**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

**FORM 10-Q**

 

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

 

**For the QuarterlyPeriod Ended March 31, 2004**

 

# **OR**

 

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

 

**For the transitionperiod from                to                **

 

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

 

**WARREN RESOURCES, INC.**(Exact Name of Registrant as Specified in its Charter.)

 

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

 

Registrant’s telephone number, including area code:

**(212) 697-9660**

 

Indicate by check mark whetherthe Registrant (1) has filed all reports required to be filed by Section 13 and15 (d) of the Securities Exchange Act of 1934 during the preceding 12 monthsand (2) has been subject to such filing requirements for the past 90 days.

 

Yes ý No o

 

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

 

Yes o No ý

 

The aggregate number of Registrant’soutstanding shares on May 12, 2004 was 19,374,070 shares of Common Stock,$0.0001 par value.

 

 

----

 

**WARREN RESOURCES,INC.**

 

**INDEX**

 
| PART I—  | FINANCIAL INFORMATION                                                                                |   |
|---------------|------------------------------------------------------------------------------------------------------|--------|
|          |                                                                                                 |   |
|          | Item 1. Financial Statements                                                                         |   |
|          |                                                                                                 |   |
|          | Balance sheets as of March 31, 2004 (Unaudited) and December 31, 2003                                |   |
|          |                                                                                                 |   |
|          | Statements of operations (Unaudited) for  the three months ended March 31, 2004 and 2003             |   |
|          |                                                                                                 |   |
|          | Statements of cash flows (Unaudited) for  the three months ended March 31, 2004 and 2003             |   |
|          |                                                                                                 |   |
|          | Notes to financial statements (Unaudited)                                                            |   |
|          |                                                                                                 |   |
|          | Item 2. Management’s discussion and  analysis of financial conditions and results of operations |   |
|          |                                                                                                 |   |
|          | Item 3. Quantitative and Qualitative  Disclosures About Market Risk                                  |   |
|          |                                                                                                 |   |
|          | Item 4. Evaluation of Disclosure Controls  and Procedures                                            |   |
|          |                                                                                                 |   |
| PART II— | OTHER INFORMATION                                                                                    |   |
|          |                                                                                                 |   |
|          | Item 1. Legal Proceedings                                                                            |   |
|          |                                                                                                 |   |
|          | Item 2. Changes in Securities                                                                        |   |
|          |                                                                                                 |   |
|          | Item 3. Defaults upon Senior Securities                                                              |   |
|          |                                                                                                 |   |
|          | Item 4. Submission of Matters to a Vote of  Security Holders                                         |   |
|          |                                                                                                 |   |
|          | Item 5. Other Information                                                                            |   |
|          |                                                                                                 |   |
|          | Item 6. Exhibits and Report on Form 8-K                                                              |   |
|          |                                                                                                 |   |
|          | Signatures                                                                                           |   |

 

2

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**PART I—FINANCIAL INFORMATION**

 

**ITEM1. FINANCIAL STATEMENTS**

 

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

 
|                                                                                                                                                                                                                                              |   | **March 31,  2004** |            | **December  31,  2003** |   |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|-----------------|-------------------------|--------|
|                                                                                                                                                                                                                                              |   | **(Unaudited)**     |            |                    |   |
| **ASSETS**                                                                                                                                                                                                                                        |   |                |            |                    |   |
| CURRENT ASSETS                                                                                                                                                                                                                                    |   |                |            |                    |   |
| Cash and cash equivalents                                                                                                                                                                                                                         |   | $                   | 29,216,042      |                    | $      | 24,528,999 |   |
| Accounts receivable – trade                                                                                                                                                                                                                  |   | 3,207,346           |            | 2,386,180               |   |
| Accounts receivable from affiliated  partnerships                                                                                                                                                                                                 |   | 249,776             |            | 389,271                 |   |
| Trading securities                                                                                                                                                                                                                                |   | 279,276             |            | 201,152                 |   |
| Restricted investments in U.S. Treasury  Bonds—available-for-sale, at fair value (amortized cost of $1,305,042 in 2004  and $1,293,411 in 2003)                                                                                              |   | 1,460,863           |            | 1,402,358               |   |
| Other current assets                                                                                                                                                                                                                              |   | 2,228,987           |            | 2,031,701               |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
| Total current assets                                                                                                                                                                                                                              |   | 36,642,290          |            | 30,939,661              |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
| OTHER ASSETS                                                                                                                                                                                                                                      |   |                |            |                    |   |
| Oil and gas properties—at cost, based on  successful efforts method of accounting, net of accumulated depletion and  amortization                                                                                                            |   | 97,329,232          |            | 94,949,545              |   |
| Property and equipment—at cost, net                                                                                                                                                                                                          |   | 513,371             |            | 591,663                 |   |
| Restricted investments in U.S. Treasury  Bonds-available for sale, at fair value (amortized cost of $12,729,496 in  2004 and $12,627,574 in 2003)                                                                                                 |   | 14,401,030          |            | 13,808,777              |   |
| Deferred bond offering costs (net of  accumulated amortization of $3,797,789 in 2004 and $3,684,097 in 2003)                                                                                                                                      |   | 2,643,279           |            | 2,756,971               |   |
| Goodwill                                                                                                                                                                                                                                          |   | 3,430,246           |            | 3,430,246               |   |
| Other assets                                                                                                                                                                                                                                      |   | 4,405,138           |            | 4,576,800               |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
| Total other assets                                                                                                                                                                                                                                |   | 122,722,296         |            | 120,114,002             |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
|                                                                                                                                                                                                                                              |   | $                   | 159,364,586     |                    | $      | 151,053,663 |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                     |   |                |            |                    |   |
| CURRENT LIABILITIES                                                                                                                                                                                                                               |   |                |            |                    |   |
| Current maturities of debentures                                                                                                                                                                                                                  |   | $                   | 4,725,970       |                    | $      | 4,809,470 |   |
| Current maturities of other long-term  liabilities                                                                                                                                                                                                |   | 296,629             |            | 208,383                 |   |
| Accounts payable and accrued expenses                                                                                                                                                                                                             |   | 7,941,646           |            | 8,956,529               |   |
| Deferred income—turnkey drilling contracts  with affiliated partnerships                                                                                                                                                                     |   | 21,529,338          |            | 22,438,272              |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
| Total current liabilities                                                                                                                                                                                                                         |   | 34,493,583          |            | 36,412,654              |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
| LONG-TERM LIABILITIES                                                                                                                                                                                                                             |   |                |            |                    |   |
| Debentures, less current portion                                                                                                                                                                                                                  |   | 42,533,730          |            | 43,285,230              |   |
| Other long-term liabilities, less current  portion                                                                                                                                                                                                |   | 1,450,944           |            | 1,613,081               |   |
|                                                                                                                                                                                                                                              |   | 43,984,674          |            | 44,898,311              |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
| MINORITY INTEREST                                                                                                                                                                                                                                 |   | 12,322,366          |            | 13,348,654              |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
| STOCKHOLDERS’ EQUITY                                                                                                                                                                                                                         |   |                |            |                    |   |
| 8% convertible preferred stock,  par value $.00001; authorized 20,000,000 shares, issued and outstanding,  6,533,145 shares in 2004 and 6,507,729 shares in 2003  (aggregate liquidation preference $78,397,740  in 2004 and $78,092,748 in 2003) |   | 76,710,530          |            | 76,334,024              |   |
| Common Stock  — $.0001 par value; authorized, 100,000,000 shares; issued  19,374,070 in 2004 and 17,349,070 shares in 2003)                                                                                                             |   | 1,937               |            | 1,735                   |   |
| Additional paid-in-capital                                                                                                                                                                                                                        |   | 60,268,032          |            | 47,739,159              |   |
| Accumulated deficit                                                                                                                                                                                                                               |   | (68,788,044         | )               | (67,729,178             | )      |
| Accumulated other comprehensive income, net  of applicable income taxes of $731,000 in 2004 and $517,000 in 2003                                                                                                                                  |   | 1,099,563           |            | 776,359                 |   |
|                                                                                                                                                                                                                                              |   | 69,292,018          |            | 57,122,099              |   |
|                                                                                                                                                                                                                                              |   |                |            |                    |   |
| Less common stock in Treasury—at cost;  632,250 shares in 2004 and  2003                                                                                                                                                                |   | 728,055             |            | 728,055                 |   |
| Total shareholders’ equity                                                                                                                                                                                                                   |   | 68,563,963          |            | 56,394,044              |   |
|                                                                                                                                                                                                                                              |   | **$**               | **159,364,586** |                    | **$**  | **151,053,663** |   |

 

The accompanying notes are an integral part of these financialstatements

 

3

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**WarrenResources, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OFOPERATIONS**

 
|                                                                  |   | **Three  Months Ended  March 31, (Unaudited)** |           |
|-----------------------------------------------------------------------|--------|------------------------------------------------|----------------|
|                                                                  |   | **2004**                                       |           | **2003** |   |
| **REVENUES**                                                          |   |                                           |           |   |   |
| Turnkey contracts with affiliated  partnerships                       |   | $                                              | 908,934        |   | $ | 863,197 |   |
| Oil and gas sales from marketing activities                           |   | 1,383,575                                      |           | 1,409,891 |   |
| Well services                                                         |   | 230,605                                        |           | 242,727 |   |
| Oil and gas sales                                                     |   | 1,226,475                                      |           | 1,535,011 |   |
| Net gain on investments                                               |   | 49,813                                         |           | 73,544 |   |
| Interest and other income                                             |   | 532,900                                        |           | 313,311 |   |
|                                                                  |   | 4,332,302                                      |           | 4,437,681 |   |
|                                                                  |   |                                           |           |   |   |
| **EXPENSES**                                                          |   |                                           |           |   |   |
| Turnkey contracts                                                     |   | 1,433,440                                      |           | 910,849 |   |
| Cost of marketed oil and gas purchased from  affiliated partnerships  |   | 1,348,219                                      |           | 1,376,662 |   |
| Well services                                                         |   | 111,878                                        |           | 168,197 |   |
| Production & exploration                                          |   | 998,417                                        |           | 960,738 |   |
| Depreciation, depletion and amortization                              |   | 402,145                                        |           | 159,975 |   |
| General and administrative                                            |   | 1,172,288                                      |           | 1,030,258 |   |
| Interest                                                              |   | 108,853                                        |           | 946,913 |   |
|                                                                  |   | 5,575,240                                      |           | 5,553,592 |   |
|                                                                  |   |                                           |           |   |   |
| Loss before provision for income taxes                                |   | (1,242,938                                     | )              | (1,115,911 | ) |
|                                                                  |   |                                           |           |   |   |
| Deferred income tax benefit                                           |   | (214,000                                       | )              | (3,000 | ) |
|                                                                  |   |                                           |           |   |   |
| Net loss before minority interest and  change in accounting principle |   | (1,028,938                                     | )              | (1,112,911 | ) |
|                                                                  |   |                                           |           |   |   |
| Minority interest                                                     |   | (29,928                                        | )              | (33,193 | ) |
|                                                                  |   |                                           |           |   |   |
| Net loss before change in accounting  principle                       |   | (1,058,866                                     | )              | (1,146,104 | ) |
|                                                                  |   |                                           |           |   |   |
| Cumulative effect of change in accounting  principle                  |   | —                                         |           | (88,218 | ) |
|                                                                  |   |                                           |           |   |   |
| Net loss                                                              |   | (1,058,866                                     | )              | (1,234,322 | ) |
|                                                                  |   |                                           |           |   |   |
| Less dividends and accretion on preferred  shares                     |   | 1,645,925                                      |           | 800,162 |   |
|                                                                  |   |                                           |           |   |   |
| Net loss applicable to common stockholders                            |   | **$**                                          | **(2,704,791** | **)** | **$** | **(2,034,484** | **)** |
|                                                                  |   |                                           |           |   |   |
| Basic and diluted loss per common share                               |   |                                           |           |   |   |
| Loss before accounting change                                         |   | $                                              | (0.15          | ) | $ | (0.12 | ) |
| Cumulative effect of change in accounting  principle                  |   | —                                         |           | — |   |
| Net loss                                                              |   | $                                              | (0.15          | ) | $ | (0.12 | ) |
|                                                                  |   |                                           |           |   |   |
| Weighted average common shares outstanding                            |   | 17,973,963                                     |           | 16,874,305 |   |

 

The accompanying notes are an integral part of these financialstatements

 

4

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**WarrenResources, Inc. and SubsidiariesCONSOLIDATED STATEMENTS OF CASH FLOWS**

 
|                                                                                       |   | **For the  three months ended  March 31, (Unaudited)** |       |
|--------------------------------------------------------------------------------------------|--------|--------------------------------------------------------|------------|
|                                                                                       |   | **2004**                                               |       | **2003** |   |
| Cash flows from operating activities:                                                      |   |                                                   |       |   |   |
| Net loss                                                                                   |   | $                                                      | (1,058,866 | ) | $ | (1,234,322 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities: |   |                                                   |       |   |   |
| Accretion of discount on available-for-sale  debt securities                               |   | (166,065                                               | )          | (125,486 | ) |
| Amortization and write-off of deferred bond  offering costs                                |   | 113,692                                                |       | 180,569 |   |
| Gain on sale of US treasury bonds-available  for sale                                      |   | —                                                 |       | (102,810 | ) |
| Depreciation, depletion and amortization                                                   |   | 402,145                                                |       | 159,975 |   |
| Accretion of asset retirement obligation                                                   |   | 16,416                                                 |       | — |   |
| Deferred tax benefit                                                                       |   | (214,000                                               | )          | (3,000 | ) |
| Change in assets and liabilities:                                                          |   |                                                   |       |   |   |
| (Increase) decrease in trading securities                                                  |   | (78,124                                                | )          | 38,690 |   |
| (Increase) decrease in accounts  receivable-trade                                          |   | (821,165                                               | )          | 3,442,064 |   |
| Decrease in accounts receivable from  affiliated partnerships                              |   | 139,494                                                |       | 536,592 |   |
| (Increase) decrease in other assets                                                        |   | (25,625                                                | )          | 97,565 |   |
| Decrease in accounts payable and accrued  expenses                                         |   | (1,079,998                                             | )          | (1,228,904 | ) |
| Decrease in deferred income from affiliated  partnerships                                  |   | (908,934                                               | )          | (863,197 | ) |
| Decrease in other long term liabilities                                                    |   | (73,291                                                | )          | (316,914 | ) |
|                                                                                       |   |                                                   |       |   |   |
| Net cash provided by (used in) operating  activities                                       |   | (3,754,321                                             | )          | 580,822 |   |
|                                                                                       |   |                                                   |       |   |   |
| Cash flows from investing activities:                                                      |   |                                                   |       |   |   |
| Purchases of oil and gas properties                                                        |   | (3,560,471                                             | )          | (1,125,477 | ) |
| Purchase of property and equipment                                                         |   | (3,827                                                 | )          | — |   |
| Proceeds from the sale of property and  equipment, net of selling fees                     |   | 3,500                                                  |       | 28,087 |   |
| Proceeds from U.S. Treasury  Bonds-available-for-sale                                      |   | 52,512                                                 |       | 573,621 |   |
|                                                                                       |   |                                                   |       |   |   |
| Net cash used in investing activities                                                      |   | (3,508,286                                             | )          | (523,769 | ) |
|                                                                                       |   |                                                   |       |   |   |
| Cash flows from financing activities:                                                      |   |                                                   |       |   |   |
| Payments on other long-term debt                                                           |   | (852,016                                               | )          | (937,511 | ) |
| Issuance of common stock, net                                                              |   | 14,175,000                                             |       | — |   |
| Issuance of preferred stock, net                                                           |   | 126,730                                                |       | 853,418 |   |
| Dividends paid on preferred stock                                                          |   | (1,500,064                                             | )          | — |   |
|                                                                                       |   |                                                   |       |   |   |
| Net cash provided by (used in) financing  activities                                       |   | 11,949,650                                             |       | (84,093 | ) |
|                                                                                       |   |                                                   |       |   |   |
| Net increase (decrease) in cash and cash  equivalents                                      |   | 4,687,043                                              |       | (27,040 | ) |
| Cash and cash equivalents at beginning of  period                                          |   | 24,528,999                                             |       | 23,184,936 |   |
|                                                                                       |   |                                                   |       |   |   |
| Cash and cash equivalents at end of period                                                 |   | $                                                      | 29,216,042 |   | $ | 23,157,896 |   |
| Supplemental disclosure of cash flow  information                                          |   |                                                   |       |   |   |
| Cash paid for interest, net of amount  capitalized                                         |   | $                                                      | —     |   | $ | 766,344 |   |
| Cash paid for income taxes                                                                 |   | —                                                 |       | — |   |

 

The accompanying notes are an integral part of these financialstatements

 

5

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**WARREN RESOURCES, INC.AND SUBSIDIARIES**

 

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS (UNAUDITED)**

 

**MARCH 31, 2004**

 

**NOTE 1—ORGANIZATION**

 

Warren Resources, Inc. (the“Company” or “Warren”), was formed on June 12, 1990 under the laws of the stateof New York for the purpose of acquiring and developing oil and gas properties.On September 5th, 2002, the Company changed its state of incorporation toDelaware. As a result, all shares of the Company’s stock were converted intoshares of the Delaware corporation. The Company’s properties are primarilylocated in New Mexico, Texas, Wyoming and California. In addition, the Companyserves as the managing general partner (the “MGP”) to affiliated partnershipsand joint ventures.

 

The accompanying unaudited financialstatements and related notes present the Company’s consolidated financialposition as of March 31, 2004 and December 31, 2003, the results of operationsfor the three months ended March 31, 2004 and 2003 and cash flows for the threemonths ended March 31, 2004 and 2003. The unaudited financial statements have beenprepared in accordance with accounting principles generally accepted in theUnited States of America for interim financial information and with theinstructions of Form 10-Q and Article 10 of Regulation S-X. Accordingly, theydo not include all of the information and footnotes required by accountingprinciples generally accepted in the United States of America for completefinancial statements. In the opinion of management, all adjustments (consistingof normal recurring accruals) considered necessary for a fair presentation havebeen included. Operating results for the three months ended March 31, 2004 arenot necessarily indicative of the results that may be expected for the fiscalyear ending December 31, 2004. The accounting policies followed by the Companyare set forth in Note A to the Company’s financial statements on Form 10-K forthe year ended December 31, 2003. These interim financial statements and notesthereto should be read in conjunction with our annual consolidated financialstatements presented in our 2003 Annual Report on Form 10-K.

 

#### **NOTE2—MANAGEMENT’S PLANS**

 

The Company had a net loss of$1.1 million for the quarter ended March 31, 2004, as compared to a loss of$1.2 million for the corresponding quarter ending March 31, 2003. At March 31,2004, current assets exceeded current liabilities by approximately $2.1million.

 

In order to improve operationsand liquidity and meet its cash flow needs, the company has or intends to dothe following:

 

•                  Raise additionalcapital through the sale of preferred and common stock.

 

•                  Obtain a creditfacility based in part on the value of our proven reserves.

 

•                  Generate turnkeyprofit and operating cash flow from turnkey drilling contracts equal toapproximately 25% of the total amount of total turnkey revenue.

 

•                  Increase oil andgas production and revenues by drilling our Wyoming and California properties.

 

•                  Increase oil andgas revenues by exchanging preferred stock for interests in producingproperties.

 

•                  Use $2.0 millionof deferred drilling credits from Anadarko Petroleum Corporation to develop ouracreage in the Washakie Basin, Wyoming.

 

As a result of theseplans, management believes that it will generate sufficient cash flows to meetits current obligations in 2004.

 

6

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##### **NOTE 3**—STOCK OPTIONS

 

At March 31, 2004, the Companyhad stock-based compensation plans. The Company accounts for those plans underthe recognition and measurement principles of Accounting Principles Board (APB)Opinion No. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations. The following table illustrates the effect on net loss andloss per share if the Company had applied the fair-value recognition provisionsof Financial Accounting Standards Board (FASB) Statement No. 123, “Accountingfor Stock-Based Compensation,” to stock-based employee compensation:

 
|                                                                                                                                          |   | **Three  months ended March 31,** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                                                                          |   | **2004**                          |       | **2003** |   |
|                                                                                                                                          |   |                              |       |   |   |
| Net loss, as reported                                                                                                                         |   | $                                 | (1,058,866 | ) | $ | (1,234,322 | ) |
| Deduct: Total stock-based employee  compensation expense determined under fair-value-based method for all awards,  net of related tax effects |   | (17,498                           | )          | — |   |
|                                                                                                                                          |   |                              |       |   |   |
| Pro forma net loss                                                                                                                            |   | $                                 | (1,076,364 | ) | $ | (1,234,322 | ) |
|                                                                                                                                          |   |                              |       |   |   |
| Basic and diluted loss per share:                                                                                                             |   |                              |       |   |   |
| As reported -                                                                                                                                 |   | $                                 | (.15       | ) | $ | (0.12 | ) |
| Pro forma -                                                                                                                                   |   | $                                 | (.15       | ) | $ | (0.12 | ) |

 

**NOTE 4—PLUGGING AND ABANDONMENT LIABILITY**

 

In June 2001, the FinancialAccounting Standard Board issued SFAS No. 143, “Accounting for Asset RetirementObligations” which requires entities to record the fair value of a liabilityfor an asset retirement obligation in the period in which it is incurred and acorresponding increase in the carrying amount of the related long-lived asset.The Company adopted SFAS No. 143 on January 1, 2003 and recorded a net asset of$557,000, a related liability of $645,000 (using a 10% discount rate) and acumulative effect of change in accounting principle of $88,000.  During the three months ending March 31,2004 and 2003 the asset retirement liability was increased by approximately$16,000 and $21,000 respectively, as a result of accretion and recorded asinterest expense. During the three months ended March 31, 2004 there has beenno significant changes in cash flow assumptions for the liability orliabilities incurred or settled during the period. The Company has treasurybills held in escrow with a fair market value of $2,789,000 which are legallyrestricted for potential plugging and abandonment liability in the Wilmingtonfield.

 

#### **NOTE 5**—CHANGES IN SHAREHOLDERS’ EQUITY

 

During the three months endedMarch 31, 2004, the Company raised $14 million through the private placement of2,000,000 shares of common stock and issued 1,000,000 warrants to fourinstitutional investors managed by a large Boston-based investment advisor. TheCompany also sold 25,000 shares of its common stock for $175,000 and issued12,500 warrants to a single investor. All warrants have expected lives of fiveyears and have a cumulative weighted average exercise price of $11.07.

 

As of March 31, 2004, 6,533,145shares of convertible preferred stock were issued and outstanding. Preferreddividends of approximately $1.6 million and $1.5 million were accrued at March31, 2004 and December 31, 2003, respectively. The Company has incurredcumulative issuance costs of approximately $2.1 million in relation to theseshares. For the three months ended March 31, 2004, the Company issued 25,416preferred shares, 14,086 relating to the recapitalization of drilling programsand 11,330 for cash consideration of approximately $135,960. The preferredstock pays an 8% cumulative dividend, which is payable quarterly, and istreated as a deduction in additional paid in capital. The holders of thepreferred stock are not entitled to vote except as defined by the agreement oras provided 

 

7

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by applicable law.  The preferred stock may be voluntarilyconverted at the election of the holder, commencing one year after the date ofissuance.  Each outstanding redeemableconvertible preferred share is convertible into common stock of the Companybased on the table below.  Theconversion rate is subject to adjustment from time to time as defined by theagreement.

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

 

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

 

**NOTE 6—LOSS PER SHARE**

 

Basic loss per share iscomputed by dividing net loss by the weighted average number of shares ofcommon stock outstanding during the period. Diluted loss per share is based onthe assumption that stock options are converted into common shares using thetreasury stock method and convertible bonds, debentures and preferred stock areconverted using the if-converted method. Conversion is not assumed if theresults are anti-dilutive.  Potentialcommon shares at March 31, 2004 and March 31, 2003 of 11,881,840 and 9,336,916respectively, relating to convertible bonds, debentures and preferred stock,2,241,012 and 1,514,459, respectively, relating to incentive stock options and1,184,643 potential shares relating to warrants at March 31, 2004, wereexcluded from the computation of diluted loss per share because they areanti-dilutive. Incentive stock options have a weighted average exercise priceof $5.10 and $5.59 at March 31, 2004 and March 31, 2003, respectively. Warrantshave a weighted average exercise price of $11.07 at March 31, 2004. Theconvertible bonds and debentures may be converted from the date of issuanceuntil maturity at 100% of principal amount into common stock of the Company atprices ranging from $5 to $50.  Thepreferred stock may be converted at the discretion of the holder (See Note 5).

 

**NOTE 7—LONG TERM DEBT**

 

The convertible bonds and debenturesmay be converted from the date of issuance until maturity at 100% of principalamount into common stock of the Company at prices ranging from $5 to $50. Eachyear the holders of the convertible debentures may tender to the Company up to10% of the aggregate debentures issued and outstanding.  Bonds and debentures outstanding are asfollows:

 
|                                                               |   | **March 31,  2004** |       | **December  31,  2003** |   |
|--------------------------------------------------------------------|--------|---------------------|------------|-------------------------|--------|
|                                                               |   |                |       |                    |   |
| 12% Sinking Fund Debentures, due December  31, 2007                |   | $                   | 9,251,000  |                    | $      | 9,616,000 |   |
| 12% Secured Convertible Debentures, due  December 31, 2009         |   | 770,000             |       | 790,000                 |   |
| 12% Secured Convertible Bonds, due December  31, 2010              |   | 1,700,000           |       | 1,705,000               |   |
| 13.02% Sinking Fund Convertible Debentures,  due December 31, 2010 |   | 14,645,200          |       | 14,655,200              |   |
| 13.02% Sinking Fund Convertible Debentures,  due December 31, 2015 |   | 11,692,500          |       | 11,792,500              |   |
| 12% Secured Convertible Bonds, due December  31, 2016              |   | 1,365,000           |       | 1,365,000               |   |
| 12% Sinking Fund Convertible Debentures,  due December 31, 2017    |   | 5,215,000           |       | 5,500,000               |   |
| 12% Secured Convertible Bonds, due December  31, 2020              |   | 1,485,000           |       | 1,485,000               |   |
| 12% Secured Convertible Bonds, due December  31, 2022              |   | 1,136,000           |       | 1,186,000               |   |
|                                                               |   |                |       |                    |   |
|                                                               |   | 47,259,700          |       | 48,094,700              |   |
| Less: Current Portion                                              |   | 4,725,970           |       | 4,809,470               |   |
|                                                               |   |                |       |                    |   |
| Long Term Portion                                                  |   | $                   | 42,533,730 |                    | $      | 43,285,230 |   |

 

8

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#### **NOTE 8**—CAPITALIZED INTEREST

 

Interest of approximately $1,501,000and $929,000 was capitalized during the three months ended March 31, 2004 and2003, respectively, relating to California and Wyoming properties. Thisincrease results from a higher cost basis in our oil and gas properties due tothe consent solicitation (See Note 12).

 

#### **NOTE 9—LITIGATION**

 

**On September 28, 1999, MagnessPetroleum Company, our joint venture partner in the Wilmington Field, filed acomplaint against Warren, Warren E&P, Inc. (“Warren E&P”), and certainWarren subsidiaries in the Superior Court of Los Angeles County, alleging thatwe had breached our joint venture agreement with Magness and an alleged oralagreement regarding advance payment of expenses for drilling and completionoperations.  Magness sought dissolutionof the joint venture, an accounting and a declaratory judgment as to the rightsof the parties under the joint venture agreement.  We were successful in enforcing the arbitration provision in thejoint venture agreement and entered into an agreement with Magness to submitthe matter for arbitration by the Judicial Arbitration Mediation Services, or“JAMS,” before the Honorable Keith J. Wisot, a retired Los Angeles SuperiorCourt Judge.  Judge Wisot, as thearbitrator, ruled that the joint venture agreement is a valid enforceableagreement, declined to dissolve the joint venture, denied Magness’ claims for breachof contract, and held that he and JAMS would retain jurisdiction to enforce theFinal Award. On August 8, 2001, Magness filed a demand with the AmericanArbitration Association, or “AAA,” reasserting its claims for dissolution ofthe joint venture and breach of contract. Subsequently Warren sought to enforcethe original Final Award rendered by Judge Wisot in the JAMS arbitration. Aftera procedural determination of proper arbitration forum that was eventuallydetermined by the California Court of Appeals in December 2002 and a Motion forClarification filed in January 2003 before the California Superior Court, inSeptember 2003 the California Superior Court ordered that JAMS will hearWarren’s motion to enforce the Final Award covering unauthorized direct laborcharges and tangible costs and AAA will hear Magness’s new theory ofdissolution of the joint venture based on their claim that voting rights withinthe joint venture should be based on ownership of working interests in theWilmington Town Unit (“WTU”), which includes property never contributed to thejoint venture, instead of ownership of joint venture working interests, adetermination whether Magness can independently drill new wells in the WTUwithout Warren’s consent if the joint venture is not dissolved and Warren’sclaims for damages for Magness preventing resumption of drilling activities byWarren as ordered by Judge Wisot in JAMS. The AAA arbitration is being heldfrom May 3, 2004 to May 14, 2004 and the JAMS arbitration hearing on the Motionto Enforce Final Award is being held from May 19, 2004 to May 21, 2004.Accordingly, pending final resolution, further development of the WilmingtonField will be curtailed. See our 2003 Form 10-K “Risk Factors - If we areunable to settle our disagreements with our joint venture partner in theWilmington Field, the value of our interest there or realization of that valuecould be significantly diminished or delayed.”**

 

In 1998, Warren E&P wassued in the 81st Judicial District Court of Frio County, Texas byStricker Drilling Company, Inc. and Manning Safety Systems to recover the valueof lost equipment based on a well blow out. Warren was later joined in the suit as a defendant.  As a result of the lawsuit, Gotham InsuranceCompany, Warren E&P’s well blow-out insurer, intervened.  The suit was settled in 1999 with allparties except Gotham.  Gotham paid over$1.7 million under the insurance policy and now seeks a refund of approximately$1.5 million of monies paid, denying coverage, and alleging fraud andmisrepresentation and a failure of Warren E&P to act with due diligence andpursuant to safety regulations.  WarrenE&P countersued for the remaining proceeds under the policy coverage.  In the summer and fall of 2000, summaryjudgments were entered for Warren E&P on essentially all claims except itsbad faith claims against Gotham. Gotham’s claims against Warren E&P and Warren were rejected.  Final judgment was rendered on May 14, 2001in Warren E&P’s favor for the remaining policy proceeds, interest andattorney fees.  Gotham appealed thefinal judgment to the San Antonio Court of Appeals seeking a refund ofapproximately $1.5 million.  The case onappeal was orally argued on March 28, 2002. On July 23, 2003, a three judgepanel of the San Antonio Court of Appeals rendered its decision in favor ofGotham on all points, except for the amount of restitution owed by WarrenE&P and related parties, reversing the earlier summary judgment entered bythe trial court for Warren E&P. Although the three judge panel of the SanAntonio Court of Appeals acknowledged that Gotham asked for the Court to renderits judgment in Gotham’s favor on its restitution claims, 

 

9

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Gotham gave no particulars, andtherefore the Court of Appeals remanded Gotham’s restitution claims to thetrial court for further proceedings consistent with its opinion. Although theultimate resolution is uncertain, counsel has advised Warren E&P that itbelieves the three judge panel of the San Antonio Court of Appeals committednumerous errors of fact and law, primarily relying on their erroneousconclusion that Warren E&P as operator of the oil well incurred no loss.Accordingly, Warren E&P has appealed the San Antonio Court of Appeals paneldecision to the Texas Supreme Court, and has been requested by the TexasSupreme Court to submit full briefs, which was done on April 15, 2004. Thedecision to accept a full review of the San Antonio Court of Appeal’s decisionwith oral argument being heard by the Texas Supreme Court is at the Court’sdiscretion.

 

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

 

**NOTE 10—BUSINESS SEGMENT INFORMATION**

 

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

 
|                   |   | **Three  Months Ended** |      |
|------------------------|--------|-------------------------|-----------|
|                   |   | **March 31,  2004**     |      | **March 31,  2003** |   |
| **Revenue**            |   |                    |      |   |   |
| Turnkey Contracts      |   | $                       | 908,934   |   | $ | 863,197 |   |
| Oil and Gas Marketing  |   | 1,383,575               |      | 1,409,891 |   |
| Oil and Gas Operations |   | 1,226,475               |      | 1,535,011 |   |
| Well Services          |   | 230,605                 |      | 242,727 |   |
| Other                  |   | 582,713                 |      | 386,855 |   |
|                   |   |                    |      |   |   |
|                   |   | $                       | 4,332,302 |   | $ | 4,437,681 |   |

 
|                        |   | **March 31,  2004** |       | **March 31,  2003** | ** ** |
|-----------------------------|--------|---------------------|------------|---------------------|------------|
| **Operating Income (Loss)** |   |                |       |                |       |
| Turnkey Contracts           |   | $                   | (550,052   | )                   | $          | (73,218 | ) |
| Oil and Gas Marketing       |   | 35,356              |       | 33,229              |       |
| Oil and Gas Operations      |   | (94,972             | )          | 453,199             |       |
| Well Services               |   | 118,727             |       | 74,530              |       |
| Other                       |   | (751,997            | )          | (1,603,651          | )          |
|                        |   |                |       |                |       |
|                        |   | $                   | (1,242,938 | )                   | $          | (1,115,911 | ) |

 

10

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**NOTE 11—COMPREHENSIVE LOSS**

 

Other comprehensive lossconsists primarily of net unrealized investment gains and losses, net of incometax effect. Total comprehensive losses for the periods are as follow:

 
|                          |   | **2004** |     | **2003** |   |
|-------------------------------|--------|----------|----------|----------|--------|
|                          |   |     |     |     |   |
| Three Months ending March 31, |   | $        | (735,662 | )        | $      | (1,230,437 | ) |
|                               |        |          |          |          |        |  |  |

 

**NOTE 12—CONSENT SOLICITATION**

 

During the fourth quarter of 2002, the Company, acting as the MGP,commenced a vote solicitation of the limited partners of the certainpartnerships (the “Partnership Recapitalization Offers”) to:  (1) obtain the requisite two-thirdsaffirmative vote of their respective partners to convert the drilling programfrom a Delaware limited partnership into a Delaware limited liability company(the “LLC”) wherein all LLC members would have limited liability, including theCompany, and (ii) upon conversion to an LLC, the Company would contribute asadditional capital to the LLC its unregistered 8% convertible preferred stockwith a value equal to between 110% to 120% of the potential repurchase price ofconsenting members’ interests (“Preferred Members”) calculated as of December31, 2002.  The Company would receiveadditional standard membership interests in the LLC and be specially allocated,pro rata as a standard member, the Preferred Members’ interests in the oil andgas properties owned by their respective programs (the“Recapitalization”).  Acceptance byPreferred Members of the Recapitalization terminated their repurchase rightsunder the original buy/sell agreements. At December 31, 2002, six of thethirteen programs obtained the requisite votes to convert to LLCs and becauseof the majority control by the Company were consolidated in the financialstatements for the year ended December 31, 2002. As a result, the Companyissued 1,342,960 preferred shares to these six LLC’s in 2002 with an estimatedfair value of $16,115,520. At March 31, 2003, the remaining seven programsobtained the requisite votes to convert to LLCs and on average 72.9% of theprogram members elected to become Preferred Members in their LLC. During thefirst quarter ended March 31, 2003, the Company issued 1,641,628 preferredshares to the remaining seven LLCs as a capital contribution, with an estimatedfair value of $19,699,536 and received its prorata share of additional standardmembership interests in the LLCs. The fair value of the preferred shares wasbased on actual cash sales to independent parties in this time period.  Due to the majority control of thesethirteen affiliated partnerships, the Company has consolidated these entitiesfor financial reporting purposes at March 31, 2003. The Company accounted forthe remaining seven LLCs as a purchase transaction with the estimated fairvalue of the assets and liabilities assumed in the acquisition as follows:

 
| Estimated fair value of assets acquired |   |       |       |
|-----------------------------------------|--------|------------|------------|
| Current assets                          |   | $          | 3,512      |   |
| Oil and gas properties                  |   | 28,342,950 |       |
|                                    |   |       |       |
| Total fair value of assets              |   | 28,346,462 |       |
|                                    |   |       |       |
| Liabilities assumed                     |   |       |       |
| Accounts payable                        |   | 144,122    |       |
| Minority Interest                       |   | 8,502,804  |       |
|                                    |   |       |       |
| Total liabilities assumed               |   | 8,646,926  |       |
|                                    |   |       |       |
| Cost of acquisition                     |   | $          | 19,699,536 |   |

 

Subsequent to therecapitalization offers that closed on March 31, 2003, and December 31, 2002,certain minority interest limited partners elected to convert to preferredmembers during the three months ended March 31, 2004, 

 

11

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which resulted in the Companyissuing 14,086 preferred shares to these individuals with an estimated fairvalue of $169,032.

 

The following summarizes pro formaunaudited results of operations for the periods ended March 31, 2004 and 2003as if these acquisitions had been consummated immediately prior to January 1,2003. These pro forma results are not necessarily indicative of future results.

 
|                                    |   | **Pro Forma  (unaudited)  Three months ended March 31,** |       |
|-----------------------------------------|--------|----------------------------------------------------------|------------|
|                                    |   | **2004**                                                 |       | **2003** |   |
|                                    |   |                                                     |       |   |   |
| Revenues                                |   | $                                                        | 4,332,302  |   | $ | 6,765,628 |   |
|                                    |   |                                                     |       |   |   |
| Net loss                                |   | $                                                        | (1,058,866 | ) | $ | (735,851 | ) |
|                                    |   |                                                     |       |   |   |
| Loss per share – basic and diluted |   | $                                                        | (0.15      | ) | $ | (0.09 | ) |

 

**NOTE 13—GOODWILL**

 

The Company adopted SFAS No.142, *Goodwilland Other Intangible Assets,* effective January 1, 2002 and as such,has not subsequently recorded any amortization of goodwill. Under the new rulethe Company only adjusts the carrying amount of goodwill or indefinite lifeintangible assets upon an impairment. During the three months ended March 31,2004 and March 31, 2003, no events occurred which would indicate that animpairment of goodwill existed.

 

During the second quarter of2003, the Company retained an independent outside valuation expert to assist indeveloping the fair value analysis necessary to conduct the testing forimpairment of its goodwill, all of which arose in its acquisition of WarrenE&P. The results of this analysis indicated that no impairment of goodwillhad occurred in 2003. The 2004 annual impairment testing will be performedduring the second quarter of 2004.

 

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

 

**FORWARD-LOOKINGINFORMATION**

 

Forward-looking statements for2004 and later periods are made in this document. Such statements representestimates by management based on the Company’s historical operating trends, itsproved oil and gas reserves and other information currently available tomanagement. The Company cautions that the forward-looking statements providedherein are subject to all the risks and uncertainties incident to theacquisition, development and marketing of, and exploration for oil and gasreserves. These risks include, but are not limited to, oil and natural gasprice risk, environmental risks, drilling risk, reserve quantity risk and operationsand production risk. For all the above reasons, actual results may varymaterially from the forward-looking statements and there is no assurance thatthe assumptions used are necessarily the most likely to occur.

 

**OVERVIEW:**

 

During 2003, we began to transition ourselves frombeing a provider of turnkey contract services into more of a traditionalexploration and production company.  Asa result, we expect oil and gas sales and production and exploration expense tobecome more material in future years.  Additionally,we anticipate that turnkey contract revenues and expenses will become lessmaterial in future years.

 

Our future success depends upon the development of ourcore acreage.  During 2004 andsubsequent, we plan to continue to develop our core acreage, which includes ourcoalbed methane acreage in the Atlantic and Pacific Rims in the Washakie Basinin Wyoming.  Also, after the legalissues have been resolved, we intend to continue to develop our secondary recoveryproject in California.  See, “LegalProceedings.”

 

**LIQUIDITY AND CAPITAL RESOURCES:**

 

We have funded our activitiesprimarily with the proceeds raised through privately placed drilling programsand our private sale of our equity and debt securities. These privateplacements primarily were made through a network of independent broker dealers.Since 1992, we have raised approximately $228 million through the privateplacements of interests in 31 drilling programs. Additionally, we have raised$71.6 million through the issuance of our debt securities and $64.4 millionthrough the issuance of our equity securities. In our drilling programs, wefund the costs associated with acreage acquisition and the tangible portion ofdrilling activities, while investors in the drilling programs fund all intangibledrilling costs.

 

Our cash and cash equivalentsincreased $4.7 million for the three months ended March 31, 2004. This resultedfrom $11.9 million in cash from financing activities offset by $3.7 million ofcash used in operating activities and $3.5 million of cash used in investingactivities.

 

Cash provided from financingactivities primarily relates to the sale of 2,000,000 shares of the Company’scommon stock to four accredited investors for $7 per share. This was partiallyoffset by payments on long term debt and dividends paid on preferred stock of$852 thousand and $1.5 million, respectively.

 

Cash used in operatingactivities primarily relates to drilling wells on behalf of the drillingprograms.

 

Cash used in investingactivities primarily relates to expenditures on oil and gas properties duringthe first three months of 2004.  Thiswas partially offset by the receipt of U.S. Treasury Bonds previously held inescrow on behalf of our drilling program and debentures.

 

Our most material commitment offunds relates to the drilling programs. Our deferred revenue balance relatingto our drilling commitments totaled $21.5 million at March 31, 2004. Thiscommitment varies pro rata with the amount of funds raised through our drillingprograms.

 

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The Company had a net loss of$1.1 million for the three months ended March 31, 2004, as compared to a netloss of $1.2 million for the corresponding period ending March 31, 2003. AtMarch 31, 2004, current assets exceeded current liabilities by approximately$2.1 million.  During the first threemonths of 2004, shareholders’ equity increased $12.2 million from $56.4 millionto $68.6 million, primarily due to the sale of common stock as discussed above.

 

During 2003, we raised $6.4million for our drilling programs compared to $5.4 million and $18.1 million in2002 and 2001, respectively. As a result, the Company’s turnkey revenue andtotal gross profit in 2004 will be similar to 2003 but less than 2002 and the numberof the Company’s oil and gas properties developed through partnershiparrangements will be reduced in comparison to prior years.

 

In order to improve operationsand liquidity and meet its cash flow needs, we have or intend to do thefollowing:

 

•                  Raiseadditional capital through the sale of preferred and common stock.

 

•                  Obtaina credit facility based in part on the value of our proven reserves.

 

•                  Generateturnkey profit and operating cash flow from turnkey drilling contracts equal toapproximately 25% of the total amount of total turnkey revenue.

 

•                  Increaseoil and gas production and revenues by drilling our Wyoming and Californiaproperties.

 

•                  Increaseoil and gas revenues by exchanging preferred stock for interests in producingproperties.

 

•                  Use$2.0 million of deferred drilling credits from Anadarko Petroleum Corporationto develop our acreage in the Washakie Basin, Wyoming.

 

As a result of these plans,management believes that it will generate sufficient cash flows to meet itscurrent obligations in 2004.

 

**RESULTS OF OPERATIONS:**

 

**Three months Ended March 31, 2004 Compared to ThreeMonths Ended March 31, 2003**

 

*Turnkey contract revenue and expenses.*Turnkey contract revenue increased $46 thousand in the first quarter to $0.9million, a 5% increase compared to the corresponding quarter of the precedingyear. Additionally, turnkey contract expense increased $0.5 million during thefirst quarter to $1.4 million, a 57% increase compared to the same period in2003.  The drilling activity in thefirst quarter was flat when compared to the corresponding quarter of 2003.

 

Net loss from turnkeyactivities was $0.5 million for the first quarter. This compares to a net lossof $48 thousand for the corresponding quarter in 2003. This increase in netloss during the first quarter of 2004 results from drilling shallow re-entrywells with higher profit margins in 2003 as compared to deeper Washakie wellsin 2004 with lower profit margins.

 

*Oil and gas sales and costs from marketingactivities.* Oil and gas sales from marketingactivities decreased $26 thousand in the first quarter to $1.4 million, a 2%decrease compared to the same period last year. Cost of oil and gas marketingactivities decreased $28 thousand in the quarter to $1.3 million, a 2% decreasecompared to the same quarter in 2003. Oil and gas production from the wells inthe drilling programs in which we earn a marketing fee for the three monthsended March 31, 2004 and 2003 was 0.3 Bcfe and 0.3 Bcfe, respectively. Theaverage price per Mcfe during the first quarter of 2004 and 2003 was $4.16 and$5.12, respectively.

 

The gross profit from marketingactivities for the first quarter of 2004 was $35 thousand as compared to $33thousand in the same period last year.

 

*Well services activities.*Well services revenue decreased $12 thousand in the first quarter to $0.2million, a 5% decrease compared to the corresponding quarter of the precedingyear. Well services expense decreased $56 

 

14

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thousand in the first quarterto $0.1 million.  These nominalfluctuations in the first quarter of 2004 are consistent with the flat drillingactivity compared to the same period in 2003.

 

Gross profit from well servicesactivities was $119 thousand for the first quarter of 2004. This compared togross profit of $75 thousand for the corresponding quarter of last year.

 

*Oil and gas sales.*Revenue from oil and gas sales decreased $0.3 million in the first quarter to$1.2 million, a 20% decrease compared to the same quarter in 2003, due to adecrease in gas prices during the first quarter in 2004 as compared to 2003.

 

*Production & exploration.*Production and exploration expense increased $38 thousand in the first quarterof 2004 to $1.0 million, a 4% increase compared to the same quarter in 2003.

 

*Net gain on investments.*Net gain on investments was $50 thousand for the first quarter of 2004.  Net gain on investments was $74 thousandduring the first quarter of 2003. Primarily, investments represent zero coupon U.S. treasury bonds held inour inventory. Fluctuations in net gain or loss on investments resulted fromchanges in long-term interest rates.

 

*Interest and other income.*Interest and other income increased $0.2 million in the first quarter to $0.5million, a 70% increase compared to the same quarter in 2003. This increasereflects the recognition of additional drilling credits relating to the jointventure with Anadarko of $0.2 million.

 

*Depreciation, Depletion and Amortization.*Depreciation, depletion and amortization expense increased $0.2 million for thequarter to $0.4 million, a 151% increase compared to the corresponding quarterlast year. This increase resulted from a higher cost basis in oil and gasproperties in 2004 due to the consent solicitation, as compared to the samequarter in 2003.

 

*General and administrative expenses.*General and administrative expenses increased $0.1 million in the first quarterof 2004 to $1.2 million, a 14% increase compared to the corresponding quarterlast year.  This increase reflects anincrease in legal fees relating to our California property. See “legalproceedings”.

 

*Interest expense.*Interest expense decreased $0.8 million in the first quarter to $0.1 million,an 89% decrease compared to the same quarter last year. This decrease reflectsan increase in the amount of interest capitalized on our Wyoming and Californiaproperties due to the consent solicitation.

 

*Contractual obligations.*Therehave been no material changes outside of the ordinary course of business in theCompany’s contractual obligations from those disclosed in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2003.

 

**CRITICAL ACCOUNTING POLICIES**

 

*Oil and Gas Properties*

 

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

 

Unproved oil and gasproperties that are individually significant are periodically assessed forimpairment of value and a loss is recognized at the time of impairment byproviding an impairment allowance. Other unproved properties are amortized based on the Company’sexperience of successful drilling, terms of leases and historical leaseexpirations.

 

Capitalized costs of producingoil and gas properties are depleted by the units-of-production method on afield-by-field basis.  Lease costs aredepleted using total proved reserves while lease equipment and intangibledevelopment costs are depleted using proved developed reserves.  The Company’s proved properties areevaluated on a field-by-

 

15

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field basis forimpairment.  An impairment loss isindicated whenever net capitalized costs exceed expected future net cash flowbased on engineering estimates.  In thiscircumstance, the Company recognizes an impairment loss for the amount by whichthe carrying value of the properties exceeds the estimated fair value (based ondiscounted cash flow).

 

On the sale or retirement of acomplete unit of a proved property, the cost and related accumulated depletionand amortization are eliminated from the property accounts, and the resultantgain or loss is recognized.  On theretirement or sale of a partial unit of proved property, the cost is charged toaccumulated depletion and amortization with a resulting gain or loss recognizedin earnings.

 

On the sale of an entire interest in an unprovedproperty, a gain or loss on the sale is recognized, taking into considerationthe amount of any recorded impairment if the property had been assessedindividually.  If a partial interest inan unproved property is sold, the amount received is treated as a reduction ofthe cost of the interest retained.

 

*Revenue Recognition*

 

Affiliated partnerships enterinto agreements with the Company to drill wells to completion for a fixedprice.  The Company, in turn, entersinto drilling contracts primarily with unrelated parties to drill wells on aday work basis.  Therefore, if problemsare encountered on a well, the cost of that well will increase and gross profitwill decrease and could result in a loss on the well.  The Company recognizes revenue from the turnkey drillingagreements on a proportional performance method as services are performed. Whenestimates of revenues and expenses indicate a loss, the total estimated loss isaccrued.  Oil and gas sales result fromundivided interests held by the Company in various oil and gas properties.  Sales of natural gas and oil produced arerecognized when delivered to or picked up by the purchaser.  Oil and gas sales from marketing activitiesresult from sales by the Company of oil and gas produced by affiliated jointventures and partnerships and are recognized when delivered to purchasers.

 

### *ContingentRepurchase Obligation*

 

A contingent repurchaseobligation is recognized when the present value of the Company’s potentialfuture obligation to affiliated partnerships under repurchase agreements isgreater than their estimated future net revenues from oil and gas properties,as determined by independent petroleum engineers.

 

**Item 3. *Quantitative and qualitative disclosure about marketrisk***

 

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

 

#### **Item 4. *Evaluation of Disclosure Controls and Procedures***

 

Our management, under thesupervision and with the participation of our Chief Executive Officer (“CEO”)and Chief Financial Officer (“CFO”), has evaluated the effectiveness of ourdisclosure controls and procedures as defined in Securities and ExchangeCommission  (“SEC”)  Rule 13a-15(e) and 15d-15(e) as of the end of the period covered by thisreport.  Based upon thatevaluation,  management has concludedthat our disclosure controls and procedures are effective to ensure that we arerequired to disclose in reports that we file or submit under the SecuritiesExchange Act is communicated to management, including the CEO and CFO, asappropriate to allow timely decisions regarding required disclosure and isrecorded,  processed,  summarized and reported within the timeperiods specified in the SEC’s rules and forms.

 

During the fiscal quartercovered by this report, there have been no significant changes in internalcontrol over financial reporting that have materially affected, or arereasonably likely to materially affect, our internal control

over financial reporting.

 

16

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**PART II—OTHER INFORMATION**

 

**Item1. *LegalProceedings***

 

**On September 28, 1999, MagnessPetroleum Company, our joint venture partner in the Wilmington Field, filed acomplaint against Warren, Warren E&P, Inc. (“Warren E&P”), and certainWarren subsidiaries in the Superior Court of Los Angeles County, alleging thatwe had breached our joint venture agreement with Magness and an alleged oralagreement regarding advance payment of expenses for drilling and completionoperations.  Magness sought dissolutionof the joint venture, an accounting and a declaratory judgment as to the rightsof the parties under the joint venture agreement.  We were successful in enforcing the arbitration provision in thejoint venture agreement and entered into an agreement with Magness to submitthe matter for arbitration by the Judicial Arbitration Mediation Services, or“JAMS,” before the Honorable Keith J. Wisot, a retired Los Angeles SuperiorCourt Judge.  Judge Wisot, as thearbitrator, ruled that the joint venture agreement is a valid enforceableagreement, declined to dissolve the joint venture, denied Magness’ claims forbreach of contract, and held that he and JAMS would retain jurisdiction toenforce the Final Award. On August 8, 2001, Magness filed a demand with theAmerican Arbitration Association, or “AAA,” reasserting its claims fordissolution of the joint venture and breach of contract. Subsequently Warrensought to enforce the original Final Award rendered by Judge Wisot in the JAMSarbitration. After a procedural determination of proper arbitration forum thatwas eventually determined by the California Court of Appeals in December 2002and a Motion for Clarification filed in January 2003 before the CaliforniaSuperior Court, in September 2003 the California Superior Court ordered thatJAMS will hear Warren’s motion to enforce the Final Award covering unauthorizeddirect labor charges and tangible costs and AAA will hear Magness’s new theoryof dissolution of the joint venture based on their claim that voting rightswithin the joint venture should be based on ownership of working interests inthe Wilmington Town Unit (“WTU”), which includes property never contributed tothe joint venture, instead of ownership of joint venture working interests, adetermination whether Magness can independently drill new wells in the WTUwithout Warren’s consent if the joint venture is not dissolved and Warren’s claimsfor damages for Magness preventing resumption of drilling activities by Warrenas ordered by Judge Wisot in JAMS. The AAA arbitration is being held from May3, 2004 to May 14, 2004 and the JAMS arbitration hearing on the Motion toEnforce Final Award is being held from May 19, 2004 to May 21, 2004.Accordingly, pending final resolution, further development of the WilmingtonField will be curtailed. See our 2003 Form 10-K “Risk Factors - If we areunable to settle our disagreements with our joint venture partner in theWilmington Field, the value of our interest there or realization of that valuecould be significantly diminished or delayed.”**

 

In1998, Warren E&P was sued in the 81st Judicial District Court ofFrio County, Texas by Stricker Drilling Company, Inc. and ManningSafety Systems to recover the value of lost equipment based on a well blowout.  Warren was later joined in thesuit as a defendant.  As a result of thelawsuit, Gotham Insurance Company, Warren E&P’s well blow-out insurer,intervened.  The suit was settled in1999 with all parties except Gotham. Gotham paid over $1.7 million under the insurance policy and now seeks arefund of approximately $1.5 million of monies paid, denying coverage, andalleging fraud and misrepresentation and a failure of Warren E&P to actwith due diligence and pursuant to safety regulations.  Warren E&P countersued for the remainingproceeds under the policy coverage.  Inthe summer and fall of 2000, summary judgments were entered for Warren E&Pon essentially all claims except its bad faith claims against Gotham.  Gotham’s claims against Warren E&P andWarren were rejected.  Final judgmentwas rendered on May 14, 2001 in Warren E&P’s favor for the remaining policyproceeds, interest and attorney fees. Gotham appealed the final judgment to the San Antonio Court of Appealsseeking a refund of approximately $1.5 million.  The case on appeal was orally argued on March 28, 2002. On July23, 2003, a three judge panel of the San Antonio Court of Appeals rendered its decisionin favor of Gotham on all points, except for the amount of restitution owed byWarren E&P and related parties, reversing the earlier summary judgmententered by the trial court for Warren E&P. Although the three judge panelof the San Antonio Court of Appeals acknowledged that Gotham asked for theCourt to render its judgment in Gotham’s favor on its restitution claims,Gotham gave no particulars, and therefore the Court of Appeals remandedGotham’s restitution claims to the trial court for further proceedingsconsistent with its opinion. Although the ultimate resolution is uncertain,counsel has advised Warren E&P that it believes the three judge panel ofthe San Antonio Court of Appeals committed numerous errors of fact and law,primarily relying on their erroneous conclusion that Warren E&P as operatorof the oil well incurred no loss. Accordingly, Warren E&P has appealed theSan Antonio Court of Appeals panel decision to the Texas Supreme Court, and hasbeen requested by the Texas Supreme Court to submit full briefs, which was 

 

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done on April 15, 2004. Thedecision to accept a full review of the San Antonio Court of Appeal’s decisionwith oral argument being heard by the Texas Supreme Court is at the Court’sdiscretion.

 

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

 

**Item 2. *Changes in Securities***

 

a. Notapplicable

 

b. Notapplicable

 

c. In February2004, the Company issued 2,025,000 Units at a price of $7.00 per Unit to fiveaccredited investors, with each Unit consisting of one share of the Company’scommon stock, par value $0.0001 per share, .25 Class A Warrants to purchase oneCommon Share at an exercise price of $10.00 per share, and .25 Class B Warrantsto purchase one Common Share at an exercise price of $12.50 per share, for anaggregate receipt of $14,175,000.  Thefollowing were filed under Item 7 “Exhibits”: Subscription and RegistrationRights Agreement executed by the purchasers and Warren, Class A Common StockPurchase Warrants and Class B Common Stock Purchase Warrants delivered byWarren to the purchasers of the Units. The Units, shares of common stock andWarrants are restricted securities. The issuance was exempt from registrationunder the Securities Act of 1933, as amended (the “Securities Act”) pursuant toSection 4(2).

 

**Item 3. *Defaults upon Senior Securitie******s***

 

Not applicable.

 

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

 

Not applicable.

 

**Item5. *OtherInformation***

 

Not applicable.

 

**Item 6. *Exhibits and Reports on Form 8-K***

 

**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**                                                                                         |   | **Original  Filed  Exhibit** |   |
|---------------------|--------|---------------------------------------------------------------------------------------------------------|--------|------------------------------|--------|
| 10.1*               |   | Employment  Agreement effective March 1, 2004 between Lloyd Davies and the Company.                     |   |                         |   |
| 10.2*               |   | Amendment to  Employment Agreement effective January 1, 2004 between Norman F. Swanton and  the Company |   |                         |   |
| 10.3*               |   | Amendment to  Employment Agreement effective January 1, 2004 between Timothy A. Larkin and  the Company |   |                         |   |
| 10.4*               |   | Employment  Agreement effective January 1, 2004 between David E. Fleming and the Company                |   |                         |   |
| 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)                          |   |                         |   |

 

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| 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 |   |   |   |

 

**(b)**                                  **Reports onForm 8-K**

 

A report on Form 8-K datedFebruary 11, 2004 was filed with the Commission reflecting that the company hadcompleted an initial closing of 2,000,000 Units to four accredited investors,with each Unit consisting of one share of the Company’s common stock, par value$0.0001 per share, .25 Class A Warrants to purchase one Common Share at anexercise price of $10.00 per share, and .25 Class B Warrants to purchase oneCommon Share at an exercise price of $12.50 per share.  The Units were sold at the price of $7.00per Unit for an aggregate of up to $19,600,000.  This event was reported under Item 5 “Other Events”.  The following were filed under Item 7“Exhibits”: Subscription and Registration Rights Agreement executed by thepurchasers and Warren, Class A Common Stock Purchase Warrants and Class BCommon Stock Purchase Warrants delivered by Warren to the purchasers of theUnits.

 

**SIGNATURES**

 

Pursuant to the requirements ofthe Securities Exchange Act of 1934, the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 
|                | WARREN  RESOURCES, INC.  (Registrant) |
|---------------------|---------------------------------------|
|                |                                  |
|                |                                  |
| Date: May  12, 2004 | By:                                   | /s/ Timothy A. Larkin |   |
|                |                                  | Timothy A.  Larkin*Executive  Vice President,  Chief Financial Officer and   Principal Accounting Officer* |

 

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