and 272,000 shares in  2006  (aggregate liquidation  preference $3,257,232 in 2007 and $3,264,000 in 2006)                                            |       | 3,251,549                    |            | 3,252,897                             |       |
| Common stock —  $.0001 par value; authorized, 100,000,000 shares; issued 58,176,146 in 2007  and 54,143,054 shares in 2006                                                                                                                                                       |       | 5,818                        |            | 5,414                                 |       |
| Additional  paid-in-capital                                                                                                                                                                                                                                                           |       | 424,183,022                  |            | 371,035,151                           |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                  |       | (81,412,768                  | )               | (88,729,921                           | )          |
| Accumulated  other comprehensive income, net of applicable income taxes of $92,000 in 2007  and $92,000 in 2006                                                                                                                                                                       |       | 140,967                      |            | 140,922                               |       |
|                                                                                                                                                                                                                                                                                  |       | 346,168,588                  |            | 285,704,463                           |       |
| Less common  stock in Treasury—at cost; 632,250 shares in 2007 and 2006                                                                                                                                                                                                          |       | 728,055                      |            | 728,055                               |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                                      |       | 345,440,533                  |            | 284,976,408                           |       |
| ** **                                                                                                                                                                                                                                                                            | ** ** | **$**                        | **407,953,717** | ** **                            | **$**      | **316,951,347** | ** ** |

 

The accompanyingnotes are an integral part of these financial statements.

 

3

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**WarrenResources, Inc. and Subsidiaries**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                 | ** ** | **Three Months Ended  September 30, (Unaudited)** | ** ** | **Nine Months Ended  September 30, (Unaudited)** | ** ** |
|------------------------------------------------------------|------------|---------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                                          | ** ** | **2006**                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                 | ** ** | ** **                                        | ** ** | **(Restated, see   Note B)**                     | ** ** | ** ** | ** ** | **(Restated, see   Note B)** | ** ** |
| **Revenues**                                               |       |                                              |       |                                             |       |   |   |   |   |
| Oil and gas  sales                                         |       | $                                                 | 16,765,358 |                                             | $          | 8,424,271 |   | $ | 39,594,086 |   | $ | 22,867,872 |   |
| Interest and  other income                                 |       | 460,903                                           |       | 1,019,482                                        |       | 1,882,448 |   | 3,528,663 |   |
| Net gain (loss)  on investments                            |       | (12,536                                           | )          | 60,362                                           |       | (34,806 | ) | 110,169 |   |
|                                                       |       | 17,213,725                                        |       | 9,504,115                                        |       | 41,441,728 |   | 26,506,704 |   |
|                                                       |       |                                              |       |                                             |       |   |   |   |   |
| **Expenses**                                               |       |                                              |       |                                             |       |   |   |   |   |
| Lease operating  expense and taxes                         |       | 7,281,518                                         |       | 3,347,393                                        |       | 16,462,317 |   | 8,952,814 |   |
| Depreciation,  depletion and amortization                  |       | 3,179,084                                         |       | 1,561,648                                        |       | 7,769,387 |   | 4,385,736 |   |
| General and  administrative                                |       | 3,042,822                                         |       | 2,061,946                                        |       | 8,674,495 |   | 6,692,851 |   |
| Interest                                                   |       | 630,252                                           |       | 98,378                                           |       | 1,218,375 |   | 302,580 |   |
|                                                       |       | 14,133,676                                        |       | 7,069,365                                        |       | 34,124,574 |   | 20,333,981 |   |
|                                                       |       |                                              |       |                                             |       |   |   |   |   |
| Income before  provision for income taxes                  |       | 3,080,049                                         |       | 2,434,750                                        |       | 7,317,154 |   | 6,172,723 |   |
|                                                       |       |                                              |       |                                             |       |   |   |   |   |
| Deferred income  tax expense (benefit)                     |       | (25,000                                           | )          | (30,000                                          | )          | — |   | 93,000 |   |
|                                                       |       |                                              |       |                                             |       |   |   |   |   |
| Net income                                                 |       | 3,105,049                                         |       | 2,464,750                                        |       | 7,317,154 |   | 6,079,723 |   |
|                                                       |       |                                              |       |                                             |       |   |   |   |   |
| Less dividends  and accretion on preferred shares          |       | 66,787                                            |       | 73,304                                           |       | 200,855 |   | 289,452 |   |
|                                                       |       |                                              |       |                                             |       |   |   |   |   |
| Net income  applicable to common stockholders              |       | $                                                 | 3,038,262  |                                             | $          | 2,391,446 |   | $ | 7,116,299 |   | $ | 5,790,271 |   |
|                                                       |       |                                              |       |                                             |       |   |   |   |   |
| Earnings per  share – Basic                           |       | $                                                 | 0.05       |                                             | $          | 0.04 |   | $ | 0.13 |   | $ | 0.11 |   |
| Earnings per  share – Diluted                         |       | 0.05                                              |       | 0.04                                             |       | 0.13 |   | 0.11 |   |
|                                                       |       |                                              |       |                                             |       |   |   |   |   |
| Weighted average  common shares outstanding – Basic   |       | 57,586,698                                        |       | 53,317,367                                       |       | 55,331,505 |   | 52,786,511 |   |
| Weighted average  common shares outstanding – Diluted |       | 58,557,994                                        |       | 54,890,425                                       |       | 56,338,604 |   | 54,450,850 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

4

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**WarrenResources, Inc. and Subsidiaries**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

** **
| ** **                                                                         | ** ** | **For the nine months ended  September 30, (Unaudited)** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                                                               | ** ** | **2006** | ** ** |
| ** **                                                                         | ** ** | ** **                                                                             | ** ** | **(Restated, see  Note B)** | ** ** |
| Cash flows from  operating activities:                                             |       |                                                                                   |       |   |   |
| Net income                                                                         |       | $                                                                                      | 7,317,154  |   | $ | 6,079,723 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                                                                   |       |   |   |
| Accretion of  discount on available-for-sale debt securities                       |       | (47,839                                                                                | )          | (59,965 | ) |
| Amortization and  write-off of deferred bond offering costs                        |       | 13,212                                                                                 |       | 14,937 |   |
| Gain on sale of  US treasury bonds – available for sale                       |       | (492                                                                                   | )          | — |   |
| Depreciation,  depletion and amortization                                          |       | 7,769,387                                                                              |       | 4,385,736 |   |
| Common stock  cancelled                                                            |       | —                                                                                 |       | (70,670 | ) |
| Stock option  expense                                                              |       | 1,065,611                                                                              |       | 443,271 |   |
| Deferred tax  expense                                                              |       | —                                                                                 |       | 93,000 |   |
| Change in assets  and liabilities:                                                 |       |                                                                                   |       |   |   |
| (Increase)  decrease in trading securities                                         |       | —                                                                                 |       | (745,147 | ) |
| (Increase)  decrease in accounts receivable—trade                             |       | (2,421,353                                                                             | )          | 1,012,664 |   |
| Decrease in  accounts receivable from affiliated partnerships                      |       | 34,890                                                                                 |       | 78,090 |   |
| Decrease in  other assets                                                          |       | 3,138,887                                                                              |       | 2,947,340 |   |
| Increase  (decrease) in accounts payable and accruals                              |       | 817,883                                                                                |       | (6,804,243 | ) |
| Increase  (decrease) in other long-term liabilities                                |       | —                                                                                 |       | 327,095 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash  provided by operating activities                                         |       | 17,687,340                                                                             |       | 7,701,831 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Cash flows from  investing activities:                                             |       |                                                                                   |       |   |   |
| Purchase,  exploration and development of oil and gas properties                   |       | (79,227,977                                                                            | )          | (66,279,565 | ) |
| Purchase of  property and equipment                                                |       | (1,224,463                                                                             | )          | (509,252 | ) |
| Proceeds from  U.S. Treasury Bonds—available-for-sale                         |       | 2,605                                                                                  |       | 571,447 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash used in  investing activities                                             |       | (80,449,835                                                                            | )          | (66,217,370 | ) |
|                                                                               |       |                                                                                   |       |   |   |
| Cash flows from  financing activities:                                             |       |                                                                                   |       |   |   |
| Proceeds from  line of credit                                                      |       | 30,000,000                                                                             |       | — |   |
| Payments on debt  and debentures                                                   |       | (75,499                                                                                | )          | (173,880 | ) |
| Issuance of  common stock, net                                                     |       | 1,047,182                                                                              |       | 5,825,549 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash  provided by financing activities                                         |       | 30,971,683                                                                             |       | 5,651,669 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net decrease in  cash and cash equivalents                                         |       | (31,790,812                                                                            | )          | (52,863,870 | ) |
|                                                                               |       |                                                                                   |       |   |   |
| Cash and cash  equivalents at beginning of period                                  |       | 43,021,884                                                                             |       | 114,632,099 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                                                      | 11,231,072 |   | $ | 61,768,229 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Supplemental  disclosure of cash flow information                                  |       |                                                                                   |       |   |   |
| Cash paid for  interest                                                            |       | $                                                                                      | 683,291    |   | $ | 287,643 |   |
| Cash paid for  income taxes                                                        |       | —                                                                                 |       | — |   |
| Noncash  investing and financing activities                                        |       |                                                                                   |       |   |   |
| Accrued  preferred stock dividend                                                  |       | $                                                                                      | 195,434    |   | $ | 71,004 |   |
| Common stock  issued on conversion of preferred stock                              |       | 6,768                                                                                  |       | 6,385,908 |   |
| Common stock  issued for acquisition of property                                   |       | 51,229,568                                                                             |       | 4,276,920 |   |

 

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 A—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 served as the managing general partner (the “MGP”)and turnkey drilling contractor to affiliated partnerships and joint ventures.

 

Theaccompanying unaudited financial statements and related notes present theCompany’s consolidated financial position as of September 30, 2007 and December31, 2006, the consolidated results of operations for the three and nine monthsended September 30, 2007 and 2006 and consolidated cash flows for the ninemonths ended September 30, 2007 and 2006. The unaudited financial statementshave been prepared in accordance with accounting principles generally acceptedin the United States of America for interim financial information and with theinstructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, theydo not include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals) considered necessary for a fair presentation havebeen included. Operating results for the three and nine months ended September30, 2007, are not necessarily indicative of the results that may be expectedfor the fiscal year ending December 31, 2007. The accounting policies followedby the Company are set forth in Note A to the Company’s financial statementsincluded in Form 10-K for the year ended December 31, 2006. These interimfinancial statements and notes thereto should be read in conjunction with theconsolidated financial statements presented in the Company’s 2006 Annual Reporton Form 10-K.

 

**NOTE B –CHANGE IN ACCOUNTING PRINCIPLE**

 

Effective April 1, 2007, the Company adopted the fullcost method of accounting for its oil and gas properties. Previously, theCompany followed the successful efforts method of accounting for its oil andgas activities. Warren believes that the full cost method is preferable for acompany that is actively involved in the exploration and development of oil andgas reserves. Additionally, the full cost method is used by the majority ofWarren’s peers and management believes the change will improve thecomparability of Warren’s financial statements with its peer group. Warren’sfinancial results have been retroactively restated to reflect the full costmethod of accounting.

 

As prescribed by full cost accounting rules, all costsassociated with property acquisition, exploration and development activitiesare capitalized. Exploration and development costs include dry hole costs,geological and geophysical costs, direct overhead related to exploration anddevelopment activities and other costs incurred for the purpose of finding oiland gas reserves. Salaries and benefits paid to employees directly involved inthe exploration and development of oil and gas properties as well as otherinternal costs that can be specifically identified with acquisition,exploration and development activities are also capitalized. Proceeds receivedfrom disposals are credited against accumulated cost except when the salerepresents a significant disposal of reserves, in which case a gain or loss isrecognized. The sum of net capitalized costs and estimated future developmentand dismantlement costs are depleted on the equivalent unit-of-productionmethod, based on proved oil and gas reserves as determined by independentpetroleum engineers.

 

In accordance with full cost accounting rules, Warrenis subject to a limitation on capitalized costs. The capitalized cost of oiland gas properties, net of accumulated depreciation, depletion andamortization, may not exceed the estimated future net cash flows from provedoil and gas reserves discounted at 10 percent, plus the lower of cost or fairmarket value of unproved properties as adjusted for related tax effects. Ifcapitalized costs exceed this limit (the “ceiling limitation”), the excess mustbe charged to expense. Warren did not have any adjustment to earnings due tothe ceiling limitation for the periods presented herein.

 

6

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The costs of certain unevaluated oil and gasproperties and exploratory wells being drilled are not included in the costssubject to amortization. Warren assesses costs not being amortized for possibleimpairments or reductions in value and if a reduction in value has occurred,the portion of the carrying cost in excess of the current value is transferredto costs subject to amortization.

 

As a result of the change in accounting principle, ouraccumulated deficit as of January 1, 2006 increased from $82,861,220 asoriginally reported using the successful efforts method to $95,164,631 usingthe full cost method. There was no change in cash flows from operations duringthese periods presented below.

 

A comparison of the Company’s net income, earnings pershare, oil and gas properties and accumulated deficit under the successfulefforts method and the full cost method as disclosed herein, as follows:

 

**IncomeStatement**

**Threemonths ended September 30, 2007**

 
| ** **                                                             | ** ** | **As computed  under  Successful  Efforts** | ** ** | **As reported  under  Full  Cost** | ** ** | **Effect  of  change** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------|------------|------------------------|------------|
| Revenues                                                               |       |                                             |       |                                    |       |                   |       |
| Oil and gas  sales                                                     |       | $                                                | 16,765,358 |                                    | $          | 16,765,358             |       | $ | — |   |
| Well services                                                          |       | 274,623                                          |       | —                                  |       | (274,623               | )          |
| Interest and  other income                                             |       | 448,367                                          |       | 448,367                                 |       | —                 |       |
|                                                                   |       |                                             |       |                                    |       |                   |       |
|                                                                   |       | 17,488,348                                       |       | 17,213,725                              |       | (274,623               | )          |
| Expenses                                                               |       |                                             |       |                                    |       |                   |       |
| Production and  exploration                                            |       | 7,336,218                                        |       | 7,281,518                               |       | (54,700                | )          |
| Well services                                                          |       | 236,947                                          |       | —                                  |       | (236,947               | )          |
| Depreciation,  depletion, amortization and impairment                  |       | 13,828,430                                       |       | 3,179,084                               |       | (10,649,346            | )          |
| General and  administrative                                            |       | 2,815,398                                        |       | 3,042,822                               |       | 227,424                |       |
| Interest                                                               |       | 630,252                                          |       | 630,252                                 |       | —                 |       |
|                                                                   |       |                                             |       |                                    |       |                   |       |
|                                                                   |       | 24,847,245                                       |       | 14,133,676                              |       | (10,713,569            | )     |
|                                                                   |       |                                             |       |                                    |       |                   |       |
| Income before  provision for income taxes                              |       | (7,358,897                                       | )          | 3,080,049                               |       | 10,438,946             |       |
| Deferred income  tax expense                                           |       | (25,000                                          | )          | (25,000                                 | )          | —                 |       |
|                                                                   |       |                                             |       |                                    |       |                   |       |
| Net income  (loss)                                                     |       | (7,333,897                                       | )          | 3,105,049                               |       | 10,438,946             |       |
| Less dividends  and accretion on preferred shares                      |       | 66,787                                           |       | 66,787                                  |       | —                 |       |
|                                                                   |       |                                             |       |                                    |       |                   |       |
| Net income  (loss) applicable to common stockholders                   |       | $                                                | (7,400,684 | )                                       | $          | 3,038,262              |       | $ | 10,438,946 |   |
|                                                                   |       |                                             |       |                                    |       |                   |       |
| Earnings per  share – basic                                       |       | $                                                | (0.13      | )                                       | $          | 0.05                   |       | $ | 0.18 |   |
| Earnings per  share – diluted                                     |       | $                                                | (0.13      | )                                       | $          | 0.05                   |       | $ | 0.18 |   |
| Depreciation,  depletion, amortization and impairment expense per Mcfe |       | $                                                | 7.89       |                                    | $          | 1.81                   |       | $ | (6.08 | ) |

 

7

----

 

**IncomeStatement**

**Ninemonths ended September 30, 2007**

 
| ** **                                                             | ** ** | **As computed  under  Successful  Efforts** | ** ** | **As reported  under  Full  Cost** | ** ** | **Effect  of  change** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------|------------|------------------------|------------|
| Revenues                                                               |       |                                             |       |                                    |       |                   |       |
| Oil and gas  sales                                                     |       | $                                                | 39,594,086 |                                    | $          | 39,594,086             |       | $ | — |   |
| Oil and gas  sales from marketing activities                           |       | 694,547                                          |       | —                                  |       | (694,547               | )          |
| Well services                                                          |       | 905,008                                          |       | —                                  |       | (905,008               | )          |
| Interest and  other income                                             |       | 1,847,642                                        |       | 1,847,642                               |       | —                 |       |
|                                                                   |       |                                             |       |                                    |       |                   |       |
|                                                                   |       | 43,041,283                                       |       | 41,441,728                              |       | (1,599,555             | )          |
| Expenses                                                               |       |                                             |       |                                    |       |                   |       |
| Production and  exploration                                            |       | 16,718,039                                       |       | 16,462,317                              |       | (255,722               | )          |
| Turnkey  contracts                                                     |       | 354,355                                          |       | —                                  |       | (354,355               | )          |
| Cost of marketed  oil and gas sales                                    |       | 681,761                                          |       | —                                  |       | (681,761               | )          |
| Well services                                                          |       | 846,666                                          |       | —                                  |       | (846,666               | )          |
| Depreciation,  depletion, amortization and impairment                  |       | 20,673,877                                       |       | 7,769,387                               |       | (12,904,490            | )          |
| General and  administrative                                            |       | 8,247,331                                        |       | 8,674,495                               |       | 427,164                | )          |
| Interest                                                               |       | 1,218,375                                        |       | 1,218,375                               |       | —                 |       |
|                                                                   |       |                                             |       |                                    |       |                   |       |
|                                                                   |       | 48,740,404                                       |       | 34,124,574                              |       | (14,615,830            | )          |
|                                                                   |       |                                             |       |                                    |       |                   |       |
| Income (loss)  before provision for income taxes                       |       | (5,699,121                                       | )          | 7,317,154                               |       | 13,016,275             |       |
| Deferred income  tax expense                                           |       | —                                           |       | —                                  |       | —                 |       |
|                                                                   |       |                                             |       |                                    |       |                   |       |
| Net income  (loss)                                                     |       | (5,699,121                                       | )          | 7,317,154                               |       | 13,016,275             |       |
| Less dividends  and accretion on preferred shares                      |       | 200,855                                          |       | 200,855                                 |       | —                 |       |
|                                                                   |       |                                             |       |                                    |       |                   |       |
| Net income  (loss) applicable to common stockholders                   |       | $                                                | (5,899,976 | )                                       | $          | 7,116,299              |       | $ | 13,016,275 |   |
|                                                                   |       |                                             |       |                                    |       |                   |       |
| Earnings per  share – basic                                       |       | $                                                | (0.11      | )                                       | $          | 0.13                   |       | $ | 0.24 |   |
| Earnings per  share – diluted                                     |       | $                                                | (0.10      | )                                       | $          | 0.13                   |       | $ | 0.23 |   |
| Depreciation,  depletion, amortization and impairment expense per Mcfe |       | $                                                | 4.64       |                                    | $          | 1.74                   |       | $ | (2.90 | ) |

 

8

----

 

**IncomeStatement**

**Threemonths ended September 30, 2006**

 
| ** **                                                             | ** ** | **As originally  reported under  Successful  Efforts** | ** ** | **As reported  under  Full  Cost** | ** ** | **Effect  of  change** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------|------------|------------------------|------------|
| Revenues                                                               |       |                                                             |       |                                    |       |                   |       |
| Oil and gas  sales                                                     |       | $                                                                | 8,424,271  |                                    | $          | 8,424,271              |       | $ | — |   |
| Turnkey  contracts with affiliated partnerships                        |       | 58,365                                                           |       | —                                  |       | (58,365                | )          |
| Oil and gas  sales from marketing activities                           |       | 393,884                                                          |       | —                                  |       | (393,884               | )          |
| Well services                                                          |       | 274,858                                                          |       | —                                  |       | (274,858               | )          |
| Interest and  other income                                             |       | 1,079,844                                                        |       | 1,079,844                               |       | —                 |       |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
|                                                                   |       | 10,231,222                                                       |       | 9,504,115                               |       | (727,107               | )          |
| Expenses                                                               |       |                                                             |       |                                    |       |                   |       |
| Production and  exploration                                            |       | 3,395,102                                                        |       | 3,347,393                               |       | (47,709                | )          |
| Turnkey  contracts                                                     |       | 51,742                                                           |       | —                                  |       | (51,742                | )          |
| Cost of marketed  oil and gas purchased from affiliated partnerships   |       | 377,527                                                          |       | —                                  |       | (377,527               | )          |
| Well services                                                          |       | 216,810                                                          |       | —                                  |       | (216,810               | )          |
| Depreciation,  depletion, amortization and impairment                  |       | 1,750,921                                                        |       | 1,561,648                               |       | (189,273               | )          |
| General and  administrative                                            |       | 2,061,946                                                        |       | 2,061,946                               |       | —                 |       |
| Interest                                                               |       | 191,334                                                          |       | 98,378                                  |       | (92,956                | )          |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
|                                                                   |       | 8,045,382                                                        |       | 7,069,365                               |       | (976,017               | )          |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
| Income before  provision for income taxes                              |       | 2,185,840                                                        |       | 2,434,750                               |       | 248,910                |       |
| Deferred income  tax expense                                           |       | (30,000                                                          | )          | (30,000                                 | )          | —                 |       |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
| Net income  (loss)                                                     |       | 2,215,840                                                        |       | 2,464,750                               |       | 248,910                |       |
| Less dividends  and accretion on preferred shares                      |       | 73,304                                                           |       | 73,304                                  |       | —                 |       |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
| Net income  (loss) applicable to common stockholders                   |       | $                                                                | 2,142,536  |                                    | $          | 2,391,446              |       | $ | 248,910 |   |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
| Earnings per  share – basic                                       |       | $                                                                | 0.04       |                                    | $          | 0.04                   |       | $ | — |   |
| Earnings per  share – diluted                                     |       | $                                                                | 0.04       |                                    | $          | 0.04                   |       | $ | — |   |
| Depreciation,  depletion, amortization and impairment expense per Mcfe |       | $                                                                | 1.85       |                                    | $          | 1.65                   |       | $ | (0.20 | ) |

 

9

----

 

**IncomeStatement**

**Ninemonths ended September 30, 2006**

 
| ** **                                                             | ** ** | **As originally  reported under  Successful  Efforts** | ** ** | **As reported  under  Full  Cost** | ** ** | **Effect  of  change** | ** ** |
|------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|-----------------------------------------|------------|------------------------|------------|
| Revenues                                                               |       |                                                             |       |                                    |       |                   |       |
| Oil and gas  sales                                                     |       | $                                                                | 22,867,872 |                                    | $          | 22,867,872             |       | $ | — |   |
| Turnkey  contracts with affiliated partnerships                        |       | 604,875                                                          |       | —                                  |       | (604,875               | )          |
| Oil and gas  sales from marketing activities                           |       | 1,912,298                                                        |       | —                                  |       | (1,912,298             | )          |
| Well services                                                          |       | 732,779                                                          |       | —                                  |       | (732,779               | )          |
| Interest and  other income                                             |       | 3,638,832                                                        |       | 3,638,832                               |       | —                 |       |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
|                                                                   |       | 29,756,656                                                       |       | 26,506,704                              |       | (3,249,952             | )          |
| Expenses                                                               |       |                                                             |       |                                    |       |                   |       |
| Production and  exploration                                            |       | 9,550,730                                                        |       | 8,952,814                               |       | (597,916               | )          |
| Turnkey  contracts                                                     |       | 852,339                                                          |       | —                                  |       | (852,339               | )          |
| Cost of marketed  oil and gas purchased from affiliated partnerships   |       | 1,854,200                                                        |       | —                                  |       | (1,854,200             | )          |
| Well services                                                          |       | 677,133                                                          |       | —                                  |       | (677,133               | )          |
| Depreciation,  depletion, amortization and impairment                  |       | 4,969,747                                                        |       | 4,385,736                               |       | (584,011               | )          |
| General and  administrative                                            |       | 6,692,851                                                        |       | 6,692,851                               |       | —                 |       |
| Interest                                                               |       | 564,432                                                          |       | 302,580                                 |       | (261,852               | )          |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
|                                                                   |       | 25,161,432                                                       |       | 20,333,981                              |       | (4,827,451             | )          |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
| Income before  provision for income taxes                              |       | 4,595,224                                                        |       | 6,172,723                               |       | 1,577,499              |       |
| Deferred income  tax expense                                           |       | 93,000                                                           |       | 93,000                                  |       | —                 |       |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
| Net income  (loss)                                                     |       | 4,502,224                                                        |       | 6,079,723                               |       | 1,577,499              |       |
| Less dividends  and accretion on preferred shares                      |       | 289,452                                                          |       | 289,452                                 |       | —                 |       |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
| Net income  (loss) applicable to common stockholders                   |       | $                                                                | 4,212,772  |                                    | $          | 5,790,271              |       | $ | 1,577,499 |   |
|                                                                   |       |                                                             |       |                                    |       |                   |       |
| Earnings per  share – basic                                       |       | $                                                                | 0.08       |                                    | $          | 0.11                   |       | $ | 0.03 |   |
| Earnings per  share – diluted                                     |       | $                                                                | 0.08       |                                    | $          | 0.11                   |       | $ | 0.03 |   |
| Depreciation,  depletion, amortization and impairment expense per Mcfe |       | $                                                                | 1.84       |                                    | $          | 1.62                   |       | $ | (0.22 | ) |

 

10

----

 

**BalanceSheet**

**September30, 2007**

 
| ** **                                                                                    | ** ** | **As computed  Under  Successful  Efforts** | ** **  | **As reported  under  Full  Cost** | ** ** | **Effect  of  change** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|-------------|-----------------------------------------|------------|------------------------|------------|
|                                                                                          |       |                                             |        |                                    |       |                   |       |
| Total current  assets                                                                         |       | $                                                | 20,074,466  |                                    | $          | 20,074,466             |       | $ | — |   |
| Oil and gas  properties, at cost net of accumulated depreciation, depletion and  amortization |       | 370,564,690                                      |        | 376,673,054                             |       | 6,108,364              |       |
| Property and  equipment                                                                       |       | 2,475,639                                        |        | 2,475,639                               |       | —                 |       |
| Other assets                                                                                  |       | 8,730,558                                        |        | 8,730,558                               |       | —                 |       |
|                                                                                          |       | 401,845,353                                      |        | 407,953,717                             |       | 6,108,364              |       |
|                                                                                          |       |                                             |        |                                    |       |                   |       |
| Current  liabilities                                                                          |       | 22,749,044                                       |        | 22,749,044                              |       | —                 |       |
| Long term  liabilities                                                                        |       | 39,764,140                                       |        | 39,764,140                              |       | —                 |       |
| Preferred stock                                                                               |       | 3,251,549                                        |        | 3,251,549                               |       | —                 |       |
| Common stock                                                                                  |       | 5,818                                            |        | 5,818                                   |       | —                 |       |
| Additional paid  in capital                                                                   |       | 424,183,022                                      |        | 424,183,022                             |       | —                 |       |
|                                                                                          |       |                                             |        |                                    |       |                   |       |
| Accumulated  deficit                                                                          |       | (87,521,132                                      | )           | (81,412,768                             | )          | 6,108,364              |       |
| Accumulated other  comprehensive income                                                       |       | 140,967                                          |        | 140,967                                 |       | —                 |       |
| Common stock in  Treasury                                                                     |       | (728,055                                         | )           | (728,055                                | )          | —                 |       |
|                                                                                          |       | $                                                | 401,845,353 |                                    | $          | 407,953,717            |       | $ | 6,108,364 |   |

 

**BalanceSheet**

**December31, 2006**

 
| ** **                                                                                    | ** ** | **As originally  reported  under  Successful****Efforts** | ** **  | **As  reported  under  Full****Cost** | ** ** | **Effect  of****change** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|-------------|---------------------------------------|------------|--------------------------|------------|
| ** **                                                                                    | ** ** | ** **                                                     | ** **  | ** **                            |       | ** **               |       |
| Total current  assets                                                                         |       | $                                                              | 52,437,690  |                                  | $          | 52,437,690               |       | $ | — |   |
| Oil and gas  properties, at cost net of accumulated depreciation, depletion and  amortization |       | 260,500,325                                                    |        | 253,592,415                           |       | (6,907,910               | )          |
| Property and  equipment                                                                       |       | 1,751,146                                                      |        | 1,751,146                             |       | —                   |       |
| Other assets                                                                                  |       | 9,170,096                                                      |        | 9,170,096                             |       | —                   |       |
|                                                                                          |       | 323,859,257                                                    |        | 316,951,347                           |       | (6,907,910               | )          |
|                                                                                          |       |                                                           |        |                                  |       |                     |       |
| Current  liabilities                                                                          |       | 22,961,671                                                     |        | 22,961,671                            |       | —                   |       |
| Long term  liabilities                                                                        |       | 9,013,268                                                      |        | 9,013,268                             |       | —                   |       |
| Preferred stock                                                                               |       | 3,252,897                                                      |        | 3,252,897                             |       | —                   |       |
| Common stock                                                                                  |       | 5,414                                                          |        | 5,414                                 |       | —                   |       |
| Additional paid  in capital                                                                   |       | 371,035,151                                                    |        | 371,035,151                           |       | —                   |       |
|                                                                                          |       |                                                           |        |                                  |       |                     |       |
| Accumulated  deficit                                                                          |       | (81,822,011                                                    | )           | (88,729,921                           | )          | (6,907,910               | )          |
| Accumulated  other comprehensive income                                                       |       | 140,922                                                        |        | 140,922                               |       | —                   |       |
| Common stock in  Treasury                                                                     |       | (728,055                                                       | )           | (728,055                              | )          | —                   |       |
|                                                                                          |       | $                                                              | 323,859,257 |                                  | $          | 316,951,347              |       | $ | (6,907,910 | ) |

 

11

----

 

Costs not subject toamortization include acquisition and exploration costs of unproved propertiesin the Atlantic Rim and Pacific Rim coalbed methane projects in south centralWyoming. These costs are excluded from amortized capital costs until it isdetermined whether or not proved reserves can be assigned to the properties.Currently, these coalbed methane wells are dewatering. The excluded propertiesare assessed quarterly for impairment. The inclusion of these costs inamortized capital costs is expected to be completed within the next two years.

 

The following is asummary of Warren’s oil and gas properties not subject to amortization as ofSeptember 30, 2007:

 
| ** **                                                | ** ** | **Costs incurred in**                 | ** ** |
|-----------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                | ** ** | **Nine  months ended  September 30,** | ** ** | **Fiscal year** | ** ** | **Fiscal year** | ** ** | **Fiscal year** | ** ** | **Prior to** | ** ** | ** ** | ** ** |
| ** **                                                | ** ** | **2007**                                        | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2004** | ** ** | **Total** | ** ** |
|                                                      |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| Acquisition  costs                                        |       | $                                               | 15,372,782 |   | $ | 1,937,296 |   | $ | 1,153,556 |   | $ | 1,237,924 |   | $ | 12,412,554 |   | $ | 32,114,112 |   |
|                                                      |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| Exploration  costs                                        |       | 179,522                                         |       | 4,268,209 |   | 2,104,113 |   | 1,112,310 |   | 10,129,163 |   | 17,803,317 |   |
|                                                      |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| Development  costs                                        |       | 11,060,178                                      |       | 7,843,750 |   | — |   | — |   | — |   | 18,903,928 |   |
|                                                      |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| Capitalized  Interest                                     |       | —                                          |       | — |   | 1,749,343 |   | 1,397,031 |   | 2,069,872 |   | 5,216,246 |   |
|                                                      |       |                                            |       |   |   |   |   |   |   |   |   |   |   |
| Total oil and  gas properties not subject to amortization |       | $                                               | 26,612,482 |   | $ | 14,049,255 |   | $ | 5,007,012 |   | $ | 3,757,265 |   | $ | 24,611,589 |   | $ | 74,037,603 |   |

 

##### **NOTE C**—STOCK BASED COMPENSATION

##### ** **

*Stock Options*

 

Compensation expense related to stock options andrestricted stock awards recognized in operating results (general andadministrative expenses) under SFAS No. 123R was approximately $1,065,000 and$443,000 for the nine months ended September 30, 2007 and 2006, respectively.

 

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

 
| ** **               | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------|------------|---------------------------------------------------------|------------|
| ** **               | ** ** | **2007**                                                | ** ** | **2006** | ** ** |
| Dividend yield           |       | 0                                                       | %          | 0 | % |
| Expected  volatility     |       | 43.6                                                    | %          | 48.2 | % |
| Risk-free  interest rate |       | 4.52                                                    | %          | 4.66 | % |
| Fair value of  options   |       | $                                                       | 4.00       |   | $ | 5.57 |   |
| Expected life            |       | 3.5 years                                               |       | 3.5 years |   |
|                          |            |                                                         |            |  |  |  |  |

 
| ** **                         | ** ** | **Number  of Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Term (in years)** | ** ** | **Aggregate  Intrinsic Value  (in thousands)** | ** ** |
|------------------------------------|------------|-----------------------------|------------|----------------------------------------|------------|-------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Outstanding at  December 31, 2006  |       | 2,456,783                   |       | $                                      | 8.07       |                                                        |       |                                                     |       |   |
| Granted                            |       | 554,250                     |       | 10.78                                  |       |                                                        |       |                                                     |       |
| Exercised                          |       | (222,533                    | )          | 4.71                                   |       |                                                        |       |                                                     |       |
| Forfeited or  expired              |       | (43,750                     | )          | 13.37                                  |       |                                                        |       |                                                     |       |
| Outstanding at  September 30, 2007 |       | 2,744,750                   |       | $                                      | 8.81       |                                                        | 2.48       |                                                     | $          | 10,808 |   |
|                               |       |                        |       |                                   |       |                                                        |       |                                                     |       |
| Exercisable at  September 30, 2007 |       | 1,898,500                   |       | $                                      | 7.48       |                                                        | 1.76       |                                                     | $          | 9,799 |   |

 

12

----

 

Thetotal intrinsic value of options exercised during the nine months endedSeptember 30, 2007 and 2006 was $1.8 million and $1.8 million respectively.

 

As ofSeptember 30, 2007, total unrecognized stock-based compensation expense relatedto non-vested stock options was $3.5 million, which we expect to recognize overa weighted average period of 3 years.

 

Cashreceived from stock option exercises under all stock-based payment arrangementsfor the nine months ended September 30, 2007 was $1.1 million. We issue newshares of common stock to settle option exercises.

 

*RestrictedShares*

 

Restricted share activityas of  September 30, 2007 was as follows:

 
| ** **                         | ** ** | **Shares** | ** ** | **Weighted  Average  Fair Value** | ** ** |
|------------------------------------|------------|------------|------------|----------------------------------------|------------|
| ** **                         | ** ** | ** ** | ** ** | ** **                             | ** ** |
| Outstanding at  December 31, 2006  |       | —     |       | $                                      | —     |   |
| Granted                            |       | 59,995     |       | 10.51                                  |       |
| Vested                             |       | —     |       | —                                 |       |
| Forfeited                          |       | (1,665     | )          | 10.51                                  |       |
| Outstanding at  September 30, 2007 |       | 58,330     |       | $                                      | 10.51      |   |

 

Restricted stock awardsfor executive officers and employees vest ratably over three years. Fair valueof our restricted shares is based on our closing stock price on the date ofgrant.  As of September 30, 2007, total unrecognized stock-basedcompensation expense related to non-vested restricted shares was $0.5 million,which is expected to be recognized over a weighted average period of approximately3 years.

 

#### **NOTED**—CHANGESIN STOCKHOLDERS’ EQUITY

#### ** **

During the nine monthsended September 30, 2007, holders of 564 shares of convertible preferred stockconverted into common stock on a basis of 0.50 shares of common stock for oneshare of convertible preferred stock. As of September 30, 2007, 271,436 sharesof convertible preferred stock remain outstanding. Preferred dividends ofapproximately $195,000 were accrued at September 30, 2007.

 

The preferred stock paysan 8% cumulative dividend 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 stockmay be voluntarily converted, at the election of the holder into common stockof the Company based on a conversion rate of 1share of preferred stock for 0.50shares of common stock.

 

Additionally, commencingseven years after the date of issuance (October 1, 2009), holders of thepreferred stock may elect to require the Company to redeem their preferredstock at a redemption price equal to the liquidation value of $12.00 per share,plus accrued but unpaid dividends, if any (“Redemption Price”). Upon thereceipt of a redemption election, the Company, at its option, shall either: (1)pay the holder cash in the amount equal to the Redemption Price or (2) issue tothe holder shares of common stock in an amount equal to 125% of the redemptionprice and any accrued and unpaid dividends, based on the weighted average closing“bid” price of the Company’s common stock for the thirty trading daysimmediately preceding the date of the written redemption election by the holderup to a maximum of 1.5 shares of common stock for each one share of preferredstock redeemed. The Company is accreting the carrying value of its preferredstock to its redemption price using the effective interest 

 

13

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method with changesrecorded to additional paid in capital. The accretion of preferred stockresults in a reduction of earnings per share applicable to common stockholders.

 

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

 

At September 30, 2007, therewere 271,436 preferred shares outstanding that the Company may be required toredeem at the aggregate redemption amount of $3,257,232 beginning July 1, 2010.As noted above, the Company could, at its option, settle the redemptionrequests in shares of its common stock.

 

During the nine monthsended September 30, 2007, employees and directors exercised a total of 222,533options at exercise prices between $4 and $9.05 per share. The Company receivedproceeds of approximately $1.1 million from these exercises.

 

**NOTE E—INCOME PER SHARE**

 

Basic income per share iscomputed by dividing net income applicable to common stockholders by theweighted average number of shares of common stock outstanding during theperiod. Diluted income per share is based on the assumption that stock optionsand warrants are converted into common shares using the treasury stock methodand convertible bonds and preferred stock are converted using the if-convertedmethod. Conversion is not assumed if the results are anti-dilutive. Potentialcommon shares for the three and nine months ended September 30, 2007 andSeptember 30, 2006 of 206,889 and 219,240 respectively, relating to convertiblebonds and preferred stock, were excluded from the computation of diluted incomeper share because they are anti-dilutive. Potential common shares of 2,357,365and 2,357,365 respectively, relating to stock options, warrants and restrictedstock were excluded from the computation of diluted income per share for thethree and nine months ended September 30, 2007, respectively, because they areanti-dilutive. Potential common shares of 415,500 and 415,500 respectively,relating to stock options were excluded from the computation of diluted incomeper share at for the three and nine months ended September 30, 2006,respectively, because they are anti-dilutive. Stock options have a weightedaverage exercise price of $8.81 and $7.93 at September 30, 2007 and September30, 2006, respectively. Anti-dilutive warrants have a weighted average exerciseprice of $12.50 at September 30, 2007. At September 30, 2007, the convertiblebonds may be converted from the date of issuance until maturity at 100% ofprincipal amount into common stock of the Company at a price of $35 to $50. Thepreferred stock may be converted at the discretion of the holder or uponmeeting certain conditions at the discretion of the Company (see Note D).

 

Basic and diluted netincome per share is computed based on the following information:

 
| ** **                                          | ** ** | **Three Months   Ended  September 30,   2007** | ** ** | **Three Months   Ended  September 30,   2006** | ** ** | **Nine Months   Ended  September 30, 2007** | ** ** | **Nine Months   Ended  September 30,   2006** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|---------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                          | ** ** | ** **                                     | ** ** | **(Restated)**                                 | ** ** | ** **                                  | ** ** | **(Restated)**                                | ** ** |
|                                                |       |                                           |       |                                           |       |                                        |       |                                          |       |
| Net income  available to shareholders               |       | $                                              | 3,038,262  |                                           | $          | 2,391,466                                   |       | $                                             | 7,116,299  |   | $ | 5,790,271 |   |
|                                                |       |                                           |       |                                           |       |                                        |       |                                          |       |
| Weighted average  shares outstanding - basic        |       | 57,586,698                                     |       | 53,317,367                                     |       | 55,331,505                                  |       | 52,786,511                                    |       |
| Effect of  dilutive securities – stock options |       | 730,571                                        |       | 536,866                                        |       | 260,396                                     |       | 600,784                                       |       |
| Effect of  dilutive securities – warrants      |       | 240,725                                        |       | 1,036,192                                      |       | 746,703                                     |       | 1,063,555                                     |       |
|                                                |       |                                           |       |                                           |       |                                        |       |                                          |       |
| Weighted average  shares outstanding - diluted      |       | 58,557,994                                     |       | 54,890,425                                     |       | 56,338,604                                  |       | 54,450,850                                    |       |
|                                                |       |                                           |       |                                           |       |                                        |       |                                          |       |
| Basic net income  per share                         |       | $                                              | 0.05       |                                           | $          | 0.04                                        |       | $                                             | 0.13       |   | $ | 0.11 |   |
| Diluted net  income per share                       |       | $                                              | 0.05       |                                           | $          | 0.04                                        |       | $                                             | 0.13       |   | $ | 0.11 |   |

 

14

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**NOTE F—LONG-TERM DEBT**

 

Long-termdebt consisted of the following at September 30, 2007 and December 31, 2006:

 
| ** **                                            | ** ** | **September 30,   2007** | ** ** | **December 31,   2006** | ** ** |
|-------------------------------------------------------|------------|--------------------------|------------|-------------------------|------------|
|                                                  |       |                     |       |                    |       |
| Line of Credit                                        |       | $                        | 30,000,000 |                    | $          | — |   |
| 12% Secured  Convertible Bonds, due December 31, 2020 |       | 1,385,000                |       | 1,390,000               |       |
| 12% Secured  Convertible Bonds, due December 31, 2022 |       | 1,106,000                |       | 1,106,000               |       |
|                                                  |       |                     |       |                    |       |
|                                                  |       | 32,491,000               |       | 2,496,000               |       |
| Less current  portion                                 |       | 249,100                  |       | 249,600                 |       |
|                                                  |       |                     |       |                    |       |
| Long-term  portion                                    |       | $                        | 32,241,900 |                    | $          | 2,246,400 |   |

 

OnNovember 20, 2006, the Company entered into a five year, $150 million creditagreement with JP Morgan Chase Bank (the “Credit Facility”). The CreditFacility provides for a revolving credit facility up to the lesser of (i) theborrowing base (ii) $150 million and (iii) the draw limit requested by theCompany. The Credit Facility matures on November 15, 2011 and is secured bysubstantially all of the assets of the Company. The borrowing base will bedetermined by the lenders at least semi-annually on each April 1 and October 1,beginning April 1, 2007 and is based in part on the proved reserves of theCompany. The Company is currently exploring additional sources of financing.The current borrowing base is $70 million. Interest payments are made quarterlyin arrears. On March 15, 2007, Warren borrowed $20 million under this facility.On June 29, 2007, Warren borrowed an additional $10 million under this facility.As of September 30, 2007, credit line interest of approximately $586,000 wasaccrued.

 

Theconvertible bonds may be converted from the date of issuance until maturity at100% of principal amount into common stock of the Company at prices rangingfrom $35 to $50. Each year the holders of the convertible bonds may tender tothe Company up to 10% of the aggregate bonds issued and outstanding.

 

#### **NOTEG—CONTINGENCIES**

#### ** **

**Litigation**

 

We are a party to legalactions arising in the ordinary course of our business. In the opinion of ourmanagement, based in part on consultation with legal counsel, the liability, ifany, under these claims is either adequately covered by insurance or would nothave a material adverse effect on the Company’s financial condition or resultsof operations.

 

For partnerships formedfrom 1999 to 2001, investor partners previously had a right to have theirinterests repurchased by the Company at a formula price seven years from thedate of the original partnership formation. During the second quarter of 2007,Warren acquired the respective oil and gas assets of all of the partnershipsformed from 2000 to 2003. The acquisitions were accounted for as the purchaseof a business. The Company accounted for the transaction using thenon-discounted closing price of its publicly traded common stock based upon theaverage closing price as defined in the referenced acquisition agreements. Asconsideration for the oil and gas properties acquired, Warren issued anaggregate of 3,365,231 shares of our unregistered restricted common stock tothe five separate partnerships. The restricted shares of Common Stock werevalued based upon a 20% discount from the weighted average sales price forWarren’s publicly traded Common Stock for the sixty-one (61) calendar daysended May 31, 2007. During that period, the weighted average sales price was$13.50 per share, and the 20% discounted price was $10.80 per share. Theeffective date of those acquisitions was April 1, 2007 and their closing datewas June 20, 2007. The reserves attributable to the oil and gas properties ofthe five drilling partnerships are approximately 9.9 Bcfe of proved developedproducing reserves. Warren also attributed an estimated fair market 

 

15

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value for related waterinjection wells and unproved dewatering wells that were in the partnerships. Inaccordance with their five respective partnership agreements, the sale ofsubstantially all of the oil and gas properties by the five partnerships formedfrom 2000 to 2003 terminated any repurchase rights that their investor partnerspreviously held.

 

Also, during the secondquarter of 2007, Warren acquired the respective oil and gas assets of the twopartnerships formed in 1999. The acquisitions are accounted for as the purchaseof a business. The Company accounted for the transaction using thenon-discounted closing price of its publicly traded common stock based upon theaverage closing price as defined in the referenced acquisition agreements. Asconsideration, Warren paid an aggregate of $1.7 million in cash and the balanceby issuing 445,046 shares of our unregistered restricted common stock to thetwo separate partnerships. The restricted shares of Common Stock were valuedbased upon a 20% discount from the weighted average sales price for Warren’spublicly traded Common Stock for the period January 1, 2007 through March 31,2007. During that period, the weighted average sales price was $11.22 pershare, and the 20% discounted price was $8.98 per share. The effective date ofthose two acquisitions was April 1, 2007 and their closing date was June 30,2007. In accordance with their respective partnership agreements, the sale ofsubstantially all of the oil and gas properties by the two partnerships formedin 1999 terminated any repurchase rights that their investor partnerspreviously held.

 
| CALCULATION OF  PURCHASE PRICE (IN MILLIONS) |   |   |   |
|----------------------------------------------|--------|--------|--------|
| Cash paid                                    |   | $      | 1.7    |   |
| Common stock  issued                         |   | 51.2   |   |
| Current  liabilities assumed:                |   | 0.3    |   |
| Total purchase  price for assets acquired    |   | $      | 53.2   |   |
|                                         |   |   |   |
| ALLOCATION OF  PURCHASE PRICE (IN MILLIONS)  |   |   |   |
| Proved oil and  gas properties               |   | $      | 38.2   |   |
| Unproved oil and  gas properties             |   | 15.0   |   |
|                                         |   |   |   |
| Total                                        |   | $      | 53.2   |   |

 

The following summarypresents unaudited pro forma consolidated results of operations for the threeand nine months ended September 30, 2007 and 2006, as if the acquisition of thedrilling partnerships had occurred as of January 1, 2006.  The pro formaresults are for illustrative purposes only and include adjustments in additionto the pre-acquisition historical results, such as increased depreciation,depletion and amortization expense resulting from the allocation of fair valueto oil and gas properties acquired. The unaudited pro forma information(presented in millions of dollars, except per share amounts) is not necessarilyindicative of the operating results that would have occurred had theacquisition been consummated at that date, nor is it necessarily indicative offuture operating results.

 
| ** **           | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** | **Nine Months Ended**  | ** ** |
|----------------------|------------|----------------------------------|------------|----------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Pro Forma:**  | ** ** | **Sept 30, 2007**      | ** ** | **Sept 30, 2006**      | ** ** | **Sept 30, 2007** | ** ** | **Sept 30, 2006** | ** ** |
| Revenues             |       | $                                | 17.2       |                             | $          | 11.2                        |       | $                           | 43.2       |   | $ | 31.1 |   |
| Net income           |       | 3.0                              |       | 2.9                              |       | 7.5                         |       | 7.1                         |       |
| Earnings per  share: |       |                             |       |                             |       |                        |       |                        |       |
| Basic—          |       | $                                | 0.05       |                             | $          | 0.05                        |       | $                           | 0.14       |   | $ | 0.12 |   |
| Diluted—        |       | $                                | 0.05       |                             | $          | 0.05                        |       | $                           | 0.13       |   | $ | 0.12 |   |

 

16

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**NOTE H—BUSINESS SEGMENTINFORMATION**

 

The Company has adoptedthe full cost method of accounting for its oil and gas properties. As a resultof this adoption and the purchase of the remaining drilling program interests,the Company will no longer have reporting segments for Turnkey activities, oiland gas marketing activities and well services. The Company’s operatingactivities will now be reported under one segment, oil and gas activities. Allcomparative results of operations and selected information for historicalreporting periods have been reclassified for this change.

 

**NOTE I—COMPREHENSIVE INCOME**

 

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

 
| ** **                         | ** ** | **2007**   | ** ** | **2006**       | ** ** |
|------------------------------------|------------|------------|------------|----------------|------------|
| ** **                         | ** ** | ** ** | ** ** | **(Restated)** | ** ** |
|                               |       |       |       |           |       |
| Nine Months  ending September 30,  |       | $          | 7,317,199  |           | $          | 5,940,174 |   |
|                               |       |       |       |           |       |
| Three Months  ending September 30, |       | $          | 3,143,429  |           | $          | 2,511,212 |   |

 

**NOTE J—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 September 30, 2007 no events occurred which would indicate that animpairment of goodwill existed.

 

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

 

**FORWARD-LOOKINGINFORMATION**

 

Forward-lookingstatements for 2007 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**

 

We are a growingindependent energy company engaged in the exploration and development ofdomestic onshore oil and natural gas reserves. We focus our efforts primarilyon our waterflood oil recovery programs and horizontal drilling in theWilmington field within the Los Angeles Basin of California and on theexploration and development of coalbed methane (“CBM”) properties located inthe Rocky Mountain region. As of September 30, 2007, we owned natural gas andoil leasehold interests in approximately 246,000 gross 138,000 net acres, 90%of which are undeveloped. Substantially all our undeveloped acreage is locatedin the Rocky Mountains. Our total net proved reserves are located on less than10% of our net acreage.

 

17

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**Liquidityand Capital Resources**

** **

Our cashand cash equivalents decreased $31.8 million during the first nine months of2007. This resulted from cash used in investing activities of $80.5 million. Thiswas partially offset by cash provided by operating activities of $17.7 millionand cash provided by financing activities of $31.0 million.

 

Cash used in investingactivities of primarily results from expenditures on oil and gas properties andequipment. Cash provided by operating activities primarily relates to oil andgas operations. Cash provided by financing activities primarily results fromproceeds received from our Credit Facility as discussed in more detail belowand from the exercise of stock options and warrants.

 

During June 2007, Warrenacquired the interests in five drilling partnerships formed from 2000 to 2003in which we served as managing general partner and turnkey contract driller. Theindependently evaluated December 31, 2006 PV-10 attributable to the aggregateproved oil and gas reserves of the five drilling partnerships was $33.2 million(approximately 9.9 Bcfe of proved developed producing reserves) as of December31, 2006. Additionally, the estimated fair market value for related waterinjection wells was $4.4 million. The purchase price was paid in the form ofrestricted shares of Warren’s common stock calculated at a discount of 20% fromthe average publicly traded share price from April 1, 2007 to May 31, 2007. TheCompany issued 3.4 million restricted shares to these drilling partnerships.

 

Also, as part ofcontractual commitments, Warren was obligated to accept requests from thepartners in two drilling partnerships formed in 1999. The aggregate purchaseprice was $1.7 million plus 0.4 million restricted shares. The Company acquired$3.9 million of PV-10 as of December 31, 2006 (approximately 1.2 Bcfe of proveddeveloped producing reserves) and water injection wells having an estimatedfair market value of $0.9 million.

 

OnNovember 20, 2006, Warren entered into a five year, $150 million creditagreement with JP Morgan Chase Bank (the “Credit Facility”). The CreditFacility provides for a revolving credit facility up to the lesser of (i) theborrowing base (ii) $150 million or (iii) the draw limit requested by theCompany. The Credit Facility matures on November 15, 2011. It is secured bysubstantially all of our assets. The borrowing base will be determined by thelenders at least semi-annually on each April 1 and October 1, and is based inpart on the proved reserves of the Company. Interest payments are madequarterly in arrears. The current borrowing base is $70 million. The Company issubject to certain covenants under the terms of the Credit Facility whichinclude, but are not limited to the maintenance of the following financialratios (1) minimum current ratio (including unused borrowing base) of 1.0 to1.0 and (2) a maximum total net debt to annualized consolidated EBITDAX (asdefined by the Credit Facility) of 3.5 to 1.0. As of  September 30, 2007, the Company has borrowed$30 million under the Credit Facility and was in compliance with all covenants.Warren is currently exploring additional sources of financing.

 

Dependingon the current level of borrowing base usage, the annual interest rate on eachbase rate borrowing under the Credit Facility will be at our option either: (a)the higher of (i) the Agent’s prime rate of interest announced from time totime, or (ii) the Federal Funds rate most recently determined by the Agent,plus 0.5% per annum, plus an applicable margin that ranges from 0.25% to 1.0%,or (b) Eurodollar Loan rate plus an applicable margin that ranges from 1.25% to2.0%. Credit line interest of approximately $0.6 million was accrued for as ofSeptember 30, 2007.

 

During the first ninemonths of 2007, the Company had net income of $7.1 million as compared to netincome of $5.8 million for the first nine months of 2006. At September 30,2007, current liabilities exceeded current assets by approximately $2.7million.

 

At September 30, 2007, wehad approximately 1.9 million vested outstanding stock options issued under ourstock based equity compensation plans. Of the total 1.9 million outstandingvested options, 139,750 options had exercise prices above the closing marketprice $12.54 of our common stock on September 30, 2007. If the options withexercise prices below the closing market price on September 30, 2007 areexercised by the holders, we would receive $12.3 million in cash.

 

18

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*Contractual Obligations*

 

The contractualobligations table below assumes the maximum amount is tendered each year. Thetable does not give effect to the conversion of any bonds to common stock whichwould reduce payments due. All bonds are secured at maturity by zero couponU.S. treasury bonds deposited into an escrow account equaling the parvalue of the bonds maturing on or before the maturity of the bonds. Such U.S.treasury bonds had a fair market value of $1.3 million at September 30, 2007. Thetable below reflects the release of U.S. treasury bonds to us uponredemption.

 
| ** **                                                   | ** ** | ** ** | ** ** | **Payments due by period** | ** ** | ** **      | ** ** |
|--------------------------------------------------------------|------------|------------|------------|----------------------------|------------|-----------------|------------|
| ** Contractual Obligations   As of September 30, 2007** | ** ** | **Total**  | ** ** | **Less Than   1 Year**     | ** ** | **1-3   Years** | ** ** | **3-5   Years** | ** ** | **More Than   5 Years** | ** ** |
|                                                         |       |       |       |                       |       |            |       |   |   |   |   |
| Line of credit                                               |       | $          | 30,000,000 |                       | —     |            | —     |   | $ | 30,000,000 |   | — |   |
| Bonds                                                        |       | 2,491,000  |       | 249,100                    |       | 425,961         |       | 345,028 |   | 1,470,911 |   |
| Drilling  commitments                                        |       | 1,235,518  |       | 1,235,518                  |       | —          |       | — |   | — |   |
| Leases                                                       |       | 619,608    |       | 217,106                    |       | 265,040         |       | 137,462 |   | — |   |
| Total                                                        |       | $          | 34,346,126 |                       | $          | 1,701,724       |       | $ | 691,001 |   | $ | 30,482,490 |   | $ | 1,470,911 |   |
|                                                              |            |            |            |                            |            |                 |            |  |  |  |  |  |  |  |  |  |

 

**RESULTS OF OPERATIONS:**

 

**Threemonths Ended September 30, 2007 Compared to Three Months Ended September 30,2006**

** **

*Oil and gas sales.*Revenue from oil and gas sales increased $8.3 million in the third quarter of2007 to $16.8 million, a 99% increase compared to the same quarter in 2006. Thisincrease resulted from significantly increasing our drilling activity in theWilmington Townlot Unit (“WTU”) in southern California. Net oil production forthe three months ended September 30, 2007 and 2006 was 226 Mbbls and 117 Mbbls,respectively. Net gas production for three months ended September 30, 2007 and2006 was 396 Mmcf and 246 Mmcf, respectively. The average realized price perbarrel of oil for the three months ended September 30, 2007 and 2006 was $66.75and $60.82, respectively. Additionally, the average realized price per Mcf ofgas for the three months ended September 30, 2007 and 2006 was $4.22 and $5.28,respectively.

 

*Production & exploration.*Production and exploration expense increased $3.9 million in the third quarterof 2007 to $7.3 million, a 118% increase compared to the same quarter in 2006. Primarily,this increase resulted from an increase in oil production. Production increasedto 1.8 Bcfe for the third quarter of 2007 compared to 949 Mmcfe for the thirdquarter of 2006, an increase of 85%.

 

*Interest and other income.*Interest and other income decreased $0.6 million in the third quarter of 2007to $0.5 million, a 55% decrease compared to the same quarter in 2006. Thisrepresents a decrease in interest earned due to lower cash and cash equivalentsduring the quarter as compared to the corresponding quarter last year.

 

*Depreciation, depletion andamortization .*Depreciation, depletion and amortizationexpense increased $1.6 million for the third quarter of 2007 to $3.2 million, a104% increase compared to the corresponding quarter last year. This increaseresults from increased production and increased capitalized costs during thethird quarter of 2007 compared to the corresponding period of 2006. Productionincreased 85% during this period.

 

*General and administrativeexpenses.* General and administrative expenses increased $1.0million in the third quarter of 2007 to $3.0 million, a 48% increase comparedto the corresponding quarter last year. This reflects an increase in personnelas a result of increased drilling activities. Also, this reflects an increasein stock option expense of $0.2 million.

 

*Interest expense.*Interest expense increased $0.5 million in the third quarter of 2007 to $0.6million compared to the same quarter last year. The increase results frominterest expense relating to the drawdown of $30 million under our CreditFacility, as previously discussed.

 

19

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**Ninemonths Ended September 30, 2007 Compared to Nine Months Ended September 30,2006**

** **

*Oil and gas sales.*Revenue from oil and gas sales increased $16.7 million in the first nine monthsof 2007 to $39.6 million, a 73% increase compared to the same period in 2006. Thisincrease resulted from significantly increasing our drilling activity in theWTU. Net oil production for the nine months ended September 30, 2007 and 2006was 599 Mbbls and 315 Mbbls, respectively. Net gas production for nine monthsended September 30, 2007 and 2006 was 861 Mmcf and 812 Mmcf, respectively. Theaverage realized price per barrel of oil for the nine months ended September30, 2007 and 2006 was $59.05 and $57.87, respectively. Additionally, theaverage realized price per Mcf of gas for the nine months ended September 30,2007 and 2006 was $4.92 and $5.71, respectively.

 

*Production & exploration.*Production and exploration expense increased $7.5 million in the first ninemonths of 2007 to $16.5 million, an 84% increase compared to the same period in2006. Primarily, this increase resulted from an increase in oil production. Productionincreased to 4.5 Bcfe for the first nine months of 2007 compared to 2.7 Mmcfefor the first nine months of 2006, an increase of 65%.

 

*Interest and other income.*Interest and other income decreased $1.6 million in the first nine months of2007 to $1.9 million, a 47% decrease compared to the same period in 2006. This representsa decrease in interest earned due to lower cash and cash equivalents during theperiod as compared to the corresponding period last year.

 

*Depreciation, depletion andamortization.* Depreciation, depletion and amortizationexpense increased $3.4 million for the first nine months of 2007 to $7.8million, a 77% increase compared to the corresponding period last year. Thisincrease results from increased production and increased capitalized costsduring the first nine months of 2007 compared to the corresponding period of2006. Production increased 65% during this period.

 

*General and administrativeexpenses.* General and administrative expenses increased $2.0million in the first nine months of 2007 to $8.7 million, a 30% increasecompared to the corresponding period last year. This reflects an increase inpersonnel as a result of increased drilling activities. Also, this reflects anincrease in stock option expense of $0.6 million.

 

*Interest expense.*Interest expense increased $0.9 million in the first nine months of 2007 to$1.2 million compared to the same period last year. The increase results frominterest expense relating to the drawdown of $30 million under our CreditFacility, as previously discussed.

 

**CRITICAL ACCOUNTING POLICIES**

 

Our discussion andanalysis of our financial condition and results of operations are based onconsolidated financial statements that have been prepared in accordance withaccounting principles generally accepted in the United States. The preparationof these financial statements requires us to make estimates and judgments thataffect the reported amounts of assets, liabilities, revenues and expenses. Webelieve that certain accounting policies affect our more significant judgmentsand estimates used in the preparation of our consolidated financial statements.Our 2006 Form 10-K includes a discussion of our critical accounting policies.

 

*Change inAccounting Principle*

 

In the second quarter of2007, we converted from the successful efforts method of accounting for our oiland gas properties to the full cost method. We believe that the full costmethod is preferable for our company as we devote a significant portion of ourtime and capital budget to exploration activities.

 

Under full cost rules,all costs associated with property acquisition, exploration and developmentactivities are capitalized. Exploration and development costs include dry holecosts, geological and geophysical costs, direct overhead related to explorationand development activities and other costs incurred for the purpose of findingoil and gas reserves. Proceeds received from disposals are credited againstaccumulated cost except when the sale represents a significant disposal ofreserves, in which case a gain or loss is recognized. The sum of net capitalizedcosts and estimated future development and dismantlement costs are depleted onthe equivalent unit-of-production method, based on proved oil and gas reservesas determined by independent petroleum engineers.

 

20

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In accordance with fullcost accounting rules, we will be subject to a limitation on capitalized costs.The capitalized cost of oil and gas properties, net of accumulateddepreciation, depletion and amortization, may not exceed the estimated futurenet cash flows from proved oil and gas reserves discounted at 10 percent,plus the lower of cost or fair market value of unproved properties as adjustedfor related tax effects. If capitalized costs exceed this limit (the “ceilinglimitation”), the excess must be charged to expense. For the three and ninemonths ended September 30, 2007 and 2006, the Company did not have any chargesassociated with its ceiling test.

 

The costs of certainunevaluated oil and gas properties and exploratory wells being drilled are notincluded in the costs subject to amortization. We will assesses costs not beingamortized for possible impairments or reductions in value and if a reduction invalue has occurred, the portion of the carrying cost in excess of the currentvalue is transferred to costs subject to amortization.

 

Certain reclassificationshave been made to the prior period’s financial statements to conform to thefull cost presentation.

 

**Item 3. *Quantitative and Qualitative Disclosure About Market Risk***

 

## ***Commodity Risk***

## ** **

**Ourmajor market risk exposure is the commodity pricing applicable to our naturalgas and oil production. Realized commodity prices received for our productionare primarily driven by the prevailing worldwide price for crude oil and spotprices applicable to natural gas. The effects of price volatility are expectedto continue.**

** **

## ***Interest Rate Risk***

## ** **

**Wehave exposure to changes in interest rates from our floating rate debt underour Credit Facility with JP Morgan Chase. All of our convertible debt has fixedinterest rates, so consequently we are not exposed to cash flow risk frommarket interest rate changes on this convertible debt. We also hold investmentsin U.S. treasury bonds available for sale, which represents securities held inescrow accounts on behalf of purchasers of certain bonds. Additionally, we mayhold U.S. treasury bonds trading securities, which predominantly represent U.S.treasury bonds released from escrow accounts. The fair market value of thesesecurities will generally increase if the federal discount rate decreases anddecrease if the federal discount rate increases.**

** **

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

## ** **

#### **The general level of inflationaffects our costs. Salaries and other general and administrative expenses areimpacted by inflationary trends and the supply and demand of qualifiedprofessionals and professional services. Inflation and price fluctuationsaffect the costs associated with exploring for and producing natural gas andoil, which have a material impact on our financial performance.**

#### ** **

*Forward-LookingStatements and Risk*

 

Certain statements inthis report, including statements of the future plans, objectives, and expectedperformance of the company, are forward-looking statements that are dependentupon certain events, risks and uncertainties that may be outside the company’scontrol, and which could cause actual results to differ materially from thoseanticipated. Some of these include, but are not limited to, the market pricesof oil and gas, economic and competitive conditions, exploration risks such asdrilling unsuccessful wells, higher-than-expected costs, potential liabilityfor remedial actions under existing or future environmental regulations andlitigation, potential liability resulting from pending or future litigation,  environmental and regulatory uncertaintiesthat could delay or prevent drilling, and not successfully completing, or anymaterial delay of, any development of new or existing fields, expansion, orcapital expenditure, legislative and regulatory changes, financial marketconditions, political and economic uncertainties of foreign governments, futurebusiness decisions, and other uncertainties, all of which are difficult topredict. Forward-looking statements are generally accompanied by words such as “estimate”,“project”, “predict”, “will”, “anticipate”, “plan”, “intend”, “believe”, “expect”or similar expressions that convey the uncertainty of future events oroutcomes. You should not place undue reliance on these forward-lookingstatements, which speak only as of the date of this report. Unless legallyrequired, Warren does not undertake any obligation to update anyforward-looking 

 

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statements, as a resultof new information, future events or otherwise. Certain risks that may affectWarren’s results of operations and financial position appear in Part 1, Item 1A“Risk Factors” of Warren’s 2006 Annual Report on Form 10-K.

 

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

 

#### **Item4. *Evaluation of Disclosure Controls and Procedures***

#### ** **

Our management, under thesupervision and with the participation of our Chief Executive Officer (“CEO”)and Chief Financial Officer (“CFO”), has evaluated the effectiveness of ourdisclosure controls and procedures as defined in Securities and ExchangeCommission (“SEC”) Rule 13a-15(e) and 15d-15(e) as of the end of the periodcovered by this report. Based upon that evaluation, management  has concluded that our  disclosure controls  and  procedures are  effective  to ensure that information  we are requiredto disclose in reports that we file or submit under the Securities Exchange Actis communicated to management, including the CEO and CFO, as appropriate toallow timely decisions  regardingrequired disclosure and is recorded,  processed,  summarized and  reported  within the time periods specified in the SEC’srules 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.

 

## **PARTII—OTHER INFORMATION**

## ** **

**Item 1. *Legal Proceedings***

 

We are a party to legalactions arising in the ordinary course of our business. In the opinion of ourmanagement, based in part on consultation with legal counsel, the liability, ifany, under these claims is either adequately covered by insurance or would nothave a material adverse effect on us.

 

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

 

Our business has manyrisks. Factors that could materially adversely affect our business, financialcondition, operating results or liquidity and the trading price of our commonstock are described under “Risk Factors” in Item 1A of our annual reporton Form 10-K for the year ended December 31, 2006. This information shouldbe considered carefully, together with other information in this report andother reports and materials we file with the Securities and ExchangeCommission. Additional risks and uncertainties not currently known to us orthat we currently deem to be immaterial also may materially adversely affectour business, financial condition and/or operating results.

 

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

** **

a.     Not applicable

 

b.     Not applicable

 

c.     Not applicable

 

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**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.

 

**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**                                                                                                                                 |
|---------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                            |
| 18.1                |       | Preferability letter  received from Grant Thornton LLP, dated August 1 2007                                                                     |
| 31.1*               |       | Certification of Chief  Executive Officer pursuant to Rule 13a-15(e)/15d-15(e)                                                                  |
| 31.2*               |       | Certification of Chief  Financial Officer pursuant to Rule 13a-15(e)/15d-15(e)                                                                  |
| 32.1*               |       | Certification of Chief  Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted by  Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2*               |       | Certification of Chief  Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted by  Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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*                         Filed herewith.

 

**SIGNATURES**

 

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

 
|                   |   | WARREN RESOURCES, INC.  (Registrant) |
|------------------------|--------|--------------------------------------|
|                   |   |                                 |   |
|                   |   |                                 |   |
| Date: November 2, 2007 |   |                                 | /s/ Timothy A. Larkin |   |
|                   |   | By:                                  | Timothy A. Larkin *Executive Vice President,   Chief Financial Officer and   Principal Accounting Officer* |

 

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