Table of Contents

** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 
| **x**                                                                                                                                                                                                         | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                    | ** **                                                                                              |
| **For the  Quarterly Period Ended September 30, 2008**                                                                                                                                                   |
| ** **                                                                                                                                                                                                    | ** **                                                                                              |
| **OR**                                                                                                                                                                                                        |
| ** **                                                                                                                                                                                                    | ** **                                                                                              |
| ** **                                                                                                                                                                                                    | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                                    | ** **                                                                                              |
| **For the  transition period from              to              ** |

 

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

 

**WARREN RESOURCES, INC.**

(Exact Name ofRegistrant as Specified in its Charter.)

 

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

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

 

Registrant’stelephone number, including area code:

**(212)697-9660**

 

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13and 15 (d) of the Securities Exchange Act of 1934 during the preceding 12months and (2) has been subject to such filing requirements for the past90 days.

 

Yes x  No o

 

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

 

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

 

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

 

Yes o  No x

 

Theaggregate number of Registrant’s outstanding shares on November 4, 2008was 58,825,881 shares of Common Stock, $0.0001 par value.

 

 

 

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Table of Contents

 

**WARRENRESOURCES, INC.**

**TABLE OF CONTENTS**

 
| PART I—        | FINANCIAL INFORMATION                                                                                        |   |
|--------------------------|--------------------------------------------------------------------------------------------------------------|--------|
|                     |                                                                                                         |   |
|                     | Item 1. Financial  Statements (Unaudited)                                                                    |   |
|                     |                                                                                                         |   |
|                     | Consolidated  Balance Sheets as of September 30, 2008 and December 31, 2007                        |   |
|                     |                                                                                                         |   |
|                     | Consolidated  Statements of Operations for the three and nine months ended  September 30, 2008 and 2007 |   |
|                     |                                                                                                         |   |
|                     | Consolidated  Statements of Cash Flows for nine months ended September 30, 2008 and  2007               |   |
|                     |                                                                                                         |   |
|                     | Notes to the Consolidated Financial Statements                                                               |   |
|                     |                                                                                                         |   |
|                     | Item 2. Management’s Discussion and Analysis of  Financial Conditions and Results of Operations         |   |
|                     |                                                                                                         |   |
|                     | Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                          |   |
|                     |                                                                                                         |   |
|                     | Item 4. Controls and Procedures                                                                              |   |
|                     |                                                                                                         |   |
|  PART II— | OTHER INFORMATION                                                                                            |   |
|                     |                                                                                                         |   |
|                     | Item  1. Legal Proceedings                                                                                   |   |
|                     |                                                                                                         |   |
|                     | Item  1A. Risk Factors                                                                                       |   |
|                     |                                                                                                         |   |
|                     | Item 2. Unregistered Sales of Equity Securities and  Use of Proceeds                                         |   |
|                     |                                                                                                         |   |
|                     | Item 3. Defaults upon Senior Securities                                                                      |   |
|                     |                                                                                                         |   |
|                     | Item 4. Submission of Matters to a Vote of Security  Holders                                                 |   |
|                     |                                                                                                         |   |
|                     | Item  5. Other Information                                                                                   |   |
|                     |                                                                                                         |   |
|                     | Item 6.  Exhibits                                                                                            |   |
|                     |                                                                                                         |   |
|                     | Signatures                                                                                                   |   |

 

2

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Table of Contents

 

**PART I—FINANCIAL INFORMATION**

 

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

 

**Warren Resources, Inc. and SubsidiariesCONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

 
| ** **                                                                                                                                                                                                                                                                                      | ** ** | **September 30,  2008** | ** **      | **December 31,   2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|-----------------|-----------------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                      |       |                    |            |                              |       |
| **ASSETS**                                                                                                                                                                                                                                                                                      |       |                    |            |                              |       |
| Current Assets                                                                                                                                                                                                                                                                                  |       |                    |            |                              |       |
| Cash and cash  equivalents                                                                                                                                                                                                                                                                      |       | $                       | 34,530,979      |                              | $          | 12,815,406 |   |
| Accounts  receivable – trade                                                                                                                                                                                                                                                               |       | 14,449,287              |            | 8,256,199                         |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                                                                           |       | 93,760                  |            | 131,625                           |       |
| Other current  assets                                                                                                                                                                                                                                                                           |       | 937,578                 |            | 1,634,826                         |       |
|                                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
| Total current  assets                                                                                                                                                                                                                                                                           |       | 50,011,604              |            | 22,838,056                        |       |
|                                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
| Other Assets                                                                                                                                                                                                                                                                                    |       |                    |            |                              |       |
| Oil and gas  properties—at cost, based on full cost method of accounting, net of  accumulated depreciation, depletion and amortization (includes unproved  properties excluded from amortization of $73,423,189 and $66,240,101 as of  September 30, 2008 and December 31, 2007) |       | 492,164,621             |            | 406,063,309                       |       |
| Property and  equipment—at cost, net                                                                                                                                                                                                                                                       |       | 2,170,887               |            | 2,422,702                         |       |
| Restricted  investments in U.S. Treasury Bonds—available for sale, at fair value                                                                                                                                                                                                           |       | 843,837                 |            | 1,184,629                         |       |
| Goodwill                                                                                                                                                                                                                                                                                        |       | 3,430,246               |            | 3,430,246                         |       |
| Other assets                                                                                                                                                                                                                                                                                    |       | 3,999,567               |            | 4,566,649                         |       |
|                                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
| Total other  assets                                                                                                                                                                                                                                                                             |       | 502,609,158             |            | 417,667,535                       |       |
| ** **                                                                                                                                                                                                                                                                                      | ** ** | **$**                   | **552,620,762** | ** **                        | **$**      | **440,505,591** | ** ** |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                  |       |                    |            |                              |       |
| Current  Liabilities                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
| Current  maturities of debentures and other long term liabilities                                                                                                                                                                                                                               |       | $                       | 314,460         |                              | $          | 608,038 |   |
| Accounts payable  and accruals                                                                                                                                                                                                                                                                  |       | 48,713,336              |            | 34,343,819                        |       |
|                                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
| Total current  liabilities                                                                                                                                                                                                                                                                      |       | 49,027,796              |            | 34,951,857                        |       |
|                                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
| Long-Term  Liabilities                                                                                                                                                                                                                                                                          |       |                    |            |                              |       |
| Debentures, less  current portion                                                                                                                                                                                                                                                               |       | 1,535,400               |            | 2,232,900                         |       |
| Other long-term  liabilities, less current portion                                                                                                                                                                                                                                              |       | 8,980,522               |            | 7,639,485                         |       |
| Line of credit                                                                                                                                                                                                                                                                                  |       | 97,400,000              |            | 46,152,498                        |       |
|                                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
|                                                                                                                                                                                                                                                                                            |       | 107,915,922             |            | 56,024,883                        |       |
|                                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
| Commitments and  Contingencies                                                                                                                                                                                                                                                                  |       |                    |            |                              |       |
|                                                                                                                                                                                                                                                                                            |       |                    |            |                              |       |
| Stockholders’  Equity                                                                                                                                                                                                                                                                      |       |                    |            |                              |       |
| 8% convertible preferred stock, par value $.0001; authorized 10,000,000  shares,  issued and outstanding, 101,525 shares in 2008  and 224,370 shares in 2007  (aggregate  liquidation preference $1,218,300 in 2008 and $2,692,440 in 2007)                                                     |       | 1,217,545               |            | 2,688,236                         |       |
| Common stock –  $.0001 par value; authorized, 100,000,000 shares; issued 58,825,881 in 2008  and 58,191,901 shares in 2007                                                                                                                                                                 |       | 5,882                   |            | 5,819                             |       |
| Additional  paid-in-capital                                                                                                                                                                                                                                                                     |       | 429,403,778             |            | 424,722,529                       |       |
| Accumulated  deficit                                                                                                                                                                                                                                                                            |       | (34,335,763             | )               | (77,324,451                       | )          |
| Accumulated  other comprehensive income, net of applicable income taxes of $74,000 in 2008  and $108,000 in 2007                                                                                                                                                                                |       | 113,657                 |            | 164,773                           |       |
|                                                                                                                                                                                                                                                                                            |       | 396,405,099             |            | 350,256,906                       |       |
| Less common  stock in Treasury—at cost; 632,250 shares in 2008 and 2007                                                                                                                                                                                                                    |       | 728,055                 |            | 728,055                           |       |
| Total  stockholders’ equity                                                                                                                                                                                                                                                                |       | 395,677,044             |            | 349,528,851                       |       |
| ** **                                                                                                                                                                                                                                                                                      | ** ** | **$**                   | **552,620,762** | ** **                        | **$**      | **440,505,591** | ** ** |

 

The accompanyingnotes are an integral part of these financial statements.

** **

**3**

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**Table ofContents**

** **

**Warren Resources, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF OPERATIONS**

** **
| ** **                                                 | ** ** | **Three Months Ended  September 30, (Unaudited)** | ** ** | **Nine Months Ended  September 30, (Unaudited)** | ** ** |
|------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------------------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2008**                                                              | ** ** | **2007**                                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                                 |       |                                                                  |       |                                                                 |       |   |   |   |   |
| **Revenues**                                               |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Oil and gas  sales                                         |       | $                                                                     | 33,926,169 |                                                                 | $          | 16,765,358 |   | $ | 91,645,684 |   | $ | 39,594,086 |   |
| Interest and  other income                                 |       | 296,536                                                               |       | 460,903                                                              |       | 865,516 |   | 1,882,448 |   |
| Net gain (loss)  on investments                            |       | —                                                                |       | (12,536                                                              | )          | 93,346 |   | (34,806 | ) |
|                                                       |       | 34,222,705                                                            |       | 17,213,725                                                           |       | 92,604,546 |   | 41,441,728 |   |
|                                                       |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Expenses                                                   |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Lease operating  expense and taxes                         |       | 8,303,635                                                             |       | 7,281,518                                                            |       | 20,686,883 |   | 16,462,317 |   |
| Depreciation,  depletion and amortization                  |       | 5,175,487                                                             |       | 3,179,084                                                            |       | 13,601,120 |   | 7,769,387 |   |
| General and  administrative                                |       | 3,639,687                                                             |       | 3,042,822                                                            |       | 11,437,877 |   | 8,674,495 |   |
| Interest                                                   |       | 1,282,975                                                             |       | 630,252                                                              |       | 3,855,978 |   | 1,218,375 |   |
|                                                       |       | 18,401,784                                                            |       | 14,133,676                                                           |       | 49,581,858 |   | 34,124,574 |   |
|                                                       |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Income before  provision for income taxes                  |       | 15,820,921                                                            |       | 3,080,049                                                            |       | 43,022,688 |   | 7,317,154 |   |
|                                                       |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Deferred income  tax expense (benefit)                     |       | (2,000                                                                | )          | (25,000                                                              | )          | 34,000 |   | — |   |
| Net income                                                 |       | 15,822,921                                                            |       | 3,105,049                                                            |       | 42,988,688 |   | 7,317,154 |   |
|                                                       |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Less dividends  and accretion on preferred shares          |       | 22,698                                                                |       | 66,787                                                               |       | 76,550 |   | 200,855 |   |
|                                                       |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Net income  applicable to common stockholders              |       | $                                                                     | 15,800,223 |                                                                 | $          | 3,038,262 |   | $ | 42,912,138 |   | $ | 7,116,299 |   |
|                                                       |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Earnings per  share – Basic                           |       | $                                                                     | 0.27       |                                                                 | $          | 0.05 |   | $ | 0.74 |   | $ | 0.13 |   |
| Earnings per  share – Diluted                         |       | 0.27                                                                  |       | 0.05                                                                 |       | 0.73 |   | 0.13 |   |
|                                                       |       |                                                                  |       |                                                                 |       |   |   |   |   |
| Weighted average  common shares outstanding – Basic   |       | 58,832,654                                                            |       | 57,586,698                                                           |       | 57,935,207 |   | 55,331,505 |   |
| Weighted average  common shares outstanding – Diluted |       | 59,359,482                                                            |       | 58,557,994                                                           |       | 58,660,202 |   | 56,338,604 |   |

 

The accompanyingnotes are an integral part of these financial statements.

** **

**4**

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** **

**Warren Resources, Inc. and Subsidiaries**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                         | ** ** | **For the nine months ended  September 30, (Unaudited)** | ** ** |
|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2008**                                                                               | ** ** | **2007** | ** ** |
| Cash flows from  operating activities:                                             |       |                                                                                   |       |   |   |
| Net income                                                                         |       | $                                                                                      | 42,988,688 |   | $ | 7,317,154 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                                                                   |       |   |   |
| Accretion of  discount on available-for-sale debt securities                       |       | (39,869                                                                                | )          | (47,839 | ) |
| Amortization and  write-off of deferred bond offering costs                        |       | 122,705                                                                                |       | 13,212 |   |
| Gain on sale of  US treasury bonds – available for sale                       |       | (93,346                                                                                | )          | (492 | ) |
| Depreciation,  depletion and amortization                                          |       | 13,601,120                                                                             |       | 7,769,387 |   |
| Stock option  expense                                                              |       | 1,723,857                                                                              |       | 1,065,611 |   |
| Deferred tax  expense                                                              |       | 34,000                                                                                 |       | — |   |
| Change in assets  and liabilities:                                                 |       |                                                                                   |       |   |   |
| Increase in  accounts receivable—trade                                        |       | (6,193,088                                                                             | )          | (2,421,353 | ) |
| Decrease in  accounts receivable from affiliated partnerships                      |       | —                                                                                 |       | 34,890 |   |
| Decrease in  other assets                                                          |       | 1,141,625                                                                              |       | 3,138,887 |   |
| Increase in  accounts payable and accruals                                         |       | 2,221,254                                                                              |       | 817,883 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash  provided by operating activities                                         |       | 55,506,946                                                                             |       | 17,687,340 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Cash flows from  investing activities:                                             |       |                                                                                   |       |   |   |
| Purchase,  exploration and development of oil and gas properties                   |       | (85,375,605                                                                            | )          | (79,227,977 | ) |
| Purchase of  property and equipment                                                |       | (246,181                                                                               | )          | (1,224,463 | ) |
| Proceeds from  U.S. Treasury Bonds—available-for-sale                         |       | 426,757                                                                                |       | 2,605 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash used in  investing activities                                             |       | (85,195,029                                                                            | )          | (80,449,835 | ) |
|                                                                               |       |                                                                                   |       |   |   |
| Cash flows from  financing activities:                                             |       |                                                                                   |       |   |   |
| Proceeds from  line of credit                                                      |       | 51,247,502                                                                             |       | 30,000,000 |   |
| Payments on debt  and debentures                                                   |       | (852,959                                                                               | )          | (75,499 | ) |
| Issuance of  common stock, net                                                     |       | 2,942,496                                                                              |       | 1,047,182 |   |
| Proceeds from  short swing sale of stock                                           |       | 91,509                                                                                 |       | — |   |
| Repurchase of  preferred stock, net                                                |       | (2,024,892                                                                             | )          | — |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net cash  provided by financing activities                                         |       | 51,403,656                                                                             |       | 30,971,683 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Net increase  (decrease) in cash and cash equivalents                              |       | 21,715,573                                                                             |       | (31,790,812 | ) |
|                                                                               |       |                                                                                   |       |   |   |
| Cash and cash  equivalents at beginning of period                                  |       | 12,815,406                                                                             |       | 43,021,884 |   |
|                                                                               |       |                                                                                   |       |   |   |
| Cash and cash  equivalents at end of period                                        |       | $                                                                                      | 34,530,979 |   | $ | 11,231,072 |   |
|                                                                               |       |                                                                                   |       |   |   |   |   |
| Supplemental  disclosure of cash flow information                                  |       |                                                                                   |       |   |   |
| Cash paid for  interest                                                            |       | $                                                                                      | 3,192,148  |   | $ | 683,291 |   |
| Cash paid for  income taxes                                                        |       | —                                                                                 |       | — |   |
| Noncash  investing and financing activities                                        |       |                                                                                   |       |   |   |
| Accrued  preferred stock dividend                                                  |       | $                                                                                      | 73,100     |   | $ | 195,434 |   |
| Common stock  issued on conversion of preferred stock                              |       | —                                                                                 |       | 6,768 |   |
| Common stock  issued for acquisition of property                                   |       | —                                                                                 |       | 51,229,568 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

5

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** **

**WARRENRESOURCES, INC. AND SUBSIDIARIES**

** **

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

** **

**NOTE A—ORGANIZATION**

 

Warren Resources, Inc.(the “Company” or “Warren”), was originally formed on June 12, 1990 forthe purpose of acquiring and developing oil and gas properties. The Company isincorporated under the laws of the state of Maryland. The Company’s propertiesare primarily located in Wyoming, California and New Mexico. In addition, theCompany previously served as the managing general partner (the “MGP”) andturnkey drilling contractor to affiliated partnerships and joint ventures.

 

Theaccompanying unaudited financial statements and related notes present theCompany’s consolidated financial position as of September 30, 2008 and December 31,2007, the consolidated results of operations for the three and nine monthsended September 30, 2008 and 2007 and consolidated cash flows for the ninemonths ended September 30, 2008 and 2007. The unaudited financialstatements have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialinformation and with the instructions of Form 10-Q and Article 10 ofRegulation S-X. Accordingly, they do not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates of America for complete financial statements. In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included. Operatingresults for the nine months ended September 30, 2008, are not necessarilyindicative of the results that may be expected for the fiscal year ending December 31,2008. The accounting policies followed by the Company are set forth in Note Ato the Company’s financial statements included in Form 10-K for the yearended December 31, 2007. These interim financial statements and notesthereto should be read in conjunction with the consolidated financialstatements presented in the Company’s 2007 Annual Report on Form 10-K.

 

##### **NOTE B**—STOCK BASEDCOMPENSATION

 

*Stock Options*

 

Compensation expense related to stock options andrestricted stock awards recognized in operating results (general andadministrative expenses) under Statement of Financial Accounting Standards (“SFAS”)No. 123R was approximately $1.7 million and $1.1 million for the ninemonths ended September 30, 2008 and 2007, respectively.

 

The followingassumptions were used to value stock options calculated using the Black-Scholesoptions pricing model:

 
| ** **               | ** ** | **Nine months ended September 30,** | ** ** |
|--------------------------|------------|---------------------------------------------------------|------------|
| ** **               | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| Dividend yield           |       | 0                                                       | %          | 0 | % |
| Expected  volatility     |       | 48.2                                                    | %          | 43.6 | % |
| Risk-free  interest rate |       | 2.06                                                    | %          | 4.52 | % |
| Fair value of  options   |       | $                                                       | 4.20       |   | $ | 4.00 |   |
| Expected life            |       | 3.5 years                                               |       | 3.5 years |   |
|                          |            |                                                         |            |  |  |  |  |

 

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| ** **                              | ** ** | ** **      | ** ** | **Weighted** | ** ** | **Weighted**         | ** ** | ** **               | ** ** |
|-----------------------------------------|------------|-----------------|------------|--------------|------------|----------------------|------------|--------------------------|------------|
| ** **                              | ** ** | ** **      | ** ** | **Average**  | ** ** | **Average**          | ** ** | **Aggregate**            | ** ** |
| ** **                              | ** ** | **Number**      | ** ** | **Exercise** | ** ** | **Remaining**        | ** ** | **Intrinsic Value** | ** ** |
| ** **                              | ** ** | **of  Options** | ** ** | **Price**    | ** ** | **Term (in  years)** | ** ** | **(in  thousands)**      | ** ** |
| Outstanding at  December 31, 2007  |       | 2,775,750       |       | $            | 8.88       |                 |       |                     |       |   |
| Granted                                 |       | 470,250         |       | 11.30        |       |                 |       |                     |       |
| Exercised                               |       | (614,535        | )          | 4.79         |       |                 |       |                     |       |
| Forfeited or  expired                   |       | (67,416         | )          | 12.59        |       |                 |       |                     |       |
| Outstanding at  September 30, 2008 |       | 2,564,049       |       | $            | 10.20      |                 | 2.40       |                     | $          | 2,082 |   |
|                                    |       |            |       |         |       |                 |       |                     |       |
| Exercisable at  September 30, 2008 |       | 1,579,793       |       | $            | 9.37       |                 | 1.51       |                     | $          | 2,082 |   |

 

Thetotal intrinsic value of options exercised during the nine months ended September 30,2008 and 2007 was $5.2 million and $1.8 million respectively.

 

As of September 30,2008, total unrecognized stock-based compensation expense related to non-vestedstock options was $3.2 million, which we expect to recognize over a weightedaverage period of 1.9 years.

 

*RestrictedShares*

 

Restricted share activityas of September 30, 2008 was as follows:

 
| ** **                              | ** ** | **Shares** | ** ** | **Weighted  Average  Fair Value** | ** ** |
|-----------------------------------------|------------|------------|------------|----------------------------------------|------------|
| ** **                              | ** ** | ** ** | ** ** | ** **                             | ** ** |
| Outstanding at  December 31, 2007  |       | 58,330     |       | $                                      | 10.51      |   |
| Granted                                 |       | 112,857    |       | 11.15                                  |       |
| Vested                                  |       | (19,445    | )          | 10.51                                  |       |
| Forfeited                               |       | —     |       | —                                 |       |
| Outstanding at  September 30, 2008 |       | 151,742    |       | $                                      | 10.99      |   |

 

Restricted stock awardsfor executive officers and employees vest ratably over three years. Fair valueof our restricted shares is based on our closing stock price on the date ofgrant.  As of September 30, 2008, total unrecognized stock-basedcompensation expense related to non-vested restricted shares was $1.3 million,which is expected to be recognized over a weighted average period ofapproximately 2.2 years.

 

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

 

During the nine monthsended September 30, 2008, the Company redeemed 122,845 shares ofconvertible preferred stock for a price of $12 per share, plus accrued dividendsof $1.44 per share, which represents the accrued dividend for 2006 and 2007. Asof September 30, 2008, 101,525 shares of convertible preferred stockremain outstanding.  Preferred dividendsof approximately $227,000 were accrued at September 30, 2008.

 

The preferred stock paysan 8% cumulative dividend which is treated as a deduction of 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 one share of preferred stock for 0.50 shares of commonstock.

 

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 theamount equal to the Redemption Price or (2) issue to the holder shares ofcommon stock in an amount equal to 125% of the redemption price and any accruedand unpaid dividends, based on the weighted average closing “bid” price of theCompany’s common stock for the thirty trading days immediately preceding thedate of the written redemption election by the holder up to a maximum of 1.5shares of common stock for each one share of preferred stock redeemed. TheCompany is accreting the carrying value of its preferred stock to itsredemption price using the effective interest 

 

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

 

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

 

Duringthe nine months ended September 30, 2008, employees and directorsexercised a total of 614,535 options at exercise prices between $4 and $10.51per share. The Company received proceeds of approximately $2.9 million fromthese exercises. We issue new shares of common stock to settle optionexercises.

 

**NOTE D—INCOME PER SHARE**

 

Basic income per share iscomputed by dividing net income applicable to common stockholders by theweighted average number of shares of common stock outstanding during theperiod. Diluted income per share is based on the assumption that stock optionsand warrants are converted into common shares using the treasury stock methodand convertible bonds and preferred stock are converted using the if-convertedmethod. Conversion is not assumed if the results are anti-dilutive.  Potential common shares for the nine monthsended September 30, 2008 and September 30, 2007 of 48,743 and 206,889respectively, relating to convertible bonds and preferred stock, were excludedfrom the computation of diluted income per share because they areanti-dilutive. Potential common shares of 2,875,526 and 2,357,365 respectively,relating to stock options, warrants and restricted stock were excluded from thecomputation of diluted income per share for the nine months ended September 30,2008 and 2007, respectively, because they are anti-dilutive. Stock options havea weighted average exercise price of $10.20 and $8.81 at September 30,2008 and September 30, 2007, respectively. At September 30, 2008, theconvertible bonds may be converted from the date of issuance until maturity at100% of principal amount into common stock of the Company at a price of $35 to$50.  The preferred stock may beconverted at the discretion of the holder or upon meeting certain conditions atthe discretion of the Company (see Note C).

 

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

 
| ** **                                            | ** ** | **Three Months  Ended  September 30,  2008** | ** ** | **Three Months  Ended  September 30,  2007** | ** ** | **Nine Months  Ended  September 30,  2008** | ** ** | **Nine Months  Ended  September 30,  2007** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|-------------------------------------------------------|------------|-------------------------------------------------------|------------|
|                                                  |       |                                                   |       |                                                   |       |                                                  |       |                                                  |       |
| Net income  available to shareholders                 |       | $                                                      | 15,800,223 |                                                   | $          | 3,038,262                                             |       | $                                                     | 42,912,138 |   | $ | 7,116,299 |   |
|                                                  |       |                                                   |       |                                                   |       |                                                  |       |                                                  |       |
| Weighted average  shares outstanding - basic          |       | 58,832,654                                             |       | 57,586,698                                             |       | 57,935,207                                            |       | 55,331,505                                            |       |
| Effect of  dilutive securities – stock options   |       | 312,834                                                |       | 730,571                                                |       | 389,673                                               |       | 260,396                                               |       |
| Effect of  dilutive securities – preferred stock |       | 50,763                                                 |       | —                                                 |       | 50,763                                                |       | —                                                |       |
| Effect of  dilutive securities – warrants        |       | 163,231                                                |       | 240,725                                                |       | 284,559                                               |       | 746,703                                               |       |
|                                                  |       |                                                   |       |                                                   |       |                                                  |       |                                                  |       |
| Weighted average  shares outstanding - diluted        |       | 59,359,482                                             |       | 58,557,994                                             |       | 58,660,202                                            |       | 56,338,604                                            |       |
|                                                  |       |                                                   |       |                                                   |       |                                                  |       |                                                  |       |
| Basic net income  per share                           |       | $                                                      | 0.27       |                                                   | $          | 0.05                                                  |       | $                                                     | 0.74       |   | $ | 0.13 |   |
| Diluted net  income per share                         |       | $                                                      | 0.27       |                                                   | $          | 0.05                                                  |       | $                                                     | 0.73       |   | $ | 0.13 |   |

 

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**NOTE E—LONG-TERM LIABILITIES**

 

Long-termliabilities consisted of the following for the balance sheets dated:

 
| ** **                             | ** ** | **September 30,  2008** | ** **  | **December 31,  2007** | ** ** |
|----------------------------------------|------------|------------------------------|-------------|-----------------------------|------------|
|                                   |       |                         |        |                        |       |
| Line of credit                         |       | $                            | 97,400,000  |                        | $          | 46,152,498 |   |
| Debentures                             |       | 1,706,000                    |        | 2,481,000                   |       |
| Debt  collateralized by treasury stock |       | 516,827                      |        | 594,786                     |       |
| Asset retirement  obligations          |       | 6,784,399                    |        | 5,581,481                   |       |
| Litigation  provision                  |       | 1,823,156                    |        | 1,823,156                   |       |
|                                   |       |                         |        |                        |       |
|                                   |       | 108,230,382                  |        | 56,632,921                  |       |
| Less current  portion                  |       | 314,460                      |        | 608,038                     |       |
|                                   |       |                         |        |                        |       |
| Long-term  portion                     |       | $                            | 107,915,922 |                        | $          | 56,024,883 |   |

#### ** **

On November 19,2007, the Company entered into a five year, $250 million credit agreement withMerrill Lynch Capital (now owned by GE Capital Corporation). The CreditFacility provides for a revolving credit line up to the lesser of (i) theborrowing base, (ii) $250 million or (iii) the draw limit requestedby the Company. The Credit Facility matures on November 19, 2012. It issecured by substantially all of our assets. The borrowing base will bedetermined by the lenders at least semi-annually on each April 1 and October 1and is based in part on the proved reserves of the Company. The currentborrowing base is $120 million with an over-advance of $15 million,representing an immediate availability of $135 million. Interest payments aremade quarterly in arrears. During the first three quarters of 2008 the Companydrew down approximately $51 million under this facility, leaving $37.6 millionof available credit. Credit line interest of approximately $0.6 million wasaccrued for as of September 30, 2008.

 

The Company is subject tocertain covenants under the terms of the Credit Facility which include, but arenot limited to the maintenance of the following financial ratios (1) minimumcurrent ratio of current assets (including unused borrowing base in currentassets) to current liabilities of 1.0 to 1.0 and (2) a minimum annualizedconsolidated EBITDAX (as defined by the Credit Facility) to net interestexpense to of 2.5 to 1.0.  As of September 30,2008, the Company has borrowed $97.4 million under the Credit Facility and wasin compliance with all covenants.

 

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

 

Theconvertible bonds may be converted from the date of issuance until maturity at100% of principal amount into common stock of the Company at prices rangingfrom $35 to $50. Each year the holders of the convertible bonds may tender tothe Company up to 10% of the aggregate bonds issued and outstanding. During thethree months ended March 31, 2008, the Company offered bond holders apremium of 33% to tender their bonds. This offer resulted in the redemption ofbonds having a face value of $775,000. The early redemption expense resultingfrom this redemption was $256,000 and is reflected in interest expense.

#### ** **

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#### **NOTE F—CONTINGENCIES**

 

*Stateof California v. Warren E&P, Inc., et al.*    On January 30,2008, the Los Angeles city attorney filed a complaint against Warren E&P, Inc.,a subsidiary of the Company, and six of its individual employees andindependent contractors in the Superior Court of California, County of LosAngeles. The complaint alleges eight misdemeanor violations concerning fouralleged events in Wilmington, California during 2007. The complaint asserts onecount of failing to report the discharge or threatened discharge of oil intomarine waters for an event occurring on or about March 7, 2007; one countof failing to prepare and implement an oil spill contingency plan; four countsof violating the California Fish and Game Code by placing petroleum or itsby-products in or at a place where they can pass into waters of the state; andtwo similar violations of the California Clean Water Act. The complaint allegesall eight counts against Warren E&P, Inc. and one to four countsagainst each of the individuals. An amended complaint was served on October 30,2008, which added one additional misdemeanor count for alleged failure toreport a release or threatened release to the certain state agencies.  Warren E&P and the various separatedefendants filed Demurrers on November 3, 2008, seeking to dismiss thecomplaints for failure to state a claim on which relief can be granted and/orfor a more definite statement. No arraignment before the Superior Court hasoccurred.

 

Warren believes theactions by the city attorney are unwarranted. Contrary to the claims made inthe complaint, Warren follows an existing regulatory-approved contingency plan,which is maintained on site at the Wilmington Townlot Unit (“WTU”) and NorthWilmington Unit (“NWU”). With respect to the alleged event on March 7,2007 at the NWU, substantially all of the oil was captured within a surroundingconcrete retainer wall and pumped to a nearby NWU oil storage tank and sold inthe ordinary course of business. None of the alleged events occurred at the WTUcentral facility.

 

Our Company policy is tofollow the law of the jurisdiction in which we operate and to comply withenvironmental protection principles. In connection with these alleged events,we believe we have followed and complied with applicable laws and regulations.We believe once we are given an opportunity to present the facts regardingthese alleged events, the outcome will be favorable to our Company, ouremployees and our independent contractors. Conversely, we do not believe anunfavorable outcome will have a material adverse effect on our business,financial condition or results of operation.

 

In 2005, Warren recordeda provision for $1.8 million relating to a contingent liability that we mayface as a result of a lawsuit originally filed in 1998 by Gotham InsuranceCompany in the 81st Judicial District Court of Frio County, Texas seekinga refund of approximately $1.8 million paid by Gotham and other insurersunder an insurance policy issued for a well blow-out that occurred in 1997.After several appeals to the Texas Court of Appeals and the Texas SupremeCourt, the case has been remanded to the trial court for further proceedings.Both parties have filed Motions for Summary Judgment before the trial courtthat are expected to be heard in the fourth quarter of 2008.

 

Except for the foregoing,we are not a party to any material pending legal or governmental proceedings,other than ordinary routine litigation incidental to our business. While theultimate outcome and impact of any proceeding cannot be predicted withcertainty, our management believes that the resolution of any proceeding willnot have a material adverse effect on our financial condition or results ofoperations.

 

**NOTE G—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:

 
| ** **                              | ** ** | **2008** | ** ** | **2007** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |
| Nine Months  ending September 30,  |       | $        | 42,937,572 |     | $          | 7,317,199 |   |
|                                    |       |     |       |     |       |
| Three Months  ending September 30, |       | $        | 15,827,548 |     | $          | 3,143,429 |   |

 

 

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**NOTE H –RECENTLY ISSUED ACCOUNTING STANDARDS**

 

Effective January 1,2008, we implemented Financial Accounting Standards Board(FASB) SFAS No. 157, “Fair Value Measurements,” which definesfair value, establishes a framework for its measurement and expands disclosuresabout fair value measurements. We elected to implement this Statement with theone-year deferral permitted by FASB Staff Position (FSP) 157-2 for nonfinancialassets and nonfinancial liabilities measured at fair value, except those thatare recognized or disclosed on a recurring basis (at least annually). Thedeferral applies to nonfinancial assets and liabilities measured at fair valuein a business combination; impaired properties, plant and equipment; intangibleassets and goodwill; and initial recognition of asset retirement obligationsand restructuring costs for which we use fair value. We do not expect anysignificant impact to our consolidated financial statements when we implementSFAS No. 157 for these assets and liabilities.

 

In February 2007,the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assetsand Financial Liabilities—Including an amendment of FASB Statement No. 115.”This Statement permits the election to carry financial instruments and certainother items similar to financial instruments at fair value on the balancesheet, with all changes in fair value reported in earnings. By electing thefair value option in conjunction with a derivative, an entity can achieve anaccounting result similar to a fair value hedge without having to comply withcomplex hedge accounting rules. We adopted this Statement effective January 1,2008. During the first quarter of 2008, we did not make the fair value electionfor any financial instruments not already carried at fair value in accordancewith other accounting standards, so the adoption of SFAS No. 159 did notimpact our consolidated financial statements.

 

The FASB revised SFAS No. 141(Revised 2007) “Business Combinations” (SFAS 141R) in 2007. The revisionbroadens the application of SFAS 141 to cover all transactions and events inwhich an entity obtains control over one or more other businesses. ThisStatement applies prospectively to business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008. An entity may not apply itbefore that date. Warren does not expect that the adoption of this Standardwill have an impact on the financial statements.

 

In December 2007,the FASB issued SFAS No. 160 “Noncontrolling Interest in ConsolidatedFinancial Statements — an Amendment of ARB 51” (SFAS 160). SFAS 160 clarifiesthat a noncontrolling interest in a subsidiary is an ownership interest in theconsolidated entity that should be reported as equity in the consolidatedfinancial statements. It also requires consolidated net income to be reportedat amounts that include the amounts attributable to both the parent and thenoncontrolling interest, and requires disclosure, on the face of theconsolidated statement of income, of the amounts of consolidated net incomeattributable to the parent and to the noncontrolling interest. SFAS 160 iseffective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008. Earlier adoption is prohibited.Warren does not expect that the adoption of this Standard will have an impacton the financial statements.

 

In March 2008, theFASB issued SFAS No. 161 “Disclosures about Derivative Instruments andHedging Activities — An Amendment of FASB Statement No. 133” (SFAS 161),that requires new and expanded disclosures regarding hedging activities. Thesedisclosures include, but are not limited to, a proscribed tabular presentationof derivative data; financial statement presentation of fair values on a grossbasis, including those that currently qualify for netting under FASBInterpretation No. 39; and specific footnote narrative regarding how andwhy derivatives are used. The disclosures are required in all interim andannual reports. SFAS 161 is effective for fiscal and interim periods beginningafter November 15, 2008. Warren does not expect that the adoption of thisStandard will have an impact on the financial statements.

 

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In May 2008, theFASB issued SFAS No. 162 “The Hierarchy of Generally AcceptedAccounting Principles,” which has been established by the FASB as a frameworkfor entities to identify the sources of accounting principles and for selectingthe principles to be used in the preparation of financial statements ofnongovernmental entities that are presented in conformity with US GAAP.SFAS No. 162 is effective 60 days following the Securities andExchange Commission’s (“SEC”) approval of the Public Company AccountingOversight Board’s (“PCAOB”) amendments to AU Section 411, “The Meaning ofPresent Fairly in Conformity With Generally Accepted Accounting Principles.”Accordingly, the Company will adopt SFAS No. 162 within the requiredperiod. Warren does not expect that the adoption of this Standard will have animpact on the financial statements.

 

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

 

**FORWARD-LOOKINGINFORMATION**

 

*TheCompany has made in this report, and may from time to time otherwise make inother public filings, press releases and discussions with Company management,forward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934 concerning the Company’s operations, economic performance and financialcondition. These forward-looking statements include information concerningfuture production and reserves, schedules, plans, timing of development,contributions from oil and gas properties, and those statements preceded by,followed by or that otherwise include the words “believes,” “expects,” “anticipates,”“intends,” “estimates,” “projects,” “target,” “goal,” “plans,” “objective,” “should”or similar expressions or variations on such expressions. For such statements,the Company claims the protection of the safe harbor for forward-lookingstatements contained in the Private Securities Litigation Reform Act of 1995.Although the Company believes that the expectations reflected in suchforward-looking statements are reasonable, it can give no assurance that suchexpectations will prove to have been correct. Important factors that couldcause actual results to differ materially from the Company’s expectationsinclude, but are not limited to, the Company’s assumptions about energymarkets, production levels, reserve levels, operating results, competitiveconditions, technology, the availability of capital resources, capitalexpenditures and other contractual obligations, the supply and demand for andthe price of oil, natural gas and other products or services, the weather,inflation, the availability of goods and services, drilling risks, futureprocessing volumes and pipeline throughput, general economic conditions, eitherinternationally or nationally or in the jurisdictions in which the Company orits subsidiaries are doing business, legislative or regulatory changes,including changes in environmental regulation, environmental risks andliability under federal, state and foreign environmental laws and regulations,potential environmental obligations, the securities or capital markets, ourability to repay debt and other factors discussed in “Risk Factors” and in “Management’sDiscussion and Analysis of Financial Condition and Results of Operations”included in the Company’s 2007 Annual Report on Form 10-K, this Form 10-Qand in the Company’s other public filings, press releases and discussions withCompany management. Warren undertakes no obligation to publicly update orrevise any forward-looking statements.*

 

**Overview**

 

We are a growingindependent energy company engaged in the exploration and development ofdomestic onshore oil and natural gas reserves. We focus our efforts primarilyon our waterflood oil recovery programs and horizontal drilling in theWilmington field within the Los Angeles Basin of California and on theexploration and development of coalbed methane (“CBM”) properties located inthe Rocky Mountain region. As of September 30, 2008, we owned natural gasand oil leasehold interests in approximately 228,000 gross, 126,272 net acres,approximately 85% of which are undeveloped. Substantially all our undevelopedacreage is located in the Rocky Mountains.

 

**Liquidityand Capital Resources**

 

Our cash and cashequivalents increased $21.7 million during the first nine months of 2008. Thisresulted from cash provided by financing activities of $51.4 million and cashprovided by operating activities of $55.5 million.  This 

 

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was partially offset bycash used in investing activities of $85.2 million.  During the first nine months of 2008, theCompany had net income of $42.9 million as compared to net income of $7.1million for the first nine months of 2007.

 

Cash used in investingactivities primarily results from expenditures on oil and gas properties andequipment.  Cash provided by operatingactivities primarily relates to oil and gas operations.  Cash provided by financing activitiesprimarily results from proceeds received from our Credit Facility as discussedin more detail below and from the exercise of stock options and warrants.

 

On October 13, 2008,Warren announced that in response to the recent steep decline in oil and gasprices combined with the ongoing credit market crisis, the Company intends toreduce its capital expenditure program for the remainder of 2008 and thebeginning of 2009.  The capital 2008expenditure budget was reduced by $18 million. As of September 30, 2008, current assets exceeded currentliabilities by approximately $1 million. Additionally, the Company had $37 million available in its creditfacility as discussed below.  For theforeseeable future, the Company intends to keep capital expenditures in linewith forecasted cash flow from operations.

 

During 2009, Warren isexpecting additional production from 30 Sun Dog wells which were drilled in ourAtlantic Rim project during the third and fourth quarters of 2008.  Additionally, the Company is expecting increasedproduction during 2009 from our Wilmington Townlot Unit (WTU) in southernCalifornia.  Currently, WTU production iscapped to due gas flaring issues with the South Coast Air Quality ManagementDistrict in California.  Once theseissues are resolved, the Company will be able to increase oil production inthis field.

 

During November 2007,Warren entered into a five year, $250 million credit agreement with MerrillLynch Capital (now owned by GE Capital Corporation) on behalf of a syndicate offive participating banks (the “Credit Facility”).   The Credit Facility provides for a revolvingcredit facility up to the lesser of (i) the borrowing base (ii) $250million or (iii) the draw limit requested by the Company.  The Credit Facility matures on November 19,2012.  It is secured by substantially allof our assets.  The borrowing base willbe determined by the lenders at least semi-annually on or about April 1and October 1 of each year, and is based in part on the proved reserves ofthe Company. Interest payments are made quarterly in arrears.  The current borrowing base is $120 millionwith an overadvance of $15 million, representing an immediate availability of$135 million. The Company is subject to certain covenants under the terms ofthe Credit Facility which include, but are not limited to the maintenance ofthe following financial ratios (1) minimum current ratio (including unusedborrowing base in current assets) of 1.0 to 1.0 and (2) a minimumannualized consolidated EBITDAX (as defined by the Credit Facility) to netinterest expense to of 2.5 to 1.0.  As ofSeptember 30, 2008, the Company has borrowed $97.4 million under theCredit Facility and was in compliance with all covenants.

 

Depending on the currentlevel of borrowing base usage, the annual interest rate on each base rateborrowing under the Credit Facility will be at our option either: (a) thehigher of (i) the Agent’s prime rate of interest announced from time totime, or (ii) the Federal Funds rate most recently determined by theAgent, plus 0.5% per annum, plus an applicable margin that ranges from 0.25% to1.0%, or (b) Eurodollar Loan rate plus an applicable margin that rangesfrom 1.25% to 2.0%. Credit line interest of approximately $0.6 million wasaccrued for as of September 30, 2008.

 

At September 30, 2008,we had approximately 1.6 million vested outstanding stock options issued underour stock based equity compensation plans. Of the total 1.6 million outstandingvested options, 436 thousand options had exercise prices above the closingmarket price $9.98 of our common stock on September 30, 2008. If theoptions with exercise prices below the closing market price on September 30,2008 are exercised by the holders, we would receive $9.3 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 parvalue of the bonds maturing on or before the maturity of the bonds. Such U.S.treasury bonds had a fair market value of $0.9 

 

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million at September 30,2008.  The table below does not reflectthe release of escrowed U.S. treasury bonds to us upon redemption.

 
| ** **                                                                     | ** ** | **Payments due by period** | ** **  |
|--------------------------------------------------------------------------------|------------|-------------------------------------------|-------------|
| **Contractual Obligations  As of September 30, 2008** | ** ** | **Total**                                 | ** **  | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More Than  5 Years** | ** ** |
|                                                                           |       |                                      |        |   |   |   |   |   |   |   |   |
| Line of credit                                                                 |       | $                                         | 97,400,000  |   | — |   | — |   | $ | 97,400,000 |   | — |   |
| Bonds                                                                          |       | 1,706,000                                 |        | 170,600 |   | 291,726 |   | 236,298 |   | 1,007,376 |   |
| Drilling  commitments                                                          |       | 1,251,580                                 |        | 1,251,580 |   | — |   | — |   | — |   |
| Leases                                                                         |       | 3,267,107                                 |        | 647,768 |   | 1,280,419 |   | 1,008,881 |   | 330,039 |   |
| Total                                                                          |       | $                                         | 103,624,687 |   | $ | 2,069,948 |   | $ | 1,572,145 |   | $ | 98,645,179 |   | $ | 1,337,415 |   |
|                                                                                |            |                                           |             |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**RESULTS OF OPERATIONS:**

 

**Three months Ended September 30, 2008 Compared toThree Months Ended September 30, 2007**

 

*Oil and gas sales.*Revenue from oil and gas sales increased $17.2 million in the third quarter of2008 to $33.9 million, a 102% increase compared to the same quarter in2007.  This increase resulted fromincreased production resulting from our drilling activity in southernCalifornia and in the Atlantic Rim Project in Wyoming and higher pricing.  Net oil production for the three months endedSeptember 30, 2008 and 2007 was 263 Mbbls and 226 Mbbls,respectively.  Net gas production for thethree months ended September 30, 2008 and 2007 was 906 Mmcf and 396 Mmcf,respectively.  The average realized priceper barrel of oil for the three months ended September 30, 2008 and 2007was $106.82 and $66.75, respectively. Additionally, the average realized price per Mcf of gas for the threemonths ended September 30, 2008 and 2007 was $6.42 and $4.22,respectively.

 

*Lease operating expense.*Lease operating expense for the third quarter increased 14% to $8.3 million($3.34 per Mcfe) compared to $7.3 million ($4.15 per Mcfe) in the third quarterof 2007. Primarily, this increase resulted from an increase in production.  Total production increased to 2.5 Bcfe forthe third quarter of 2008 compared to 1.8 Bcfe for the third quarter of 2007,an increase of 42%.

 

*Interest and other income.*Interest and other income decreased $0.2 million in the third quarter of 2008to $0.3 million, a 36% decrease compared to the same quarter in 2007. Thisrepresents a decrease in interest earned due to lower cash and cash equivalentsbalances and lower interest rates during the quarter as compared to thecorresponding quarter last year.

 

*Depreciation, depletion andamortization .*Depreciation, depletion and amortizationexpense increased $2.0 million for the third quarter of 2008 to $5.2 million, a63% increase compared to the corresponding quarter last year. This increaseresults from increased production and increased capitalized costs during thethird quarter of 2008 compared to the corresponding period of 2007.  Production increased 42% during this period.

 

*General and administrativeexpenses.* General and administrative expenses increased $0.6million in the third quarter of 2008 to $3.6 million, a 20% increase comparedto the corresponding quarter last year. This reflects an increase in personnel as a result of increased drillingactivities.  Also, this reflects anincrease in stock option expense of $0.2 million.

 

*Interest expense.*Interest expense increased $0.7 million in the third quarter of 2008 to $1.3million compared to the same quarter last year. The increase results from interest expense relating to the drawdownunder our Credit Facility.

 

**Nine months Ended September 30, 2008 Compared toNine Months Ended September 30, 2007**

 

*Oil and gas sales.*Revenue from oil and gas sales increased $52.1 million in the first threequarters of 2008 to $91.6 million, a 131% increase compared to the same periodin 2007.  This increase resulted fromincreased production 

 

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resulting from ourdrilling activity in southern California and in the Atlantic Rim Project inWyoming and higher pricing.  Net oilproduction for the nine months ended September 30, 2008 and 2007 was 759Mbbls and 599 Mbbls, respectively.  Netgas production for the nine months ended September 30, 2008 and 2007 was2.0 Bcf and 0.9 Bcf, respectively.  Theaverage realized price per barrel of oil for the nine months ended September 30,2008 and 2007 was $101.68 and $59.05, respectively.  Additionally, the average realized price perMcf of gas for the nine months ended September 30, 2008 and 2007 was $7.38and $4.92, respectively.

 

*Lease operating expense.*Lease operating expense for the first the nine months of 2008 increased 26% to$20.7 million ($3.17 per Mcfe) compared to $16.5 million ($3.70 per Mcfe) inthe first nine months of 2007. Primarily, this increase resulted from anincrease in production.  Total productionincreased to 6.5 Bcfe for the nine months ended September 30, 2008compared to 4.5 Bcfe for the same period of 2007, an increase of 46%.

 

*Interest and other income.*Interest and other income decreased $1.0 million during the nine months ended September 30,2008 to $0.9 million, a 54% decrease compared to the same period in 2007. Thisrepresents a decrease in interest earned due to lower cash and cash equivalentsbalances at September 30 and lower interest rates during the first threequarters of 2008 as compared to the corresponding period last year.

 

*Depreciation, depletion andamortization .*Depreciation, depletion and amortizationexpense increased $5.8 million for the first three quarters of 2008 to $13.6million, a 75% increase compared to the corresponding period last year. Thisincrease results from increased production and increased capitalized costsduring the nine months ended September 30, 2008 compared to thecorresponding period of 2007.  Productionincreased 46% during this period.

 

*General and administrativeexpenses.* General and administrative expenses increased $2.8million in the first three quarter of 2008 to $11.4 million, a 32% increasecompared to the corresponding period last year. This reflects an increase in personnel as a result of increased drillingactivities.  Also, this reflects anannual bonus accrual of $0.8 million and an increase in stock option expense of$0.6 million.

 

*Interest expense.*Interest expense increased $2.6 million in the first three quarters of 2008 to$3.9 million compared to the same period last year.  The increase results from interest expenserelating to the drawdown under our Credit Facility.

 

**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 2007 Form 10-K includes a discussion of our critical accountingpolicies.

 

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

***Energy PriceRisk***

 

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

 

***Commodity Risk***

 

In 2007 we entered into afinancial derivative put contract to hedge our exposure to commodity price riskassociated with anticipated future crude oil production. Currently, we haveused floor price put agreements to hedge approximately 700 barrels per day(Bbl/d) of crude oil. We believe we will have more predictability of our crudeoil revenues as a result of these financial derivative contracts.

 

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The following tablesummarizes our open financial derivative positions as of September 30,2008 related to crude oil production.

 
| **Product ** | ** ** | **Type ** | ** ** | **Remaining  Contract Period ** | ** ** | **Volume ** | ** ** | **Price per  Mcf or Bbl ** | ** ** | **Fair Value ** | ** ** |
|-------------------|------------|----------------|------------|-------------------------------------------|------------|------------------|------------|------------------------------------------------|------------|---------------------------|------------|
| Oil               |       | Put            |       | Oct. 2008-Dec. 2008             |       | 700 Bbl/d        |       | $                                              | 70.00      |                      | $          | 19,628 |   |
|                   |            |                |            |                                           |            |                  |            |                                                |            |                           |            |  |  |

 

The Company has notelected to designate the aforementioned derivative as a hedge. The change infair value resulted in approximately $119,000 of net losses recorded to oil andgas revenue for the nine months ended September 30, 2008. Our remaininganticipated production for 2008 and beyond is subject to commodity pricefluctuations.

 

***Interest Rate Risk***

** **

**We have exposure to changes in interest rates from ourfloating rate debt under our Credit Facility with GE Capital Corporation. Allof our convertible debt has fixed interest rates, so consequently we are notexposed to cash flow risk from market interest rate changes on this convertibledebt. 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 rate increases.**

 

***Financial Instruments***

 

Our financial instrumentsconsist of cash and cash equivalents, U.S. treasury bonds and other long-termliabilities. The carrying amounts of cash and cash equivalents, U.S. treasurybonds and other long-term liabilities, approximate fair market value due to thehighly liquid nature of these short-term instruments or they are reported atfair value.

*** ***

***Inflation and Changes in Prices***

 

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

 

***Forward-LookingStatements and Risk***

 

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

 

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of operations andfinancial position appear in Part 1, Item 1A “Risk Factors” of Warren’s2007 Annual Report on Form 10-K.

 

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

 

#### **Item 4. **Controls and Procedures

 

***Evaluation ofDisclosure Controls and Procedures***

 

Our management,under the supervision and with the participation of our Chief Executive Officer(“CEO”) and Chief Financial Officer (“CFO”), has evaluated the effectiveness ofour disclosure controls and procedures as defined in Securities and ExchangeCommission (“SEC”) Rule 13a-15(e) and 15d-15(e) as of the end ofthe period covered by this report.  Basedupon that evaluation, management  hasconcluded that our  disclosure  controls and  procedures  are effective to ensure  thatinformation  we are required to disclosein reports that we file or submit under the Securities Exchange Act iscommunicated to management, including the CEO and CFO, as appropriate to allowtimely decisions  regarding requireddisclosure and is  recorded,  processed, summarized  and  reported within the time periods specified in the SEC’s rules and forms.

 

***Changes inInternal Control over Financial Reporting***

 

There have been nochanges in our internal controls over financial reporting or in other factorsduring the quarter ended September 30, 2008, that have materiallyaffected, or are reasonably likely to materially affect, the Company’s internalcontrol over financial reporting.

## ** **

## **PART II—OTHERINFORMATION**

 

**Item 1. *Legal Proceedings***

 

*Stateof California v. Warren E&P, Inc., et al.*    OnJanuary 30, 2008, the Los Angeles city attorney filed a complaint againstWarren E&P, Inc., a subsidiary of the Company, and six of itsindividual employees and independent contractors in the Superior Court ofCalifornia, County of Los Angeles. The complaint alleges eight misdemeanorviolations concerning four alleged events in Wilmington, California during2007. The complaint asserts one count of failing to report the discharge orthreatened discharge of oil into marine waters for an event occurring on orabout March 7, 2007; one count of failing to prepare and implement an oilspill contingency plan; four counts of violating the California Fish and GameCode by placing petroleum or its by-products in or at a place where they canpass into waters of the state; and two similar violations of the CaliforniaClean Water Act. The January 30, 2008 complaint alleges all eight countsagainst Warren E&P, Inc. and one to four counts against each of theindividuals. An amended complaint was served on October 30, 2008, whichadded one additional misdemeanor count for alleged failure to report a releaseor threatened release to the certain state agencies.  No arraignment or subsequent proceedingsbefore the Superior Court have occurred.

 

Warren believes theactions by the city attorney are unwarranted. Contrary to the claims made inthe complaint, Warren follows an existing regulatory-approved contingency plan,which is maintained on site at the WTU and NWU. With respect to the allegedevent on March 7, 2007 at the NWU, substantially all of the oil wascaptured within a surrounding concrete retainer wall and pumped to a nearby NWUoil storage tank and sold in the ordinary course of business. None of thealleged events occurred at the WTU central facility.

 

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Our Company policy is tofollow the law of the jurisdiction in which we operate and to comply withenvironmental protection principles. In connection with these alleged events,we believe we have followed and complied with applicable laws and regulations.We believe that we are given an opportunity to present the facts regardingthese alleged events, the outcome will be favorable to our Company, ouremployees and our independent contractors. Conversely, we do not believe anunfavorable outcome will have a material adverse effect on our business,financial condition or results of operation.

 

Except for the foregoing,we are not a party to any material pending legal or governmental proceedings,other than ordinary routine litigation incidental to our business. While theultimate outcome and impact of any proceeding cannot be predicted with certainty,our management believes that the resolution of any proceeding will not have amaterial adverse effect on our financial condition or results of operations.

 

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

 

Our business has manyrisks. Factors that could materially adversely affect our business, financialcondition, operating results or liquidity and the trading price of our commonstock are described under “Risk Factors” in Item 1A of our annual reporton Form 10-K for the year ended December 31, 2007 and also disclosurein our “Management’s Discussion and Analysis of Financial Condition and Resultsof Operations” in Item 2 above. This information should be consideredcarefully, together with other information in this report, our press releasesand other reports and materials we file with the Securities and ExchangeCommission. Additional risks and uncertainties not currently known to us orthat we currently deem to be immaterial also may materially adversely affectour business, financial condition and/or operating results. All of thereferenced Risk Factors remain applicable with certain risk factors beingupdated by the following:

 

## ***We are highly dependent on oil and gas commodityprices***

 

Our revenues,profitability and future growth depend substantially on prevailing prices for oiland gas and on our ability to find, develop and acquire oil and gas reservesthat are economically recoverable. The preparation of our financial statementsin conformity with generally accepted accounting principles requires us to makeestimates and assumptions that affect our reported results of operations andthe amount of our reported assets, liabilities and proved oil and gas reserves.

 

Pricesfor oil and gas fluctuate widely. Oil and gas prices directly affect:

 

·**      **the amount of cash flowavailable for capital expenditures;

 

·**      **Our ability to borrowand raise additional capital;

 

·**      **the quantity of oil andgas that we can economically produce; and

 

·**      **the accounting for ouroil and gas activities.

 

The risk that we will berequired to writedown the carrying value of our oil and gas propertiesincreases when oil and gas prices decrease.  We did not have aceiling test writedown at September 30, 2008.  Holding all otherfactors constant, if the applicable index for oil and gas prices were to dropto levels below the current levels, it is possible that we could experience aceiling test writedown of our oil and gas properties at December 31,2008.  In addition, given current market conditions it is reasonablypossible that some or all of our goodwill could be impaired in the future.

 

***Lowcommodity prices may adversely impact the Company’s ability to maintainadequate liquidity.***

 

All of our revenues arederived from the sale of our oil and gas production. While the Company’s cashflows from operations and its available capital from the capital markets andthe Amended Credit Facility have been sufficient to meet its current operatingexpenses, capital expenditures, drilling obligations and debt servicerequirements to date, the Company’s future liquidity could be negativelyimpacted by many factors including, but not limited to, continued substantialdecreases in the price of crude oil and natural gas from earlier 2008 levels. TheNYMEX crude oil spot price declined from to a record high of approximately $145per barrel in

 

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July 2008 toapproximately $63 per barrel on October 27, 2008. Current crude oil pricesare significantly lower than prices in 2007 and earlier 2008. Based on crudeand natural gas prices at recent levels, the Company’s oil and gas revenues areexpected to decrease in the fourth quarter of 2008 as compared to the each ofthe prior quarters of 2008, resulting in a negative impact on liquidity. SeeItem 2. “Management’s Discussion and Analysis of Financial Condition andResults of Operations” for further information regarding the Company’sliquidity.

 

The Company’s currentplans to address lower crude and natural gas prices are primarily to reducecapital expenditures to a level equal to cash flow from operations, reduceoperating expenses and seek additional capital financing. However, the Company’splans may not be successful in improving its results of operations andliquidity. The Company will be required to use cash to implement itsoperational activities, including such items as committed well drilling andgeneral and administrative costs and, among others, to pay debt service on itsAmended Credit Facility. At September 30, 2008, the Company was in fullcompliance with the covenants and other provisions of the Amended CreditFacility. The Amended Credit Facility contains affirmative and negativecovenants including the following financial maintenance covenants: an interestcoverage ratio for any period of four consecutive fiscal quarters to not beless than 2.5 to 1.0, determined as of the last day of each fiscal quarter, anda minimum current ratio of current assets to current liabilities of 1.0 to 1.0.In addition to those described above, other factors may impair the Company’sability to comply with the covenants. Any failure to be in compliance with anymaterial provision or covenant of the Amended Credit Facility could result in adefault which would have a material adverse effect on our liquidity, results ofoperations and financial condition. At certain oil and natural gas pricelevels, the Company’s current cost structure, inclusive of our current plans,may exceed the costs required to operate profitably.

 

***Decliningeconomic conditions could negatively impact our business.***

 

Our operations areaffected by local, national and worldwide economic conditions. Markets in theUnited States and elsewhere have been experiencing extreme volatility and disruptionfor more than 12 months, due in part to the financial stresses affectingthe liquidity of the banking system and the financial markets generally. Inrecent weeks, this volatility and disruption has reached unprecedented levels.The consequences of a potential or prolonged recession may include a lowerlevel of economic activity and uncertainty regarding energy prices and thecapital and commodity markets.  A lowerlevel of economic activity might result in a decline in energy consumption,which may adversely affect our revenues and future growth.  Instability in the financial markets, as aresult of recession or otherwise, also may affect the cost of capital and ourability to raise capital, which are discussed in greater detail above and inthe Risk Factors section in our  2007Annual Report on Form 10-K.

 

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** **

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

 

a.    Notapplicable

 

b.    Notapplicable

 

c.    Notapplicable

 

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

 

Notapplicable.

 

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

 

Not applicable.

 

**Item 5. *Other Information***

 

Not applicable.

** **

**Item 6. *Exhibits***

*** ***

**a)**                                 **Exhibits**

** **

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

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

 

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

 

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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) |
|-------------------------------|--------------------------------------|
|                          |                                 |   |
| Date: November  5,  2008 |                                 | /s/ Timothy A. Larkin |
|                          |                                 |   |
|                          | By:                                  | Timothy A. Larkin*Executive Vice President,  Chief Financial Officer and  Principal Accounting Officer* |

 

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