**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

x        **QUARTERLY REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES****EXCHANGE ACT OF 1934**

 

**For theQuarterly Period Ended March 31, 2007**

# **OR**

**o****        TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934**

 

**For thetransition period from              to              **

# **CommissionFile No. 000-33275**

**WARREN RESOURCES, INC.**

(Exact Name ofRegistrant as Specified in its Charter.)

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

 

Registrant’s telephonenumber, including area code:

**(212)697-9660**

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

Yes 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

The aggregate number of Registrant’s outstanding shares on May 3, 2007was 54,179,336 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 March 31, 2007 and December 31, 2006                              |   |
|           |   |                                                                                                 |   |
|           |   | Consolidated Statements of Operations for the three  months ended March 31, 2007 and 2006            |   |
|           |   |                                                                                                 |   |
|           |   | Consolidated Statements of Cash Flows for three months  ended March 31, 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

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**PART I—FINANCIAL INFORMATION**

###### **ITEM1. FINANCIAL STATEMENTS**

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

**(Unaudited)**
| ** **                                                                                                                                                                                                                                 | ** ** | **March 31,**     | ** ** | **December 31,** | ** **      |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|-----------------|
| ** **                                                                                                                                                                                                                                 | ** ** | **2007**               | ** ** | **2006**              | ** **      |
| **ASSETS**                                                                                                                                                                                                                                 | ** ** | ** **             | ** ** | ** **            | ** **      |
| Current Assets                                                                                                                                                                                                                             |       |                   |       |                  |            |
| Cash and cash  equivalents                                                                                                                                                                                                                 |       | $                      | 39,464,848 |                  | $               | 43,021,884 |   |
| Accounts  receivable – trade                                                                                                                                                                                                          |       | 8,869,033              |       | 5,949,369             |            |
| Accounts  receivable from affiliated partnerships                                                                                                                                                                                          |       | 34,890                 |       | 34,890                |            |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                      |       | 121,677                |       | 121,855               |            |
| Other current  assets                                                                                                                                                                                                                      |       | 296,933                |       | 3,309,692             |            |
|                                                                                                                                                                                                                                       |       |                   |       |                  |            |
| Total current  assets                                                                                                                                                                                                                      |       | 48,787,381             |       | 52,437,690            |            |
|                                                                                                                                                                                                                                       |       |                   |       |                  |            |
| Other Assets                                                                                                                                                                                                                               |       |                   |       |                  |            |
| Oil and gas  properties—at cost, based on successful efforts method of accounting, net of  accumulated depreciation, depletion and amortization                                                                                       |       | 282,504,676            |       | 260,500,325           |            |
| Property and  equipment—at cost, net                                                                                                                                                                                                  |       | 2,646,925              |       | 1,751,146             |            |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                      |       | 1,095,091              |       | 1,096,695             |            |
| Deferred bond  offering costs                                                                                                                                                                                                              |       | 254,003                |       | 258,383               |            |
| Goodwill                                                                                                                                                                                                                                   |       | 3,430,246              |       | 3,430,246             |            |
| Other assets                                                                                                                                                                                                                               |       | 4,214,582              |       | 4,384,772             |            |
|                                                                                                                                                                                                                                       |       |                   |       |                  |            |
| Total other  assets                                                                                                                                                                                                                        |       | 294,145,523            |       | 271,421,567           |            |
| ** **                                                                                                                                                                                                                                 | ** ** | **$ 342,932,904** | ** ** | **$**                 | **323,859,257** | ** ** |
| ** **                                                                                                                                                                                                                                 | ** ** | ** **             | ** ** | ** **            | ** **      |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                                                                                             | ** ** | ** **             | ** ** | ** **            | ** **      |
| ** **                                                                                                                                                                                                                                 | ** ** | ** **             | ** ** | ** **            | ** **      |
| Current Liabilities                                                                                                                                                                                                                        |       |                   |       |                  |            |
| Current  maturities of debentures                                                                                                                                                                                                          |       | $                      | 249,600    |                  | $               | 249,600 |   |
| Current  maturities of other long-term liabilities                                                                                                                                                                                         |       | 276,007                |       | 257,028               |            |
| Accounts payable  and accruals                                                                                                                                                                                                             |       | 20,550,884             |       | 22,455,043            |            |
|                                                                                                                                                                                                                                       |       |                   |       |                  |            |
| Total current  liabilities                                                                                                                                                                                                                 |       | 21,076,491             |       | 22,961,671            |            |
|                                                                                                                                                                                                                                       |       |                   |       |                  |            |
| Long-Term Liabilities                                                                                                                                                                                                                      |       |                   |       |                  |            |
| Debentures, less  current portion                                                                                                                                                                                                          |       | 2,246,400              |       | 2,246,400             |            |
| Other long-term  liabilities, less current portion                                                                                                                                                                                         |       | 6,922,333              |       | 6,766,868             |            |
| Line of credit                                                                                                                                                                                                                             |       | 20,000,000             |       | —                |            |
|                                                                                                                                                                                                                                       |       |                   |       |                  |            |
|                                                                                                                                                                                                                                       |       | 29,168,733             |       | 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) |       | 3,248,100              |       | 3,252,897             |            |
| Common stock -  $.0001 par value; authorized, 100,000,000 shares; issued 54,178,336 in 2007  and 54,143,054 shares in 2006                                                                                                                 |       | 5,418                  |       | 5,414                 |            |
| Additional  paid-in-capital                                                                                                                                                                                                                |       | 371,377,013            |       | 371,035,151           |            |
| Accumulated  deficit                                                                                                                                                                                                                       |       | (81,345,240            | )          | (81,822,011           | )               |
| Accumulated  other comprehensive income, net of applicable income taxes of $85,000 in 2007  and $92,000 in 2006                                                                                                                            |       | 130,444                |       | 140,922               |            |
|                                                                                                                                                                                                                                       |       | 293,415,735            |       | 292,612,373           |            |
|                                                                                                                                                                                                                                       |       |                   |       |                  |            |
| Less common  stock in Treasury—at cost; 632,250 shares in 2007 and 2006                                                                                                                                                               |       | 728,055                |       | 728,055               |            |
| Total  stockholders’ equity                                                                                                                                                                                                           |       | 292,687,680            |       | 291,884,318           |            |
| ** **                                                                                                                                                                                                                                 | ** ** | **$ 342,932,904** | ** ** | **$**                 | **323,859,257** | ** ** |

 

The accompanyingnotes are an integral part of these financial statements.

3

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**WarrenResources, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF OPERATIONS**

 
| ** **                                                           | ** ** | **Three Months Ended**    | ** ** |
|----------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                           | ** ** | **March 31, (Unaudited)** | ** ** |
| ** **                                                           | ** ** | **2007**                            | ** ** | **2006** | ** ** |
| Revenues                                                             | ** ** | ** **                          | ** ** | ** ** | ** ** |
| Oil and gas sales                                                    |       | $                                   | 9,481,685  |   | $ | 6,809,441 |   |
| Turnkey contracts with affiliated partnerships                       |       | —                              |       | 426,597 |   |
| Gas sales from marketing activities                                  |       | 373,755                             |       | 1,015,045 |   |
| Well services                                                        |       | 304,706                             |       | 248,289 |   |
| Net gain (loss) on investments                                       |       | 8,081                               |       | (22,924 | ) |
| Interest and other income                                            |       | 832,761                             |       | 1,356,002 |   |
|                                                                 |       | 11,000,988                          |       | 9,832,450 |   |
|                                                                 |       |                                |       |   |   |
| Expenses                                                             |       |                                |       |   |   |
| Production & exploration                                         |       | 4,024,622                           |       | 2,979,621 |   |
| Turnkey contracts                                                    |       | 354,355                             |       | 705,716 |   |
| Cost of marketed oil and gas purchased from  affiliated partnerships |       | 360,970                             |       | 992,006 |   |
| Well services                                                        |       | 359,626                             |       | 295,483 |   |
| Depreciation, depletion, amortization and impairment                 |       | 2,593,116                           |       | 1,558,377 |   |
| General and administrative                                           |       | 2,667,660                           |       | 2,273,119 |   |
| Interest                                                             |       | 156,868                             |       | 105,172 |   |
|                                                                 |       | 10,517,217                          |       | 8,909,494 |   |
|                                                                 |       |                                |       |   |   |
| Income before  provision for income taxes                            |       | 483,771                             |       | 922,956 |   |
|                                                                 |       |                                |       |   |   |
| Deferred income tax expense                                          |       | 7,000                               |       | 67,000 |   |
|                                                                 |       |                                |       |   |   |
| Net income                                                           |       | 476,771                             |       | 855,956 |   |
|                                                                 |       |                                |       |   |   |
| Less dividends and accretion on preferred shares                     |       | 67,116                              |       | 170,925 |   |
|                                                                 |       |                                |       |   |   |
| Net income  applicable to common stockholders                        |       | $                                   | 409,655    |   | $ | 685,031 |   |
|                                                                 |       |                                |       |   |   |
| Earnings per  share – Basic                                     |       | $                                   | 0.01       |   | $ | 0.01 |   |
| Earnings per  share – Diluted                                   |       | 0.01                                |       | 0.01 |   |
|                                                                 |       |                                |       |   |   |
| Weighted average  common shares outstanding – Basic             |       | 53,519,642                          |       | 52,199,474 |   |
| Weighted average common  shares outstanding – Diluted           |       | 54,466,840                          |       | 54,314,040 |   |

 

The accompanyingnotes are an integral part of these financial statements.

4

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**Warren Resources, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF CASH FLOWS**
| ** **                                                                         | ** ** | **For the three months ended** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                                         | ** ** | **March 31, (Unaudited)**                | ** ** |
| ** **                                                                         | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                             |       |                                               |       |   |   |
| Net income                                                                         |       | $                                                  | 476,771    |   | $ | 855,956 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                               |       |   |   |
| Accretion of discount on available-for-sale debt  securities                       |       | (15,695                                            | )          | (23,731 | ) |
| Amortization and write-off of deferred bond offering  costs                        |       | 4,380                                              |       | 5,625 |   |
| Depreciation, depletion, amortization and impairment                               |       | 2,593,116                                          |       | 1,558,377 |   |
| Common stock cancelled                                                             |       | —                                             |       | (1,478 | ) |
| Stock option expense                                                               |       | 206,963                                            |       | 32,119 |   |
| Deferred tax expense                                                               |       | 7,000                                              |       | 67,000 |   |
| Change in assets  and liabilities:                                                 |       |                                               |       |   |   |
| Increase in trading securities                                                     |       | —                                             |       | (242,548 | ) |
| (Increase) decrease in accounts receivable—trade                              |       | (2,919,664                                         | )          | 494,066 |   |
| Decrease in accounts receivable from affiliated partnerships                       |       | —                                             |       | 67,340 |   |
| Decrease in other assets                                                           |       | 3,182,949                                          |       | 2,009,968 |   |
| Decrease in accounts payable and accruals                                          |       | (1,614,465                                         | )          | (568,909 | ) |
| Decrease in deferred income from affiliated  partnerships                          |       | —                                             |       | (570,964 | ) |
|                                                                               |       |                                               |       |   |   |
| Net cash provided by operating activities                                          |       | 1,921,355                                          |       | 3,682,821 |   |
|                                                                               |       |                                               |       |   |   |
| Cash flows from  investing activities:                                             |       |                                               |       |   |   |
| Purchase, exploration and development of oil and gas  properties                   |       | (24,639,791                                        | )          | (24,604,427 | ) |
| Purchase of property and equipment                                                 |       | (1,010,910                                         | )          | (175,982 | ) |
| Proceeds from U.S. Treasury Bonds—available-for-sale                          |       | —                                             |       | 209,784 |   |
|                                                                               |       |                                               |       |   |   |
| Net cash used in investing activities                                              |       | (25,650,701                                        | )          | (24,570,625 | ) |
|                                                                               |       |                                               |       |   |   |
| Cash flows from  financing activities:                                             |       |                                               |       |   |   |
| Proceeds from line of credit                                                       |       | 20,000,000                                         |       | — |   |
| Payments on debt and debentures                                                    |       | (22,940                                            | )          | (95,765 | ) |
| Issuance of common stock, net                                                      |       | 195,250                                            |       | 776,622 |   |
|                                                                               |       |                                               |       |   |   |
| Net cash provided by financing activities                                          |       | 20,172,310                                         |       | 680,857 |   |
|                                                                               |       |                                               |       |   |   |
| Net decrease in cash and cash equivalents                                          |       | (3,557,036                                         | )          | (20,206,947 | ) |
|                                                                               |       |                                               |       |   |   |
| Cash and cash  equivalents at beginning of period                                  |       | 43,021,884                                         |       | 114,632,099 |   |
|                                                                               |       |                                               |       |   |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                  | 39,464,848 |   | $ | 94,425,152 |   |
|                                                                               |       |                                               |       |   |   |
| Supplemental  disclosure of cash flow information                                  |       |                                               |       |   |   |
| Cash paid for interest                                                             |       | $                                                  | 91,940     |   | $ | 99,548 |   |
| Cash paid for income taxes                                                         |       | —                                             |       | — |   |
| Noncash  investing and financing activities                                        |       |                                               |       |   |   |
| Accrued preferred stock dividend                                                   |       | $                                                  | 65,145     |   | $ | 147,766 |   |
| Common stock issued on conversion of preferred stock                               |       | 6,768                                              |       | 439,557 |   |
| Common stock  issued for acquisition of property                                   |       | —                                             |       | 6,185,389 |   |

 

The accompanyingnotes are an integral part of these financial statements.

5

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**WARRENRESOURCES, INC. AND SUBSIDIARIES**

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

**NOTE 1—ORGANIZATION**

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

The accompanying unaudited financial statements and related notespresent the Company’s consolidated financial position as of March 31, 2007 andDecember 31, 2006, the consolidated results of operations for the three monthsended March 31, 2007 and 2006 and consolidated cash flows for the three monthsended March 31, 2007 and 2006. The unaudited financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited 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 months ended March 31, 2007, arenot necessarily indicative of the results that may be expected for the fiscalyear ending December 31, 2007. The accounting policies followed by the Companyare set forth in Note A to the Company’s financial statements included in Form10-K for the year ended December 31, 2006. These interim financial statementsand notes thereto should be read in conjunction with the consolidated financialstatements presented in the Company’s 2006 Annual Report on Form 10-K.

 

##### **NOTE2—STOCK BASED COMPENSATION**

*StockOptions*

Compensationexpense related to stock options and restricted stock awards recognized inoperating results (general and administrative expenses) under SFAS No. 123R wasapproximately $207,000 and $32,000 for the three months ended March 31, 2007and 2006, respectively.

Thefollowing assumptions were used to value stock options calculated using theBlack-Scholes options pricing model:
|                          | ** ** | **Three months ended March 31,** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|
| ** **               | ** ** | **2007**                                             | ** ** | **2006** | ** ** |
| Dividend yield           |       | 0                                                    | %          | 0 | % |
| Expected  volatility     |       | 43.8                                                 | %          | 48.2 | % |
| Risk-free  interest rate |       | 4.48                                                 | %          | 4.66 | % |
| Fair value of  options   |       | $                                                    | 3.91       |   | $ | 5.57 |   |
| Expected life            |       | 3.5 years                                            |       | 3.5 years |   |
|                          |            |                                                      |            |  |  |  |  |

 
| ** **                        | ** ** | ** **          | ** ** | **Weighted** | ** ** | **Weighted**                  | ** ** | ** **               | ** ** |
|-----------------------------------|------------|---------------------|------------|--------------|------------|-------------------------------|------------|--------------------------|------------|
| ** **                        | ** ** | ** **          | ** ** | **Average**  | ** ** | **Average**                   | ** ** | **Aggregate**            | ** ** |
| ** **                        | ** ** | **Number**          | ** ** | **Exercise** | ** ** | **Remaining**                 | ** ** | **Intrinsic Value** | ** ** |
| ** **                        | ** ** | **of Options** | ** ** | **Price**    | ** ** | **Term (in years)** | ** ** | **(in thousands)**  | ** ** |
| Outstanding at  December 31, 2006 |       | 2,456,783           |       | $            | 8.07       |                          |       |                     |       |   |
| Granted                           |       | 497,250             |       | 10.51        |       |                          |       |                     |       |
| Exercised                         |       | (35,000             | )          | 5.58         |       |                          |       |                     |       |
| Forfeited or  expired             |       | (30,750             | )          | 13.70        |       |                          |       |                     |       |
| Outstanding at  March 31, 2007    |       | 2,888,283           |       | $            | 8.46       |                          | 2.84       |                     | $          | 13,530 |   |
|                              |       |                |       |         |       |                          |       |                     |       |
| Exercisable at March  31, 2007    |       | 2,086,198           |       | $            | 7.22       |                          | 2.16       |                     | $          | 12,252 |   |

 

6

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The total intrinsic value of options exercised during the three monthsended March 31, 2007 and 2006 was $0.2 million and $0.8 million respectively.

 

As of March 31, 2007, total unrecognized stock-based compensationexpense related to non-vested stock options was $4.1 million, which we expectto recognize over a weighted average period of 3 years.

 

Cash received from stock option exercises under all stock-based paymentarrangements for the three months ended March 31, 2007 was $0.2 million. Weissue new shares of common stock to settle option exercises.

 

*RestrictedShares*

Restricted share activityas of March 31, 2007 was as follows:
|                                   | ** ** | **Shares** | ** ** | **Weighted  Average  Fair Value** | ** ** |
|-----------------------------------|------------|------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | ** ** | ** ** | ** **                             | ** ** |
| Outstanding at  December 31, 2006 |       | —     |       | $                                      | —     |   |
| Granted                           |       | 59,995     |       | 10.51                                  |       |
| Vested                            |       | —     |       | —                                 |       |
| Forfeited                         |       | —     |       | —                                 |       |
| Outstanding at March  31, 2007    |       | 59,995     |       | $                                      | 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 March 31, 2007, total unrecognized stock-based compensationexpense related to non-vested restricted shares was $0.6 million, which isexpected to be recognized over a weighted average period of approximately 3years.

#### **NOTE3—CHANGES IN STOCKHOLDERS’ EQUITY**

During the three monthsended March 31, 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 March 31, 2007, 271,436 shares ofconvertible preferred stock remain outstanding. Preferred dividends of approximately $65,000 were accrued at March 31,2007.

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 stock may be voluntarilyconverted, at the election of the holder into common stock of the Company basedon a conversion rate of 1 to 0.50.

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 the receipt of a redemption election,the Company, at its option, shall either: (1) pay the holder cash in the amountequal to the Redemption Price or (2) issue to holder shares of common stock inan amount equal to 125% of the redemption price and any accrued and unpaiddividends, based on the weighted average closing “bid” price of the Company’scommon stock for the thirty trading days immediately preceding the date of thewritten redemption election by the holder up to a maximum of 1.5 shares ofcommon stock for each one share of preferred stock redeemed. The Company isaccreting the carrying value of its preferred stock to its redemption priceusing the effective interest method with changes recorded to additional paid incapital. The accretion of preferred stock results in a reduction of earningsper 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

7

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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 March 31, 2007, therewere 271,436 preferred shares outstanding that the Company may be required toredeem at the aggregate redemption price 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 three monthsended March 31, 2007, employees and directors exercised a total of 35,000options at exercise prices between $4 and $9.05 per share. The Company receivedproceeds of approximately $0.2 million from these exercises.

**NOTE 4—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 isbased on the assumption that stock options and warrants are converted intocommon shares using the treasury stock method and convertible bonds andpreferred stock are converted using the if-converted method. Conversion is notassumed if the results are anti-dilutive. Potential common shares for the three months ended March 31, 2007 andMarch 31, 2006 of 207,032 and 563,019 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 2,315,030,relating to stock options, warrants and restricted stock were excluded from thecomputation of diluted income per share for the three months ended March 31,2007 because they are anti-dilutive. Potential common shares of 3,343,706,relating to stock options and warrants, respectively, were excluded from thecomputation of diluted income per share at March 31, 2006 because they areanti-dilutive. Stock options have a weighted average exercise price of $8.46and $8.14 at March 31, 2007 and March 31, 2006, respectively. Anti-dilutivewarrants have a weighted average exercise price of $12.50 and $11.17 at March31, 2007 and March 31, 2006, respectively. At March 31, 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.  The preferred stock may beconverted at the discretion of the holder or upon meeting certain conditions atthe discretion of the Company (see Note 3).

Basic and diluted netincome per share is computed based on the following information:
| ** **                                          | ** ** | **Three Months  Ended  March 31, 2007** | ** ** | **Three Months  Ended  March 31, 2006** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
|                                                |       |                                                   |       |                                                   |       |
| Net income  available to shareholders               |       | $                                                      | 409,655    |                                                   | $          | 685,031 |   |
|                                                |       |                                                   |       |                                                   |       |
| Weighted average  shares outstanding - basic        |       | 53,519,642                                             |       | 52,199,474                                             |       |
| Effect of  dilutive securities – stock options |       | 781,142                                                |       | 1,289,048                                              |       |
| Effect of  dilutive securities – warrants      |       | 166,056                                                |       | 825,518                                                |       |
|                                                |       |                                                   |       |                                                   |       |
| Weighted average  shares outstanding - diluted      |       | 54,466,840                                             |       | 54,314,040                                             |       |
|                                                |       |                                                   |       |                                                   |       |
| Basic and diluted net  income per share             |       | $                                                      | 0.01       |                                                   | $          | 0.01 |   |

 

8

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**NOTE 5—LONG-TERM DEBT**

 

Long-term debt consisted of the following at March 31, 2007 andDecember 31, 2006:

 
| ** **                                            | ** ** | **March 31, 2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                                  |       |                         |       |                        |       |
| Line of Credit                                        |       | $                            | 20,000,000 |                        | $          | — |   |
| 12% Secured  Convertible Bonds, due December 31, 2020 |       | 1,390,000                    |       | 1,390,000                   |       |
| 12% Secured  Convertible Bonds, due December 31, 2022 |       | 1,106,000                    |       | 1,106,000                   |       |
|                                                  |       |                         |       |                        |       |
|                                                  |       | 22,496,000                   |       | 2,496,000                   |       |
| Less current  portion                                 |       | 249,600                      |       | 249,600                     |       |
|                                                  |       |                         |       |                        |       |
| Long-term portion                                     |       | $                            | 22,246,400 |                        | $          | 2,246,400 |   |

 

On November 20, 2006, the Company entered into a five year, $150million credit agreement with JP Morgan Chase Bank (the “Credit Facility”).   The Credit Facility provides for a revolvingcredit facility up to the lesser of (i) the borrowing base (ii) $150 millionand (iii) the draw limit requested by the Company.  The Credit Facility matures on November 15,2011 and is secured by substantially all of the assets of the Company. Theborrowing base will be determined by the lenders at least semi-annually on eachApril 1 and October 1, beginning April 1, 2007 and is based in part on theproved reserves of the Company. The Company is currently in the process ofdetermining the revised borrowing base. The initial borrowing base is $40million. Interest payments are made quarterly in arrears. On March 15, 2007,Warren borrowed $20 million under this facility. As of March 31, 2007, creditline interest of approximately $60,000 was accrued.

 

The convertible bonds may be converted from the date of issuance untilmaturity at 100% of principal amount into common stock of the Company at pricesranging from $35 to $50. Each year the holders of the convertible bonds maytender to the Company up to 10% of the aggregate bonds issued and outstanding.

 

#### **NOTE6—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.

**Repurchase Agreements**

 

For repurchase agreementsrelating to partnerships formed from 1999 to 2001, investor partners have aright to have their interests repurchased by the Company at a formula priceseven years from the date of the original partnership formation.  In determining the amount of the repurchaseobligation, the obligation is computed based on the lesser of a formulapurchase price as set forth in the respective partnership agreement, whichformula price cannot exceed the Partner’s allocable share of the then netpresent value, calculated in the future at December 1 of the year preceding thebuy-back window, of the future net revenues from the Partnership’s proved oiland gas reserves (determined in the manner described in the partnership agreement.)At March 31, 2007, before applying the net present value limitation, theformula purchase price with respect to these partnerships was approximately$73.9 million. However, estimating the partnerships’ net cash flows from theirproved reserves discounted at 10% (“PV-10”), this amount is limited toapproximately $13.0 million based on the PV-10 of the assets in thesepartnerships at December 31, 2006. This limitation does not include reservesfor approximately 26 net wells awaiting to be placed on production on behalf ofthese five drilling partnerships, and will fluctuate due to the futurevariables in determining discounted cash flows, such as oil and gas commodityprice changes, reserve revisions, etc. In the event of repurchase, the Company receives the investor’s interestin the partnership and the investor’s pro rata share of the partnershipsreserves and related future cash flows. During the first quarter of 2007,Warren submitted separate proposals to acquire the respective oil and gasassets of five drilling partnerships that Warren formed from 2000 to 2003.  Warren

9

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serves as ManagingGeneral Partner for these drilling partnerships.  In order to sell its properties, approval of51% of the interests of the drilling partnerships is required.  If the proposed acquisition is approved bythe partners of a program, the effective date of that acquisition will be April1, 2007 and its target closing date will be June 15, 2007.  The independently evaluated December 31, 2006PV-10 attributable to the aggregate proved oil and gas reserves of the fivedrilling partnerships is $33.2 million (approximately 9.9 Bcfe of proveddeveloped producing reserves) and the estimated fair market value for relatedwater injection wells is $4.4 million. This results in a $37.6 million total purchase price for the propertiesif all five drilling partnerships approve the sale.  The purchase price will be paid in the formof restricted shares of Warren’s common stock calculated at a discount of 20%from the average publicly traded share price from April 1, 2007 to May 31,2007. Warren will also be acquiring 21.3 net coalbed methane wells that arecurrently not producing economical amounts of natural gas.

Also, as part ofcontractual commitments, Warren is obligated to accept requests from thepartners in two drilling partnerships formed in 1999.  If all of the partners elected to withdrawfor cash, the aggregate purchase price would be $4.8 million, consisting of$3.9 million of PV-10 (approximately 1.2 Bcfe of proved developed producingreserves) and $0.9 million for the estimated fair market value of waterinjection wells.  As an alternative tothis cash withdrawal, Warren proposed to pay this obligation in restrictedshares of its common stock discounted at 20% for the period January 1, 2007 toMarch 31, 2007 or $8.98 per share.

**NOTE 7—BUSINESS SEGMENTINFORMATION**

The Company’s operatingactivities can be divided into four major segments: turnkey contracts, oil andgas marketing, oil and gas exploration and production operations and wellservices. The Company drills oil and natural gas wells for Company-sponsoreddrilling partnerships and retains an interest in each well. Also, the Companymarkets natural gas for affiliated drilling partnerships. The Company chargesCompany-sponsored drilling partnerships and other third parties competitiveindustry rates for well operations and gas gathering. Segment information is asfollows:
|                         | ** ** | **Three Months Ended** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **March 31,**               | ** ** | **March 31,** | ** ** |
| ** **              | ** ** | **2007**                         | ** ** | **2006** | ** ** |
|                    |       |                             |       |   |   |
| **Revenue**             |       |                             |       |   |   |
| Oil and Gas  Operations |       | $                                | 9,481,685  |   | $ | 6,809,441 |   |
| Turnkey  Contracts      |       | —                           |       | 426,597 |   |
| Oil and Gas  Marketing  |       | 373,755                          |       | 1,015,045 |   |
| Well Services           |       | 304,706                          |       | 248,289 |   |
| Other                   |       | 840,842                          |       | 1,333,078 |   |
|                    |       |                             |       |   |   |
|                    |       | $11,000,988                      |       | $ | 9,832,450 |   |
|                         |            |                                  |            |  |  |  |  |

 
|                                | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                     | ** ** | **2007**           | ** ** | **2006**           | ** ** |
|                           |       |               |       |               |       |
| **Operating  Income / (Loss)** |       |               |       |               |       |
| Oil and Gas  Operations        |       | $                  | 3,019,412  |               | $          | 2,377,888 |   |
| Turnkey  Contracts             |       | (354,355           | )          | (304,923           | )          |
| Oil and Gas  Marketing         |       | 12,785             |       | 23,039             |       |
| Well Services                  |       | (107,238           | )          | (47,194            | )          |
| Other                          |       | (2,086,833         | )          | (1,125,854         | )          |
|                           |       |               |       |               |       |
|                           |       | $                  | 483,771    |               | $          | 922,956 |   |

 

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**NOTE 8—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** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|
|                           |       |     |       |     |       |
| Three Months  ending March 31, |       | $        | 466,293    |     | $          | 756,508 |   |
|                                |            |          |            |          |            |  |  |

 

**NOTE 9—GOODWILL**

The Companyaccounts for goodwill 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 three monthsended March 31, 2007 no events occurred which would indicate that animpairment of goodwill existed.

**NOTE 10 –CHANGE IN ACCOUNTING PRINCIPLE**

As of April 1, 2007, theCompany will convert to the full cost method of accounting for its oil and gasproperties.  Currently, the Company follows the successful efforts methodof accounting for its oil and gas activities. The Company believes thatthe full cost method is preferable for a company that is actively involved inthe exploration and development of oil and gas reserves. Additionally, the fullcost method is used by the majority of the Company’s peers and managementbelieves the change will improve the comparability of the Company’s financialstatements with its peer group. The Company is currently evaluating the effectthat this transition will have on the financial statements.

**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 the forward-lookingstatements provided herein are subject to all the risks and uncertaintiesincident to the acquisition, development and marketing of, and exploration foroil and gas reserves. These risks include, but are not limited to, oil andnatural gas price risk, environmental risks, drilling risk, reserve quantityrisk and operations and production risk. For all the above reasons, actualresults may vary materially from the forward-looking statements and there is noassurance that the assumptions used are necessarily the most likely to occur.

**Overview**

We are a growingindependent energy company engaged in the exploration and development ofdomestic onshore natural gas and oil reserves. We focus our efforts primarilyon the exploration and development of coalbed methane (“CBM”) propertieslocated in the Rocky Mountain region and on our waterflood oil recoveryprograms in the Wilmington field within the Los Angeles Basin of California. Asof March 31, 2007, we owned natural gas and oil leasehold interests in approximately254,480 gross (139,254 net) acres, 92% of which are undeveloped. Substantiallyall our undeveloped acreage is located in the Rocky Mountains. Our total netproved reserves are located on less than 10% of our net acreage.

From our inception in1990 through 2003, we functioned principally as the sponsor of privately placeddrilling programs and joint ventures. Under these programs, we contributedrilling locations, pay tangible drilling costs and provide turnkey drillingservices, natural gas marketing services and well services to the drillingprograms and retain an interest in the wells. Historically, a substantialportion of our revenue was attributable to these turnkey drilling services.

11

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For fiscal years 2007 andlater, Warren will not recognize revenue from turnkey drilling services. As ofDecember 31, 2006, we have performed our obligations under the turnkey drillingcontracts.  As a result, we have nodeferred income liability as of December 31, 2006.  Our future revenue growth is primarily dependenton our ability to increase our oil and gas reserves and production.

**Liquidityand Capital Resources**

Our cash and cash equivalents decreased $3.6 million during the firstquarter of 2007. This resulted from cash used in investing activities of $25.7million.  This was offset by cashprovided by operating activities of $1.9 million and cash provided by financingactivities of $20.2 million.

 

Cash used in investingactivities results from expenditures on oil and gas properties andequipment.  Cash provided by operatingactivities of $1.9 million primarily relates to oil and gas operations.  Cash provided by financing activities of$20.2 million primarily results from proceeds received from our Credit Facilityas discussed in more detail below and from the exercise of stock options andwarrants.

During the first quarterof 2007, Warren submitted separate proposals to acquire the respective oil andgas assets of five drilling partnerships that Warren formed from 2000 to2003.  Warren serves as Managing GeneralPartner for these drilling partnerships. In order to sell its properties, approval of 51% of the interests of thedrilling partnerships is required.  Ifthe proposed acquisition is approved by the partners of a program, theeffective date of that acquisition will be April 1, 2007 and its target closingdate will be June 15, 2007.  Theindependently evaluated December 31, 2006 PV-10 attributable to the aggregateproved oil and gas reserves of the five drilling partnerships is $33.2 million(approximately 9.9 Bcfe of proved developed producing reserves) and theestimated fair market value for related water injection wells is $4.4million.  This results in a $37.6 milliontotal purchase price for the properties if all five drilling partnershipsapprove the sale.  The purchase pricewould be paid in the form of restricted shares of Warren’s common stockcalculated at a discount of 20% from the average publicly traded share pricefrom April 1, 2007 to May 31, 2007. Warren would also be acquiring 21.3 netcoalbed methane wells that are currently not producing economical amounts ofnatural gas.

Also, as part ofcontractual commitments, Warren is obligated to accept requests from thepartners in two drilling partnerships formed in 1999.  If all of the partners elected to withdrawfor cash, the aggregate purchase price would be $4.8 million, consisting of$3.9 million of PV-10 (approximately 1.2 Bcfe of proved developed producingreserves) and $0.9 million for the estimated fair market value of waterinjection wells.  As an alternative tothis cash withdrawal, Warren proposed to pay this obligation in restrictedshares of its common stock discounted at 20% for the period January 1, 2007 toMarch 31, 2007 or $8.98 per share.

On November 20, 2006, Warren entered into a five year, $150 millioncredit agreement with JP Morgan Chase Bank (the “Credit Facility”).   The Credit Facility provides for a revolvingcredit facility up to the lesser of (i) the borrowing base (ii) $150 millionand (iii) the draw limit requested by the Company.  The Credit Facility matures on November 15,2011.  It is secured by substantially allof our assets.  The borrowing base willbe determined by the lenders at least semi-annually on each April 1 and October1, beginning April 1, 2007 and is based in part on the proved reserves of theCompany. Interest payments are made quarterly in arrears.  The initial borrowing base is $40 million.The company is subject to certain covenants under the terms of the Credit Facilitywhich include, but are not limited to the maintenance of the followingfinancial ratios (1) minimum current ratio of 1.0 to 1.0 and (2) a maximumtotal net debt to annualized consolidated EBITDAX (as defined by the CreditFacility) of 3.5 to 1.0.  As of March 31,2007, the Company was in compliance with all covenants. On March 15, 2007,Warren borrowed $20 million under this facility. Warren is in the process ofdetermining the revised borrowing base.

 

Depending on the current level of borrowing base usage, the annualinterest rate on each base rate borrowing under the Credit Facility will be atour option either: (a) the higher of (i) the Agent’s prime rate of interestannounced from time to time, or (ii) the Federal Funds rate most recentlydetermined by the Agent, plus 1⁄2% per annum, plus an applicable margin thatranges from 0.25% to 1.0%, or (b) Eurodollar Loan rate plus an applicablemargin that ranges from 1.25% to 2%. Credit line interest of approximately$60,000 was accrued for as of March 31, 2007.

 

During the first quarterof 2007, the Company had net income of $0.4 million as compared to net incomeof $0.7 million for the first quarter of 2006. At March 31, 2007, currentassets exceeded current liabilities by approximately $27.7 million.

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At March 31, 2007, we hadapproximately 2.1 million vested outstanding stock options issued under ourstock based equity compensation plans. Of the total 2.1 million outstandingvested options, 139,915 options had exercise prices above the closing marketprice ($13.03) of our common stock on March 31, 2007. If the options withexercise prices below the closing market price on March 31, 2007 are exercisedby the holders, we would receive $13.1 million in cash.

*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 par valueof the bonds maturing on or before the maturity of the bonds. Such U.S.treasury bonds had a fair market value of $1.2 million at March 31, 2007.  The table below reflects the release ofU.S. treasury bonds to us upon redemption.
| ** **                                   | ** ** | **Payments due by period** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations**             | ** ** | ** **                                | ** ** | **Less Than** | ** ** | **1-3** | ** ** | **3-5** | ** ** | **More Than** | ** ** |
| **As of March 31, 2007** | ** ** | **Total**                                 | ** ** | **1 Year** | ** ** | **Years** | ** ** | **Years** | ** ** | **5 Years** | ** ** |
|                                         |       |                                      |       |   |   |   |   |   |   |   |   |
| Line of credit                               |       | $                                         | 20,000,000 |   | — |   | — |   | $ | 20,000,000 |   | — |   |
| Bonds                                        |       | 2,496,000                                 |       | 249,600 |   | 426,816 |   | 345,721 |   | 1,473,863 |   |
| Drilling  commitments                        |       | 2,208,988                                 |       | 2,208,988 |   | — |   | — |   | — |   |
| Leases                                       |       | 333,084                                   |       | 210,430 |   | 108,756 |   | 13,898 |   | — |   |
| Total                                        |       | $                                         | 25,038,072 |   | $ | 2,669,018 |   | $ | 535,572 |   | $ | 20,359,619 |   | $ | 1,473,863 |   |
|                                              |            |                                           |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Off-Balance Sheet Arrangements**

Under the terms of our drilling partnerships formedfrom 1999 to 2001, investors have the right to tender their interest back tothe drilling partnership and other program investors during the periodseven years after the date of the partnership’s formation. The tenderrights were included to make such partnerships more attractive to potentialinvestor partners, thereby enabling the Company to obtain more capital to drillmore oil and gas wells. To the extent that an investor tenders a drillingpartnership interest for sale and the drilling partnership and other investorselect not to repurchase the withdrawing partner’s interest, we will be requiredto repurchase the interest from the investor.  In determining the amount of the repurchaseobligation, the obligation is computed based on the lesser of a formula purchaseprice as set forth in the respective partnership agreement, which formula pricecannot exceed the Partner’s allocable share of the then net present value,calculated in the future at December 1 of the year preceding the buy-backwindow, of the future net revenues from the Partnership’s proved oil and gasreserves (determined in the manner described in the partnership agreement.) Asof March 31, 2007, based on the December 31, 2006 reserve reports of therespective five drilling partnerships, the aggregate PV-10 value of the assetsin these partnerships is $13.0 million. Because this PV-10 value is less thanthe formula price of $73.9 million at March 31, 2007, the maximum repurchaseprice obligation at March 31, 2007 was $13.0 million based on the December 31,2006 reserve report. This PV-10 value could be higher if current prices forcrude oil and natural gas were to increase or we received additional provedreserves for approximately 26 net wells that are waiting to be placed on productionas of March 31, 2007. In the event of repurchase, we receive the investor’sinterest in the partnership, which includes the investor’s beneficial share ofthe partnership’s reserves and related future net cash flows. There are noknown events that would result in termination of the material benefits of ouroff-balance sheet arrangements except for a decrease in oil and gas pricingthat occurs after an acquisition. The only material off-balance sheet benefitof this arrangement is the acquisition of proved reserves. To the extent thatwe acquire interests for their PV-10 value based on this arrangement, anddeclining oil and natural gas prices, or other factors, render those interestsless valuable, a material reduction in the benefits of this arrangement to theCompany would occur.

The table belowpresents the projected timing of our maximum potential repurchase commitmentassociated with these partnerships as of March 31, 2007:

13

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| ** **                                   | ** ** | **Amount of repurchase commitment per period** | ** ** |
|----------------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Total**                                                               | ** ** | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** |
| ** **                                   | ** ** | ** **                                                              | ** ** | ** ** | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                         |       |                                                                    |       |   |   |   |   |   |   |   |   |
| Maximum potential  repurchase commitment (1) |       | $                                                                       | 13,017     |   | $ | 1,887 |   | $ | 11,130 |   | $ | — |   | $ | — |   |
|                                              |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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(1)                   Based on thereserves taken from the partnership reserve report prepared by Williamson as ofDecember 31, 2006 and using pricing at that date. This report does not includeproved reserves for the 26 net wells that were waiting to be placed onproduction as of March 31, 2007.

**RESULTS OF OPERATIONS:**

**Three months Ended March 31, 2007Compared to Three Months Ended March 31, 2006**

*Oil and gas sales.*Revenue from oil and gas sales increased $2.7 million in the first quarter of2007 to $9.5 million, a 39% increase compared to the same quarter in 2006.  This increase in production resulted from significantlyincreasing our drilling activity in the Wilmington Townlot Unit (“WTU”) insouthern California.  Net oil productionfor the three months ended March 31, 2007 and 2006 was 161 Mbbls and 93 Mbbls,respectively.  Net gas production forthree months ended March 31, 2007 and 2006 was 216 Mmcf and 309 Mmcf,respectively.  The average realized priceper barrel of oil for the three months ended March 31, 2007 and 2006 was $50.51and $52.47, respectively.  Additionally,the average realized price per Mcf of gas for the three months ended March 31,2007 and 2006 was $6.15 and $6.28, respectively.

*Production & exploration.*Production and exploration expense increased $1.0 million in the first quarterof 2007 to $4.0 million, a 35% increase compared to the same quarter in2006.  Primarily, this increase resultedfrom an increase in oil production. Production increased to 1.2 Bcfe for the first quarter of 2007 comparedto 866 Mmcfe for the first quarter of 2006, an increase of 36%.

*Turnkey contract revenue andexpenses.* As of December 31, 2006, the Company has no furtherturnkey drilling obligations.  Therefore,there will be no turnkey contract revenue during 2007.  Turnkey contract revenue was $0.4 millionduring the first quarter of 2006.  TheCompany incurred $0.4 million in turnkey contract expense during the firstquarter of 2007 due to performing additional drilling work on turnkey wellsdrilled during the fourth quarter of 2006. Turnkey expense was $0.7 million for the first quarter of 2006.

*Gas sales and costs frommarketing activities.* Gas sales from marketing activitiesdecreased $0.6 million in the first quarter of 2007 to $0.4 million, a 63%decrease compared to the same period last year. Cost of gas marketingactivities decreased $0.6 million in the quarter to $0.4 million, a 64%decrease compared to the same quarter in 2006. The decrease results fromacquiring the assets in our 1998 drilling partnerships.  Additionally, we acquired all of theremaining assets in our drilling partnerships formed between 1994 and1997.  Gas production from the wells inthe drilling partnerships in which we earn a marketing fee for the three monthsended March 31, 2007 and 2006 was 0.1Bcfe and 0.1 Bcfe, respectively. Theaverage price per Mcfe during the first quarter of 2007 and 2006 was $6.75 and$8.87, respectively.  The gross profitfrom marketing activities for the first quarter of 2007 was $13 thousand ascompared to $23 thousand in the same period last year.

*Well services activities.*Well services revenue increased $0.1 million in the first quarter of 2007 to$0.3 million, a 23% increase compared to the corresponding quarter of thepreceding year. Well services expense increased $0.1 million in the firstquarter of 2007 to $0.4 million, a 22% increase compared with the prior year.Well services revenue and expense increased due to increased supervision andoverhead charges to non-operated working interest owners.

Net loss from wellservices activities was $55 thousand for the first quarter of 2007. Thiscompared to a net loss of $47 thousand for the corresponding quarter of lastyear.

*Interest and other income.*Interest and other income decreased $0.5 million in the first quarter of 2007to $0.8 million, a 39% decrease compared to the same quarter in 2006. This representsa decrease in interest earned due to lower cash and cash equivalents during thequarter as compared to the corresponding quarter last year.

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*Depreciation, depletion,amortization and impairment.* Depreciation, depletion,amortization and impairment expense increased $1.0 million for the firstquarter of 2007 to $2.6 million, a 66% increase compared to the correspondingquarter last year. This increase results from increased production andincreased capitalized costs during the first quarter of 2007 compared to thecorresponding period of 2006.  Productionincreased 36% during this period.

*General and administrativeexpenses.* General and administrative expenses increased $0.4million in the first quarter of 2007 to $2.7 million, a 17% increase comparedto the corresponding quarter last year. This reflects an increase in stock option expense of $0.2 million.  Additionally, this increase reflects anincrease in personnel as a result of increased drilling activities.

*Interest expense.*Interest expense increased $0.1 million in the first quarter of 2007 to $0.2million compared to the same quarter last year. The increase results from interest expense relating to the drawdown of$20 million under our Credit Facility, 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 in Accounting Principle*

As of April 1, 2007, we will convert from thesuccessful efforts method of accounting for our oil and gas properties to thefull cost method. We believe that the full cost method is preferable forour company as we devote a significant portion of our time and capital budgetto exploration activities.

Under full cost rules, all costs associated withproperty acquisition, exploration and development activities are capitalized.Exploration and development costs include dry hole costs, geological andgeophysical costs, direct overhead related to exploration and developmentactivities and other costs incurred for the purpose of finding oil and gasreserves. Proceeds received from disposals are credited against accumulatedcost except when the sale represents a significant disposal of reserves, inwhich case a gain or loss is recognized. The sum of net capitalized costs andestimated future development and dismantlement costs are depleted on theequivalent unit-of-production method, based on proved oil and gas reserves asdetermined by independent petroleum engineers.

In accordance with full cost accounting rules, we willbe 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 proved oiland 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.

The costs of certain unevaluated oil and gasproperties and exploratory wells being drilled are not included in the costssubject to amortization. We will assesses costs not being amortized forpossible impairments or reductions in value and if a reduction in value hasoccurred, the portion of the carrying cost in excess of the current value istransferred to costs subject to amortization.

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**Item 3. *Quantitative andQualitative Disclosure About Market Risk***

## *Commodity Risk*

**Our major market risk exposure is the commodity pricingapplicable to our natural gas and oil production. Realized commodity pricesreceived for our production are primarily driven by the prevailing worldwideprice for crude oil and spot prices applicable to natural gas. The effects ofprice volatility are expected to continue as we do not hedge any of our futureproduction.**

## *Interest Rate Risk*

**We have exposure to changes in interest rates from ourfloating rate debt under our Credit Facility with JP Morgan Chase. All of ourconvertible debt has fixed interest rates, so consequently we are not exposedto cash flow risk from market interest rate changes on this convertible debt.We also hold investments in U.S. treasury bonds available for sale, whichrepresents securities held in escrow accounts on behalf of purchasers ofcertain bonds.  Additionally, we may holdU.S. treasury bonds trading securities, which predominantly represent U.S.treasury bonds released from escrow accounts. The fair market value of these securities will generally increase if thefederal discount rate decreases and decrease if the federal discount rateincreases.**

## *Inflation and Changes in Prices*

#### The generallevel of inflation affects our costs. Salaries and other general and administrative expenses are impacted byinflationary trends and the supply and demand of qualified professionals andprofessional services.  Inflation andprice fluctuations affect the costs associated with exploring for and producingnatural gas and oil, which have a material impact on our financial performance.

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

Our management,under the supervision and with the participation of our Chief Executive Officer(“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness ofour disclosure controls and procedures as defined in Securities and ExchangeCommission (“SEC”) Rule 13a-15(e) and 15d-15(e) as of the end of the periodcovered by this report.  Based upon thatevaluation, management  has concludedthat our  disclosure  controls and  procedures  are effective  to ensure  that information  we are required to disclose in reports thatwe file or submit under the Securities Exchange Act is communicated tomanagement, including the CEO and CFO, as appropriate to allow timelydecisions  regarding required disclosureand is  recorded,  processed, summarized  and  reported within the time periods specified in the SEC’s rules and forms.

*Changesin internal control*

We continue toimplement a new integrated accounting system using a multi-phased approachwhich has resulted in certain changes in internal controls. The internalcontrols which changed were successfully tested in the quarter ended March 31,2007. There have been no other changes in the Company’s internal control overfinancial reporting during the period covered by this quarterly report on Form10-Q that have materially affected, or a reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

## **PART II—OTHER INFORMATION**

**Item 1. *Legal Proceedings***

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

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

For informationregarding risk factors, please refer to Item 1A in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2006.

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

a.                       Notapplicable

b.                      Notapplicable 

c.                       Notapplicable

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

Not applicable.

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

 

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**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)           |
|               |                   |   |
|               |                   | /s/ Timothy A.  Larkin |   |
| Date: May 3,  2007 | By:                    | Timothy A.  Larkin |
|               |                   | *Executive  Vice President,* |
|               |                   | *Chief  Financial Officer and* |
|               |                   | *Principal  Accounting Officer* |

 

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